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thesis entitled

THE PERFORMANCE POST AUDIT IN STATE GOVERNMENT:
AN ANALYSIS OF

ITS NATURE, ITS PURPOSE, AND ITS POSSIBILITY
presented by

LENNIS M. KNIGHTON

has been accepted towards fulfillment
of the requirements for

Ph. D Business Administration

degree in

JJ‘NW

Major professor

 

Date July 5, 1966

 

0-169

 

ABSTRACT
THE PERFORMANCE POST AUDIT IN STATE GOVERNMENT:

AN ANALYSIS OF
ITS NATURE, ITS PURPOSE, AND ITS POSSIBILITY

by

Lennis M. Knighton

In recent years, almost every state in the nation has undertaken a
Special study of its post audit prOgram, and two trends have emerged
from these studies. The first is a shift from elected auditors or those
appointed by the Governor to auditors appointed by and responsible to
the legislature. The second is an increased emphasis on broadening the
scope of the audit examination, which traditionally has been limited to
financial transactions, accounting records, and internal controls.

Michigan, for example, in its 1963 constitution transferred the audi-
tor general from an elective office to one of appointment by the legisla-
ture, and it specified that he should conduct both financial and performance
post audits. This study is concerned with the latter. Such audits are
defined as independent examinations, conducted by the Auditor General, for
the purpose of providing the legislature with an evaluation and report of
the manner in which administrative officials discharge their responsibili-
ties to faithfully, efficiently, and effectively administer the programs
of the state. Faithful performance requires that programs be administered
in accordance with executive promises and expressed legislative policy.
Effective performance requires that programs achieve their planned objec-
tives. Efficient performance requires that program accomplishment be
achieved at a minimum of cost to the state.

An extensive analysis was made of the constitutional convention of

Michigan and of the events whiCh preceeded it. It was found that the

Lennis M. Knighton
provision for a legislative auditor general and that for the performance
post audit were inseparably connected. Both were designed to strengthen
the legislature relative to the executive, thus restoring and preserving
a balance oflxwer in the state. Such strengthening of the legislative
branch was necessitated by growth in the size and complexity of state
agencies responsible to the executive, which made effective legislative
control of state operations a practical impossibility under the existing
system.

The role of the auditor in the legislative control system was anal—
yzed, as was the purpose and nature of the control system itself. The
performance post audit was found to be an essential and natural part of
such a system. An audit of financial affairs alone is inadequate. And
to be effective, the performance audit needs the full support of the legis—
lature. Legislative policy must be clearly determined and expressed if
faithfulness of performance is to be evaluated. And audit reports and
recommendations must be reviewed and enforrced by the legislature. Sug-
gestions were made of methods to accomplish each of these items.

If the auditor is to evaluate administrative performance, he must
know the areas of administrative reSponsibility. Therefore, the manage-
ment function is analyzed. Basically administrators are responsible to
plan, execute, and review the programs of the state. Planning includes
(1) selecting desirable objectives, (2) programming state activities to
accomplish the objectives, (3) identifying relevant standards by which
performance may be evaluated in terms of the objectives, (4) assigning
reSponsibility within the organization consistent with programs, (5)
developing budgetary and accounting systems on a program basis consistent
with the patterns of organizational responsibility, and (6) enunciating

executive policies to guide the decisions and actions of operating

Lennis M. Knighton
personnel. When planning is properly accomplished and management controls
are effective, performance will agree with the plans. Consistent with the
patterns of state responsibility, the executive must present and justify
his program plans before the legislature and report program performance.
Finally, he must review performance to determine variances from plans and
to take the necessary corrective action. This requires an effective inter—
nal audit program.

Finally, an approach to the conduct of the performance post audit is
outlined. It consists of five steps: (1) advanced planning, (2) initial
survey, (3) evaluation of the management control system, (4) examination
of exceptional areas, and (5) the report and recommendations. Major
emphasis in the audit is placed upon the management control evaluation.

It is not enough for the auditor to report what program performance was
during a specified period of time; he must also determine why it was as

it was. Thus he must evaluate the adequacy of each element of planning
and control to determine the cause of deviations from expectations. Only
then can the legislature or an executive official take appropriate correc-
tive action.

This study is primarily a theoretical analysis of the performance
post audit, based upon conditions as they exist in the states today and
upon the consensus of opinion of leading state and national officials and
other noted authorities throughout the country. Its conclusion is that a
performance post audit is not only meaningfully possible; it is essential
to the continued vitality of state governmnet as known in the United

States today.

