Chapter

6 Central Bank Accounting and Internal Audit

Author(s):
Robert Price, Malcolm Knight, and Arne Petersen
Published Date:
May 1999
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Author(s)
John Dalton

The range of basic central bank accounting reforms adopted by the Baltics, Russia, and other countries of the former Soviet Union underscores the importance of reliable financial information in the effective conduct of market-based monetary and exchange market operations. With recent efforts by Azerbaijan, Kyrgyz Republic, and Ukraine, 11 central banks have introduced accounting systems that are broadly consistent with International Accounting Standards (IAS). Together with the information needed in a market economy, these systems promise to provide central bank managers with the financial information needed to inform policy deliberations as well as public financial statements. In nearly all of these cases, the reliability of the financial information produced by these new systems has also been subjected to varying degrees of independent assessment by internationally qualified external auditors. As part of the new accounting systems, the internal controls used by central banks to maintain the integrity of accounting information have been improved. Table 6.1 summarizes accounting reforms for each country during 1992-97.

Table 6.1.Central Bank Accounting Reforms, 1992-97
New Chart of Accounts IntroducedAccruals Basis AdoptedInternational Accounting Standards (IAS) External Audits (1 995-97)1
ArmeniaJanuary 1996YesYes (1995-97)
AzerbaijanFebruary 1997YesYes (1996)
BelarusJanuary 1996YesYes (1996)
Estonia1993YesYes (1993-97)
GeorgiaJanuary 1996YesYes (1996-97)
KazakhstanJanuary 1997YesYes (1996-97)
Kyrgyz RepublicApril 1997YesYes (1995-97)
Latvia1993YesYes (1993-97)
Lithuania1993YesYes (1994-97)
Moldova1995YesNo
RussiaJanuary 1998NoNo2
TajikistanNew chart not yet introducedNoNo
TurkmenistanMarch 1998YesNo
UkraineFebruary 1998YesYes (1995-96)3
UzbekistanMarch 1997YesNo
Source: IMF staff.

The first year shown refers to limited audit of closing balances only.

Diagnostic audits were made for 1993-95 accounts.

Qualified opinion.

Source: IMF staff.

The first year shown refers to limited audit of closing balances only.

Diagnostic audits were made for 1993-95 accounts.

Qualified opinion.

Internal audit reform has received less attention and has thus far proceeded at a slower rate of progress. The objective of reform in this area has been to promote the creation of independent audit departments with responsibility for reviewing the operation and effectiveness of management control systems used to limit or reduce key risks faced by central banks. Efforts in this area have gained momentum in the past two years in at least two-thirds of the 15 countries under review.

Recent Developments

Five countries—Armenia, Estonia, Latvia, Lithuania, and Kazakhstan—have now introduced central bank accounting systems that are consistent with IAS, and have also undergone a fall external audit of their financial statements.1 Each has demonstrated a clear ability to develop and implement accounting reforms that have enabled the central bank to introduce more transparent and fuller disclosure of accounting information and to lead the way in building confidence in the financial sector. The Baltic countries are the most experienced, having received “clean” audit reports from internationally qualified auditors since 1994. Armenia and Kazakhstan have more recently moved into the annual audit cycle.

During 1997-98, another six countries—Azerbaijan, Belarus, Georgia, Kyrgyz Republic, Moldova, and Ukraine—continued to progress in their adoption of a range of basic accounting reforms, including implementation of a chart of accounts that permits compilation of accounting reports and IAS-consistent financial statements. Each of these, however, needs to take some additional steps to complete the basic reform process. Generally these steps are required because various countries have not fully adopted IAS-based principles, or they have not completely implemented new systems. In Georgia, for example, policies are consistent with IAS, but farther systems work is necessary to enable the new chart of accounts to be used for recording transactions at the detailed or analytical account level. In Ukraine, IAS-compliant financial statements were produced for 1996, and a new chart became operational at the head office level in February 1998, but consolidation of branch data on the same basis is still to come. In the Kyrgyz Republic, live operation of the new chart has commenced, but farther work is required to enable compilation of data for inclusion in the IMF’s International Financial Statistics. In Moldova, the central bank adopted accrual-based accounting in January 1998. IAS were also adopted economywide from that date.

