Last week I attended a conference involving finance and administration professionals from international organizations based in Vienna Austria.  One of the side conversations that came up was managing an increasing number of audit recommendations with diminishing resources.

Public Sector versus For-Profit Auditor

There are important differences to note of the audit universe of the public sector.  For a for-profit organization, the auditor is a service another for-profit organization provides on the behest of the board and to provide assurance to the shareholders.  Even for non-profit organizations, this relationship exists – there is an inherent value for money question.

In the public sector, this relationship not only is absent but may also be perverted.  There can be an incentive of an auditor general (and its equivalents) to make comments on the public sector so as to justify the continuing existence of the auditor general.  Worse still is a ‘lime-light auditor’ who enjoys the unveiling of recommendations and the hero culture that can accrue to the auditor as a result.

The above of course is a worst case and the vast majority public sector auditors are dedicated and competent professionals with the tax payers and citizen’s interest in mind.  In addition, auditors have uncovered waste and have been effective change agents to ensure the best possible civil service for a political entity.  Alas, the vast majority are so but not all – and thus the question of how the value for money question can be applied to a public sector audit?

The Audit as a Rationale and Rotational Process

It is easier to make an audit comment (observation, recommendation, etc.) than it is to implement them.  As the public sector becomes more strapped for resources, it must balance the new audit comment against current operations, projects, public policy changes or even completing past audit recommendations.

Part of this challenge is that the public sector is abysmal at estimating the costs and the resulting benefits of operations or new initiatives.  A for-profit organization is laser focused on current operations costs.  If revenue cannot change, then costs must drop to sustain or improve the bottom line.  Alternatively, if a new project does not result in new revenue or other benefits (lower costs, regulatory compliance, operational effectiveness, etc.) then it is dropped in favour of a different investment.

The Public Sector does not always share the same rationality.  The primary financial discipline comes from the allocated budget and not overall profitability.  Additionally, public sector auditors reach into wider areas of the organization (as they should) resulting in recommendations that go far beyond the financial statements.

To go into these wider areas, public audit entities may engage outside expertise (e.g. an IT security audit firm) or they offer long-term employment to develop broad public sector expertise.  The problem with the second strategy is that there may not be enough turn over of the public sector audit organization that parallels the effect of firm rotation in the private sector world.

The Price of a Recommendation

Given the nature of both the auditors and the audit engagement are different in the public sector should not the output also be different?  How about pricing each audit suggestion (recommendation, observation, etc.)?

The auditor and management would independently develop an estimated number of hours and associated costs to implement a recommendation.  The auditor would use its larger experience from other Ministries, organizations etc. and the organization based on its insider experience.  The cost should be a full cost as if whatever is being implemented is entirely done so by a third-party with the same knowledge as current management.  For example, if there is a recommendation to perform an additional verification of a payment voucher, the cost would be as if a contractor is engaged to come in and do the verification.

The reason for this third-party approach is to avoid the pitfall of ‘wishing away the problem’.  Thus an auditor could say that the check is nominal by the payments clerk and therefore there is no cost.  In contrast, management knows that they payment clerk is doing other activities that the auditor is not factoring in and thus the cost is not free.

The auditor and management would ideally compare and agree to a high-low range of cost to implement.  These costs would be aggregated and the total cost of audit comments would be estimated (once again in a range).  The actual costs of implementation (both project and run-costs) would be reported against the past audits.  This reporting would help to fine-tune the estimations and provides a comparison point for other audit engagements.  Thus in the above example, the auditor could state that implementing an additional check in other organizations typically consumes 10-20 hours of additional effort per week as compared to management’s assertion that it would take 15-30 additional hours per week.

Pricing and Gaming the Auditor General’s Report

The above cost methodologies can be aggregated and reported as a companion piece of information with the respective audit reports.  Currently such reports provide a bias view of the recommendations.  The auditor general will list numerous infractions and the hundreds of changes they are proposing.  Implicit in this list is that these are things the public sector organization should have thought of long ago.  By pricing the suggestions it balances the report so that the public knows that perhaps a change was not done because the benefits do not exceed the costs.

The problem with applying a cost to something is that there is a risk of it being gamed.  The auditor wishing away the costs and management overestimating.  Thus the importance of the comparison function and a longer-term comparison of how good the estimates are from both the auditors and management.

Thoughts, should a public sector auditor price their recommendations?  Leave me a comment or drop me a note with your views.