THE PERFORMANCE POST AUDIT IN STATE GOVERNMENT:
AN ANALYSIS OF

ITS NATURE, ITS PURPOSE, AND ITS POSSIBILITY

By _-

Lennis Mi Knighton

A THESIS

Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY

Department of Accounting and Financial Administration

1966

Copyright by
LENNIS M. KNIGHTON

1966

ACKNOWLEDGEMENTS

The author wishes to express his sincere thanks to Dr. James Don
Edwards, Chairman, and Dr. Charles Lawrence and Dr. Richard F. Gonzales,
members of his doctoral committee. Each has contributed valuable assis-
tance and constant encouragement to the progress of this study.

Special appreciation is also expressed to Dr. James Don Edwards,
Chairman, and to each faculty member of the Department of Accounting and
Financial Administration for the financial assistance recieved and for
the outstanding contributions that each has made to my development.

A special debt of gratitude is expressed to the many persons who
have contributed directly to this study. Particular thanks goes to
Hon. Albert Lee, Auditor General of Michigan, for providing research
fUnds which enabled the writer to travel across the country in pursuit
of information relative to this study. Likewise, special thanks is
expressed to the Ford Foundation for providing a doctoral fellowship
which enabled the author to spend full time on his dissertation research,
thus facilitating the timely completion of the project.

Finally, this study would not have been possible without the constant
encouragement of friends and loved ones. Gratitude is expressed to my
parents, to my wife's parents, and to my precious little daughter Diane.
And above all, I am deeply indebted to my devoted wife, Peggy, whose
sacrifice and faith have inspired the completion of this study, and whose
love and cheerful Spirit have made this period of our lives together one
of happiness and fond memories.

ii

TABLE OF CONTENTS

Page

ACKNOWLEDGMENTS . . . . . . . . . . . . . . . . . . . . . . . . . ii
Chapter

I. INTRODUCTION 1

Purpose of the Study 1

Importance of the Study . 2

Hypothesis 4

Methodology . . 4

Scope of the Study . . 6

Organization of the Study . 8

II. THE BIRTH OF PERFORMANCE POST AUDITING . . . . . . . . 10

Introduction . . . . . . . . . . . . . . . . . . . . 10

Separation of Powers . . . . . . . . . . . . . . . . 10

The Budget Cycle . . . . . . . . . . . . . . . . 11

Patterns of Responsibility . . . . . . . . . . . 12

Implications of Growth in Government . . . . . . . 13

Executive Accountability . . . . . . . . . . . . . 16

Choosing the State Auditor . . . . . . . . . . . . . 17

Traditional State Audits . . . . . . . . . . . . . . 20

Michigan History . . . . . . . . . . 22

The Michigan Constitutional Convention . . . . . . . 25

The Initial Proposal . . . . . . . . . . . . . . . 26

Debate and Clarification . . . . . . . . . . . . . 28

Performance Auditing Debated . . . . . . . . . . . 30

Not Unlimited Authority . . . . . . . . . . . . . 30

No Other Duties . . . . . . . . . . . . . . . . . 33

Independence . . . . . . . . . . . . . 35

A Certified Public Accountant . . . . . . . . . . 38

Conclusion . . . . . . . . . . . . . . . . . . . . . 40

III. THE POST AUDIT IN A SYSTEM OF LEGISLATIVE CONTROL . . . 41

Introduction . . . . . . . . . . . . . . . . . . . . 41

The Control System . . . . . . . . . . . . . . 42

Evaluating the Control Methods . . . . . . . . . . . 44

Policy Formation . . . . . . . . . . . . . . . . . . 48

The Legislative Process . . . . . . . . . . . . . . . 49

Policy Enunciation . . . . . . . . . . . . . . . . . 52

iii

Chapter Page

The Inadequacy of Policy Expression . . . . . . . . . 53
The Direction of Change . . . . . . . . . . . . . . . 57
Legislative Review . . . . . . . . . . . . 59
The Objectives of Legislative Review . . . . . . . . 60
The Role of the Legislative Auditor . . . . . . . . . 62
The Functions of an Auditor . . . . . . . . . . . 63
The Scope of Audit Inquiry . . . . . . . . . . . . 65
The Competence of the Auditor . . . . . . . . . . 67
The Audit of Efficiency and Economy . . . . . . 69
Relationship to Management Responsibility . . . . 74
Realtionship to the Internal Audit . . . . . . . . 77
Legislative Support of the Auditor . . . . . . . 82
The Case of the Illinois Legislative Audit
Commission . . . . . . . . . . . . . . 84
The Audit Advisory Board. . . . . . . . . . . . . 89
Summary and Conclusion .. . . . . . . . . . . . . . . 91
IV. THE MANAGEMENT FUNCTION AND THE PERFORMANCE AUDIT . . . 94
Introduction . . . . . . . . . . . . . 94
The Management Function in Brief . . . . . . . . . . 95
Implications for the Auditor . . . . . . . . . . . 99
Planning . . . . . . . . . . . . . . . . . . . . . . 102
Objectives . . . . . . . . . . . . . . . . . . . . . 104
Programming . . . . . . . . . . . . . . . . . . . . . 107
Program Budgeting . . . . . . . . . . . 111
Progress in Program Budget Development . . . . . . . 116
Organization Planning . . . . . . . . . . . . . . . . 122
Performance Standards . . . . . . . . . . . . . . . . 124
Executive Policy . . . . . . . . . . . . . 132
Accounting and Reporting Systems . . . . . . . . . . 133
The Case of New York State . . . . . . . . . . 139
Executive Proposals to the Legislature . . . . . . . 143
Program Execution . . . . . . . . . . . . . . . 146
Management Review and Report . . . . . . . . . . . . 148
Relationship to the Auditor General . . . . . . . . . 149
Summary and Conclusion . . . . . . . . . . . . . . . 151