Progress in the reform of internal audit procedures in the 11 countries noted in the previous two paragraphs is mixed, but all have recognized the need for internal audit policies and practices that can be used to assess key risk areas in market-based central bank operations. Countries that have made more notable progress are Belarus and Kazakhstan. The National Bank of Kazakhstan, for example, has drafted a set of auditing standards that focus on identifying the main risk areas of operations, audit responsibilities, management responsibilities for internal controls, planning and scheduling of audits, and requisite staff qualifications.

Countries that have shown less progress in the implementation of accounting reform—Russia, Tajikistan, Turkmenistan, and Uzbekistan—have nonetheless made some gains. Uzbekistan in March 1997 and Turkmenistan in early 1998 each introduced a new central bank chart of accounts that more closely reflects market-based operations and adopts the accrual principle.

In Russia, a new central bank chart of accounts came into operation in January 1998, but it does not fully adopt the accrual principle, on which IAS are based. Financial statements compiled from the chart are not in a form or content that is consistent with the requirements of IAS, nor has an IAS external audit been conducted. The failure to adopt the accrual principle is a particular concern to professional accountants. It also has implications for commercial bank accounting reform, given the central bank’s key role in specifying the chart of accounts and related instructions for commercial banks. Objections have been raised to the adoption of the accrual principle by commercial banks in part because the tax system is not consistent with such treatment, and partially because commercial banks might misapply the principle where nonperforming loans are concerned.2 The Central Bank of Russia has identified this inconsistency as a future reform issue resolution in the transition from cash to accrual accounting.

Turkmenistan and Uzbekistan have now implemented a new chart of accounts. The Uzbekistan authorities believe that the new chart is broadly consistent with IAS. In Turkmenistan, implementation was set to begin in early 1998 with parallel operation of both new and old charts. Both countries have yet to complete an external audit by an internationally-recognized auditor. Tajikistan has received some initial guidance on reform work and has indicated a commitment to reform, but plans continue to be hampered by unsettled conditions in the country—thus progress can be classified only as very limited.

Consistent with the slower rate of progress on accounting issues, internal audit reform in Russia, Tajikistan, Turkmenistan, and Uzbekistan has been modest at best. With the exception of Russia, where resources have been devoted to auditing the large branch structure, the internal audit function in the other three countries largely remains focused on the traditional areas of operation such as cash handling and payment processing, and on detailed checking of all transactions.

Country Rankings

Table 6.2 provides an overall ranking of progress by individual countries in their implementation of central bank accounting and audit reforms. As indicated by the discussion of recent developments, more than two-thirds of the countries under review are now regarded as having made substantial progress.

Table 6.2.Progress in Central Bank Accounting and Internal Audit
IIIIII
Limited ProgressModerate ProgressSubstantial Progress
TajikistanRussia

Turkmenistan

Uzbekistan
Armenia

Azerbaijan

Belarus

Estonia

Georgia

Kazakhstan

Kyrgyz Republic

Latvia

Lithunia

Moldova

Ukraine

While individual experiences differ, countries included in Group III have generally reached the stage of reform where a new chart of accounts based on the principles underlying IAS has been adopted and is being used as the basis for the preparation of financial statements. In almost all cases there has also been an external audit examination by an internationally recognized auditor. One particular distinguishing feature is that these countries have overcome some of the earlier conceptual and practical impediments to reform that confronted them initially. These obstacles included acceptance of basic principles relating to the accrual principle and asset valuation, as well as developing or acquiring adequate computer systems to support accounting processing and reporting.

Countries in Group II, while having made progress in the development of new charts of accounts, have yet to translate this developmental work into practical application through testing or limited operation, or financial statement formats reflecting a new chart. In particular, financial statements have not been subject to an official audit by internationally qualified auditors that included an opinion on the statements. In Russia, however, external auditors have made several annual diagnostic audits of the central bank’s accounts.

Priorities for Reform

Notwithstanding the substantial progress achieved by many countries, a range of technical issues remain to be addressed if each country is to develop central bank accounting and audit procedures that reflect best international practices, and to ensure the constant availability of reliable, transparent, and fully disclosed financial information.3

For the more advanced (Group III) countries, reform issues for central banks involve:

  • enhancing accounting control and information systems to support effective management of central bank resources;
  • establishing policies for the maintenance of central bank financial soundness; and
  • promoting financial discipline through the central bank, which should take a lead role in establishing full and transparent disclosure standards for its own financial statements.