V. THE CONDUCT OF THE PERFORMANCE POST AUDIT . . . . . . . 153

Introduction . . . . . . . . . . . . . . . . . . . 153
Preliminary Planning . . . . . . . . . . . . . . . . 154
Legislative Intent . . . . . . . . . . . . . . . . 155
Other Legal Factors . . . . . . . . . . . . . . . 156
Programs and Budgets . . . . . . . . . . . . . . . 156
Administrative Manuals . . . . . . . . . . . . . . 157
Prior Audits . . . . . . . . . . . . . . . . . . . 157
Permanent File . . . . . . . . . . . . . . . . . . 157
Summary . . . . . . . . . . . . . . . . . . . . 158
The Initial Survey . . . . . . . . . . . . . . . . . 158
The Audit Program . . . . . . . . . . . . . . . . . . 159

iv

Chapter

The Evaluation of Management Control
The Extent of the Control Evaluation .
Planning .
Organization and Policy .
Performance Standards
Accounting and Reporting
Internal Audit and Review .
Method of Testing Management Controls
Implications of the Management Control
Evaluation
Financial Aspects of the Performance Audit
The Analysis of Exceptional Areas
Comparative Analysis .
The Borrowed Standard
The Test of Reasonableness
Audit Reports and Recommendations .
Implications for Staffing .
The Need for Independence .

Other Audit Policy Implications and Considerations

Hindsight . .
A Reasonable Attack
Easy Areas .
Frequency of Audits . .
Evaluating Auditor Performance .
Progress Among the States .
Summary and Conclusions .

VI. CONCLUSIONS AND RECOMMENDATIONS .
Contributions of the Study
Challenges for the Future .
Conclusion

BIBLIOGRAPHY

APPENDIX

Page

161
162
163
163
165
167
169
171

175
176
179
180
182
184
185
189
193
195
195
196
197
197
198
199
203

205
206
208
210
211

232

CHAPTER I

INTRODUCTION

Purpose of the Study

 

On April 1, 1963, the citizens of Michigan approved a new consti-
tution which became effective on January 1, 1964. Article IV, Section
53 of the new constitution states in part:

The legislature . . . shall appoint an auditor general,

who . . . shall conduct post audits of financial transactions

and accounts of the state and of all branches, departments,

offices, boards, commissions, agencies, authorities and

institutions of the state established by this cpnstitution

or by law, and performance post audits thereof.

This constitutional provision is singularly significant in that
for the first time in the history of any state in the United States
the requirement of a performance post audit is given constitutional
recognition and sanction. The purpose of this study, is to provide an
analysis of the nature, the purpose, and the possibility of such an
audit in state government.

A ”performance post audit,” as defined in this study, is an inde-
pendent examination, conducted by the auditor general, for the purpose
of providing the legislature with an evaluation and report of the manner
in which administrators of the agencies and departments of the state

have discharged their responsibilities to faithfully, efficiently, and

effectively administer the programs of the state. Faithfulness refers to

 

1For a full text of this constitutional provision, see Appendix A.

1

2
whether or not programs have been administered in accordance with pro-
mises made to the legislature and the expression of legislative will.
Effectiveness refers to whether or not planned program objectives have
been achieved. And efficiency refers to whether or not program accom-
plishment has been achieved by using the least—cost combination of

resources and with a minimum of waste.

Importance of the Study

 

In the last twenty five years, the United States has experienced
a period of unprecedented growth in both the size and the complexity of
state governments. Due to bulging populations and changing social and
economic standards, state agencies have faced increasing demands for
their services, particularly in the fields of education, public health,
and social welfare. And the future shows no sign of a change in this
growth trend.

Along with this growth has come the need for bold new concepts and
methods for conducting state affairs, both for administrative officials
and for the legislature. No longer are the methods which were used a
generation ago applicable or adequate. And particularly is this true
in the area of state post auditing.

Traditionally state post audits have been limited primarily to
examinations of financial transactions and internal controls to deter-
mine that fhnds have been legally and honestly spent. Such an audit is
certainly important. But it is far from adequate to meet the needs
and purposes of the legislature, which has the responsibility not only
to pass laws, to approve programs, and to authorize the expenditure
of funds, but also to review administrative performance and to determine

that the laws and programs are administered in the public interest.

3
Likewise, without a more comprehensive review and appraisal of the
prOgrams and activities of the agencies, even executive officials can-
not know whether their decisions are being implemented adequately and
whether programs are achieving the desired results.

Recognizing this problem, almost every state in the nation has, in
the last decade, undertaken a study of the adequacy of its post audit
program. The result has been a wide-Spread shift from the use of elected
state auditors, or thaneappointed by and responsible to the Governor,
to the establishment of a legislative post audit system, where the
auditor general is appointed by and responsible to the legislature.

One of the purposes of this shift has been to make the auditor more
independent of the executive branch of government. But equally impor-
tant has been the objective of having an auditor capable and authorized
to conduct audit examinations more in keeping with the needs and desires
of the legislature. This objective is no better illustrated than in the
provision of the Michigan ConstitUtion quoted above.

Yet in Spite of the fact that numerous individuals have noted the
desirability of such an audit system, no one has yet undertaken a study
to determine what guideliness Should be used in conducting such an audit.
Neither has anyone defined the nature of the auditor's responsibility as
part of the legislative control system or identified the relevant areas
of management responsibility properly subject to such an audit review.
Without such a study, an orderly approach to the conduct of the audit
is impossible.

Also, at the present time, exactly half of the fifty states in the
nation have legislative auditors, most of them having been established
within the last ten years. And at least a dozen more states have taken

steps to move in that direction. No doubt others will follow later.

4
The importance of this study, therefore, is not limited to the State
of Michigan, but rather it extends to every state which now has or which
may in the future have a legislative post audit system in which the
reSponsibilities of the auditor general either permit or require a

comprehensive approach to auditing.

The Hypothesis

 

It is the hypothesis of this Study that a performance post audit
is not only meaningfully possible; it is essential to the continued
vitality and effectiveness of State government as known in the United
States today. Moreover, such an audit is an essential element of a
legislative control system, and therefore it is a logical and natural
responsibility of an auditor general responsible to the legislature.

It is further the hypothesis of this study that such an audit is
greatly facilitated by the existence of an effective management control
system, including program planning, program budgeting, program accoun—
ting, and comprehensive internal audits; however, even in the absence
of suCh a control system, performance post audits are still meaning-
fully possible.

This hypothesis is confirmed in the develOpment of this Study.

The Methodology

 

The research methodology used in this study consisted of the
following six parts.

1. An extensive survey was made of the literature in the fields
of accounting, public administration, and other related areas. The
purpose of this survey was to gain familiarity with current thinking
on the subject of state post auditing, to determine what research had

already been done in this and related areas, and to obtain information

5
and insights into the various processes of state government.

2. An extensive investigation was made to ascertain clearly the
intent of the Michigan Constitutional Convention when it passed the
provision quoted above. First, the official record of the convention
was reviewed in detail and copies of all major studies and reports to
the convention which in any way related to this subject were obtained
and examined. Second, personal interviews were held with principle
delegates to the convention who were reSponSible for introducing and
promoting this provision in the convention. Finally, interviews were
held with state officials, research consultants, and other persons in
the state who were interested and active with the convention proceed-
ings at that time.

3. One of the early Steps in this study was to review all materials
gathered or prepared by the office of the Auditor General in Michigan
which related to this subject. Subsequent reports and statements by
that office have also been examined. In addition, personal visits have
frequently been made to that office to discuss these problems with the
Auditor General, his deputy, and other members of the Staff, and to
review with them not only their own experiences and thinking but also
some of the concepts and findings of this study.

4. Personal visits were made to California, Illinois, New York,
and the General Accounting Office in Washington, D.C. In each instance,
interviews were held with tOp audit officials, and reports and audit
manuals (when they existed) were examined and discussed. The purpose
of these visits and interviews was to become familiar with the develop-
ment of audit policies and procedures in each of these States and in
the Federal Government, and to discuss with these officials some of the

concepts and theories developed in this study. Each of the states

6
selected is noted throughout the country for its audit program.