For those countries that have made significant progress but are still in the final stages of implementing new accounting systems, additional reform issues include addressing technical aspects associated with the installation of new computerized accounts processing systems, and further developing appropriate controls to ensure the integrity and security of those systems.

For those countries that have experienced only moderate (Group II) or limited progress (Group I), reform issues require the delivery of the fundamental principles on which IAS accounting are based, including the accounting procedures associated with implementation of a chart of accounts for market-based central bank operations. Additional steps may also require removing legislative obstacles to the adoption of accrualbased accounting or the appointment of external auditors who are not nationals of the country concerned. Until these countries can address these basic issues they will not have the capability to produce regular, reliable, and comparable financial information that provides a sound basis for policy actions and financial sector surveillance.

Additional issues of relevance for all countries include:

  • adoption of accounting policies and procedures, and internal controls for central bank operations involving new financial instruments, especially those involving off-balance sheet activities;
  • more structured staff training and development programs to improve central banks’ own internal capacity in accounting and audit, and to reduce reliance on external advisors for assistance with day-to-day problems;
  • addressing control and operational problems associated with the use of new technologies, including resolution of Year 2000 date change issues;
  • development of internal audit systems that are responsible for assessing the effectiveness of internal controls, as set by management, in limiting the risks faced in market-based central bank operations; and
  • harmonization of overall central bank and financial sector accounting and reporting standards generally.4

One farther related issue of importance concerns the role central banks can play in promoting commercial bank accounting reforms that are consistent with IAS. In the 15 countries reviewed in this study, central banks have been responsible for issuing accounting standards and instructions for commercial bank accounting generally, and for the collection of financial information for economic, prudential, and financial market surveillance purposes. The adoption of commercial bank accounting standards that are consistent with IAS is a key factor in achieving transparency in commercial bank financial reporting and in developing well-functioning financial markets and sound banking systems.

The stages reached by central banks in individual countries, and future issues, have particular implications for coordinated technical assistance. For instance, the Baltic states and Armenia, listed in Group III of Table 6.2, might now be regarded as no longer requiring assistance on accounting reform issues through the IMF’s Monetary and Exchange Affairs (MAE) department-coordinated program. However, this should not preclude future requests to the IMF for technical assistance on the issues they have identified, or for any other specific technical issue that may arise. For the other countries with substantial progress to their credit, expert involvement in technical assistance can be expected to be by way of shortterm visits on an occasional basis, with the length of visits varying across individual countries.

In countries showing moderate progress, some combination of shortterm or, possibly, longer-term assignments probably would be necessary, particularly where countries see a clear benefit in committing to an implementation program and use of cooperating central bank experts. Since a program might be expected to take two to three years, the support of a cooperating central bank can provide continuity to a project even if individual experts have to change. In Tajikistan, intensive assistance will be necessary, and likely to require substantial on-site-based advice from a longer-term expert.

1

A full external audit in this context refers to an audit that expresses an opinion on the accounts for the whole year. It attests to the truth and fairness of the opening and closing balances, as well as the integrity of the accounts and records. This type of audit differs from the more limited audit of end-year balances only. For the 15 countries, the limited audit has typically occurred when a bank’s financial accounts have been audited for the first time. In this instance, the certification of closing balances sets a basis for a full audit in the following year.

2

There is a concern that income would be overstated because accrual accounting recognizes interest income when it is due and not when it is received. Thus when interest is later found to be uncollectible, income has already been measured. Accrual procedures have mechanisms to avoid such overstatement by, for example, cessation of interest accrual (for income determination purposes) once a loan is more than 90 days overdue; by reversal of previously accrued income when interest is more than 180 days overdue; and, if necessary, provisioning against interest previously capitalized as part of a borrowers’ indebtedness.

3

Important reform issues of relevance for individual countries are summarized in Chapter 8, Table 8.10.

4

This important issue must not be confused with the differences that exist between, for example, central bank and commercial bank operations. Both can follow broadly similar standards, since this promotes better understanding by the general public and financial specialists. To the extent that differences exist in operations, these issues can best be covered not by different standards, or by failure to adopt standards, but by full and transparent disclosure of the respective operations.

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