5. Contact was made either by personal visit or by mail with other
leading state, local, and national authorities throughout the country
to obtain their opinions on selected items in this study and to acquire
copies of research studies and other relevant reports on the subject
of post auditing in the states. Included in this group of authorities
were the auditors of Colorado, Hawaii, New Mexico, Maryland, and Texas;
research groups in New York City, Montana, Washington (state), Kansas,
and Chicago; members of the Bureau of the Budget in Washington, D.C.
and in Michigan; and leading authorities in governmental accounting
and auditing in the public accounting profession.1

6. Selected audit reports were obtained and/or reviewed to obtain
a better understanding of state auditing problems and to determine the
type and scope of audit reports as presently prepared by the following
states: Michigan, California, Illinois, New York, Texas, Colorado, and
Hawaii. Several reports from the General Accounting Office were similarly
reviewed.

From the Six steps above, some importantFelements of the performance
post audit system have been identified, some conclusions concerning the
approach to the audit have been reached, and a theoretical description
of the nature, the purpose, and the possibility of the audit has been

developed in this Study.

The Scope of the Study

 

The subject of performance auditing is indeed a very broad and com-

prehensive area for research. Thus it was necessary to restrict the

 

1A list of the interviews held and the printed materials received
which were helpful and significant in this Study is contained in the
bibliography.

7
scope of the study in order to insure that a meaningful contribution could
be made and the Objective of the study achieved.

The study is designed to provide a theoretical analysis of the nature,
the purpose, and the possibility of performance post auditing in the state.
This analysis is based upon empirical facts, established patterns of reS-
ponsibility, and the consensus of opinion of the authorities contacted in
this study.

This Study is not designed to serve as a guide for the establishment
of a legislative control system, although such a system is described and
analyzed in order to define the role and the reSponsibility of the auditor
general in that system and thereby determine the purpose of the perfor—
mance post audit. Likewise, in the discussion of administrative or
executive responsibility, the concepts of planning, programming, perfor-
mance Standards, program budgeting, program accounting, and other related
areas are discussed. But again, this study is not designed to serve as
a guide to programming or to any other of these items, but only to des-
cribe them in theoretical terms and to identify their functions and
characteristics so that the auditor will understand them when he reviews
and evaluates them as part of the management control system.

Also, the discussion of the conduct of the audit itself is neces-
sarily general. It is designed to identify the basic approach to the
audit, not provide a detailed Step-by-Step procedure. To become more
Specific would require an analysis of individual and Specific agencies
or departments, and this is not within the design of this study.

Finally, this study is limited to an analysis of state auditing
systems. Many of the concepts and policies described herein may prove
useful to auditors in other governmental audit groups, but they have

not been developed for that purpose. Likewise, these procedures relate

8
only to audits of the departments, agencies, or other organizations of
the State, and not to county audits, tax audits, or any other type of

special investigation.

Organization

 

This study is divided into six chapters, each with a Specific pur-
pose and an important centribution. The sUbjects discussed in each of the
chapters have been arranged in a logical order so that basic building
blocks needed in the theoretical development of later chapters are them-
selves developed in the earlier ones.

In the chapter which follows, the fundamental relationships and
historical trends that characterize State governments in the United
States today are outlined, and the events and circumstances leading up
to the Michigan Constitutional Convention are described. The constitu-
tional provision requiring performance post audits is then analyzed
in light of these trends and relationships to determine the clear
intent of the convention when it adopted this unique provision.

Chapter 111 describes the legislative control system of which the
auditor general is a significant part. All elements of the control
system having important bearing on the ability of the auditor to con-
duct a meaningful audit and to make an effective evaluation of the
quality of administrative performance are discussed. Likewise, the need
for effective review and enforcement of audit recommendations and reports
is noted, and suggestions are made of ways in which this can be done.

The most significant contribution of this chapter, however, is the develop-
ment of the role of the auditor general as a part of the legislative con-
trol system and the identification of the implications of that control

system for the conduct of the audit.

9

In Chapter IV the subject matter of the audit is developed. If the
auditor is to examine and evaluate administrative performance, he must
know what are the areas of administrative reSponsibility to the legisla-
ture and which of these areas are legitamately subject to performance
post audit review. Furthermore, the auditor must know what constitutes
acceptable performance in each of the areas which he is expected to
evaluate before he can judge the quality of performance. This chapter
is an attempt to develop the area of administrative responsibility with
these purposes in mind.

Chapter V is a description of the approach to be used in conducting
the audit. The approach described is a theoretical approach based upon
the material developed in the preceding chapters. Moreover, it is one
which can be used regardless of the state of the development of the
management control system, and it is Specifically designed to test
those areas which most affect the efficient, effective, and faithful
conduct of state programs.

Finally, Chapter VI summarizes the contributions of the study and
provides some recommendations and suggestions for both the researcher
who wishes to pick up the torch and continue the study and deve10pment
of these important concepts and prOblems and for state auditors who
are faced with the practical problems of implementation of the audit

approach described.

CHAPTER II

THE BIRTH OF PERFORMANCE POST AUDITING

Introduction

 

The idea of a performance post audit, while unique to the Michigan
constitution, did not suddenly appear on the scene nor was it something
which just happened to catch the fancy of the convention delegates.
Rather, seen in its prOper context, it becomes clearly a natural conse-
quence of the major deve10pments and trends that have recently occurred
in state government. And far from being a threat to existing power
structures in government, this audit is as an important tool in the
preservation of the democratic state system. This chapter will examine
the background of events leading up to this provision, and will point
out important implications of performance auditing as it relates to the

system of government used in the United States.

Separation of Powers

 

The doctrine of the separation of powers is as old as democracy,
and it forms the foundation upon which all state governments in the
United States are organized. The division of power into the legislative,
executive, and judicial branches of government constitutes a fundamental
part of American constitutional theory and practice. Under this principle,
a broad system of checks and balances has been established in each of
the states to insure that one branch of government does not assume exces-

sive power relative to the other two branches. This system of checks

10

11

and balances is clearly portrayed in the budgetary process, and it is
from this system of basic and fundamental balance-of power relationships

that the need for and the purpose of performance post audits is born.

The Budget Cycle

 

The importance of this power relationship is clearly demonstrated
in the budgetary process in what has been termed ”the budget cycle."
Basically, this cycle consists of four partS-—budget preparation, budget
authorization, budget execution, and performance review or audit.1 And
although budget procedures vary widely from state to state, these four
Steps are generally characteristic of the process.

The first step consists of all of the methods and procedures used
in compiling the budget request in the executive branch of government.

It includes the determination of priorities of programs, the adoption,
deletion or modification of activities within each agency and department,
and the setting of over—all budgetary policy by the Governor and his Staff.
It further includes the defense and justification of proposals before the
legislature.

The second step is legislative. It consists of the enactment into
law of the programs proposed by the Governor and the appropriation of
funds sufficient to carry out the programs enacted. In this step, the
legislature has complete freedom to amend, delete, modify, or add to the
programs and budgetary requests of the Governor; and in the process of
the hearings both on programs and on fiscal matters, and in the language
of the laws and appropriation bills themselves, the legislature is able

to express its intent and dictate its policy for execution.

 

1Jesse Burkhead, Government Budgeting, (New York: John Wiley 6
Sons, Inc., 1956), p. 88.

 

12

The third Step is budget execution, and the responsibility for this
execution centers primarily in the executive branch. The degree of discre-
tion allowed the department or agency heads in the execution of the programs
may be broad or narrow, and if not Specified constitutionally, is generally
subject to legislative modification and review. In either case, the execu-
tive is generally held responsible to the legislature for the proper expen-
diture of funds and implementation of programs as set forth in the laws
of the state.

The final step is the audit, and on this Step there has always been
much confusion in state government. The purpose of the audit is to review
the execution of the budget as approved by the legislature. The nature
and purpose of this review together with the function and authority of

the auditor is the subject of this Study.

Patterns of ReSponsibility

 

This cycle or system of budgeting suggests two significant generali-
zations concerning the distribution of state responsibility.

First, this system has developed as an instrument or means of demo-
cratic control over the executive. By requiring that the executive obtain
from the legislature both the authorization for programs and the appro-
priation of funds, the executive is prevented from imposing willful and
arbitrary taxes upon the peOple and from dictating programs at his Own
will. As Burkhead notes, "The budget is an expression of ultimate legis-
lative authority.”1

Second, a dual responsibility on the part of the executive is implied

by this system. The first involves a line of administrative responsibility

running from the executive to the administrative agencies. It requires

 

llbid., p. 83.

13

that the executive be charged with the general supervision of administra-
tive affairs and that his authority be sufficient to enable him to control
administration. The Hoover Commission, for example, said, “ReSponsibility
and accountability are impossible without authority-~the power to direct.
The exercise of authority is impossible without a clear line of command
from the top to the bottom, and a return line of responsibility and
accountability from the bottom to the tOp.”1 In the absence of such
authority, it is impossible for the chief executive either to prepare
and propose a meaningful financial plan or to implement and execute such
a plan if adOpted by the legislature.

Another line of responsibility runs from the executive to the legis-
lature. This reSponsibility is explained by Burkhead as follows:

In every democratic government the legislature may approve

or reject the proposals of the executive; in some governments

the legislature may also modify executive proposals. In the

exercise of this authority the legislature must be able to hold

the executive accountable-~both for the execution of last year's

financial plan and for the comprehensiveness of this year's

program.2

Within this two-way pattern of responsibility, the question of the
location and reSponsibility of the auditor become vitally important. Before

turning to this problem, however, it will be helpful to look at some his-

torical trends and developments in state government.

Implications of Growth in Government

 

Over the past half-century, both the size and the complexity of govern-
ment activities have vastly increased. The consequences of this growth have

important implications in this balance-of-power relationship.

 

1Commission on the Organization of the Executive Branch of Government,
General Management of the Executive Branch (Washington, D.C.: Government
Printing Office, 1949), p. l.

 

2Burkhead, 92. cit., p. 84.

14

First, it is important to recognize that an increase in the Size
of government activities is almost synonymous with an increase in the
size of the Executive branch of government. AS new programs are insti-
tuted or old programs expanded, the work of the legislature is certainly
increased. But the major impact is felt in the establishment of new
executive agencies to administer the programs or in the expansion of
present agencies and departments. It is the responsibility of the Execu-
tive branch to administer the programs, and it is precisely in the admini-
stration and implementation of such programs that these growth pains are
felt most keenly.

Second, it must be recognized that the larger the executive branch
of government becomes and the larger the budget it has to work with gets,
the more powerful the executive becomes relative to the legislature.
When programs are few and reasonably Simple, it is not difficult for legis-
lators to keep a close watch on the activities and administration of
departmental programs. When it becomes evident that budget execution
has deviated or is deviating from the policies as set down by the legis-
lature, legislative investigations and hearings can quickly and effectively
establish reSponsibility for such deviation, and appropriate action
can be taken to insure future compliance. But when programs number in
the hundreds or thousands and budgets run in the billions, the possibility
of close legislative control over executive operations is lost. AS a
consequence, much of the legislature's work in budget authorization becomes
an analysis of changes or additions to existing programs, and seldom if
ever are major established programs called into serious question. To
a great extent, state legislatures have over the years come to be rubber
stamps for executive requeasts.

A third and perhaps an even more important trend in the power relationship

15

in state government has been the explicit granting of additional powers
to the chief executive to enable him to administer the broader programs
as enacted by the legislature. One of the primary objectives sought in
the Michigan constitutional convention, for example, was a clarification
of the authority and responsibility of the Governor and other executive
officials and the consolidation of the numerous state agencies into a

few major departments where programs could be administered and controlled
more effectively.1

One of the major recommendations generally made by constitutional
authorities to strengthen administrative leadership is the establishment
of a department of administration. For example, Lambert says:

AS an aid in providing administrative leadership, the

governor should be served by a department of administration

headed by a chief director and composed of such divisions as

budget, personnel, planning, purchasing, accounting, and

preauditing, each headed by a director. Since they will

work in an intimate relationship with the governor, the

chief director and the division directors should be appointed

by the governor (withogt senatorial confirmation) and Should

serve at his pleasure.

This recommendation is always made with the view of strengthening
the governor by giving him power sufficient to provide more effective
leadership in State government. Yet, as Lambert notes, when the powers
of the executive are increased and expanded, the question arises; "Will
a governor with such powers be controllable by anything other than his

own character and personal integrity? Will such a concentration of

. . . . . 3
authorlty in one off1ce affront our concept of 11m1ted government?”

 

1Michigan, Constitution, Art. 5, sec. 2.

 

2Louis E. Lambert, "The Executive Article,” Major Problems in Con-
stitutional Revision, ed. W. Brooke Graves (Chicago: Public Admini-
stration Service, 1960), p. 195.

31bid., p. 197.

 

 

16

Executive Accountability

 

"Power and Strict accountability for its use,” said Woodrow Wilson,
"are the essential constituents of good government.”1 This concept is
very fundamental to students of constitutional development in the United
States. Seldom can one find a recommendation for improving the power
and control of the chief executive without some mention of the need for
also insuring that he be held accountable for the increased authority.

The first and most important curb on the executive is the power of
the legislature. Yet, as pointed out by the Citizens Research Council
of Michigan:

There has been little . . . emphasis on the creation

or improvement of legislative tools to enable the legislature

to keep abreast of developments in the executive branch, in

order to make prudent legislative policy with respect to it.

While it is not intended here to Suggest that the legislative

branch should keep pace with the executive branch in growth

of personnel and expenditures, it is clear that the expansion

and increasing complexity of the executive branch challenges

the legislature's ability to maintain its role as a separate

and equal branch of government exercising effective checks on

the executive branch.

It is the general recognition of this dilemma which has caused
authorities to turn to the post audit function as the one tool still avail-
able to the legislature to insure executive compliance with the legis-
lative policies and to hold administrative officials accountable for their
conduct. And at this point it becomes clearly apparent that if the auditor
is to fill this important role in the legislative-executive power relation-
ship, some important modifications are necessary in traditional government

auditing procedures. In addition, the location of the auditor in the

structure of state government is of critical importance.

 

1Woodrow Wilson, Congressional Government (New York: Meridian
Books, 1956), p. 187.

 

2"A Legislative Auditor General,” Council Comments, No. 728 (Lansing,
Michigan: Citizens Research Council of Michigan, February 7, 1962), p. l.

 

17

Choosing The State Auditor

 

There is a variety of methods of appointing or electing state
auditors, but for the most part, they can be lumped into three categories:
those appointed by the Governor, those elected by the people, and those
appointed by the legislature. The arguments for and against each of these
methods will be examined in light of the above discussion and the nature
of the auditor's responsibilities.

The Executive Appointment: Although a few States continue to use

 

this system of choosing a state auditor, it finds little acceptance in
theory. It clearly violates the concept of independence in that it requires
the auditor to audit the work of the man who employes him. And even
though the personal character of the auditor himself may never be ques-
tioned by the legislature, it is difficult to see how an effective eval-
uation of executive activities can be made in a manner wholly acceptable
to the legislature unless more independence is provided. Perhaps the
one case in which this system seems to have worked fairly well in Spite
of this weakness is in the General Accounting Office, but critics are
unanimous in their agreement that this is one provision which ought to
be changed.

The Elected Auditor: Still the most widely used method of choosing

 

the State auditor, this method has also fallen under heavy criticism in
recent years. Proponents of this method claim that one of its advantages
is that it provides more ”dollar honesty” in government, since the auditor
general must return regularly to the people who can judge the adequacy

of his performance and hold him reSponsible for any irregularities.1

Furthermore, by making the auditor directly responsible to the people,

 

1For example, see the minority report recorded in Michigan, State of
Michigan Constitutional Convention: Official Record, 1961, p. 1673.

 

18
he supposedly is not subject to as much influence by the Governor or
the legislature as might'otherwise be the case.

The problem with these arguments, however, is that they fail to
recognize that the people have nOTWay of judging the performance or
competence of the auditor. The Citizen's Research Council of Michigan
reports, for example, that tests made in Michigan when Michigan had an
elected auditor general Showed that ”less than one percent of a sample
of voters selected the auditor general as an officer best known to them,
and that only two percent could name the occupant of the office."1
Furthermore, this lack of voter familiarity with the incumbent auditor
general may well be an incentive for him to seek sensational news through
questionable tactics of investigation and reporting just prior to election
time in order that people may know who he is and recognize that he is
doing something. It is a well-known fact that in our society a routine
audit where findings confirm full compliance and proper reporting on the
part of an agency is hardly the kind of report likely to bring personal
fame and popularity to the auditor.

Perhaps an even more important point, however, is the fact that an
elected state auditor is virtually independent of the legislature, while
it is the legislature which has the greatest need for the function which
the auditor performs--the post audit of executive activities.

Thus, neither the elected auditor nor the auditor appointed by the
executive are acceptable arrangements in the context in which we are
considering them. In commenting on these two methods, John P. Wheeler
of the National Municipal League explains:

". . . The demands of the short ballot principle would be
reason enough to disparage the election of an official with as

 

1"A Legislative Auditor General," op. cit., p. 3.

19

technical an assignment as that of auditor. His appointment
by the executive is indefensible as the primary responsibility
of the auditor is to render an independent review of the acti-
vities of the executive branch.

The Legislative Auditor: One cannot survey the literature nor visit

 

with constitutional authorities without being impressed with their unani-
mity of opinion in favor of a legislatively appointed state auditor. The
National Municipal League, for example, says unequivocally, ”A post audi-
tor should be appointed by the legislature and accordingly should report

to that body."2 The Citizen's Research Council of Michigan concluded in

its *study that ”the legislative function can become uniformly effective
only if all of the post—audit function is made a legislative responsibil—

ity."3

Likewise, the Model Constitution contains the suggested provision
that ”the legislature shall appoint an auditor . . .," and in the discus-
sion which follows, the comment is made that ”the auditor should, of
course, be directly responsible to the legislature and be chosen by that
body."4 This has also been the unmistakable conclusion of every other
study dealing with this problem which has been reviewed in the research
for this thesis.5

In view of the above discussion of the separation and balance of

power concepts and in light of the patterns of responsibility implied

 

1John P. Wheeler, Jr. (ed.), Salient Issues of Constitutional Revision

 

(New York: National Municipal League, 1961), p. 146.

2Ibid. 5"A Legislative Auditor General," 0p. cit., p. 2.

4Model State Constitution (6th ed.; New York: National Municipal

League, 1963), p. 62.

 

5For another vigorous defense of this position, see Harvey Walker,
”The Role of the Legislature in Government,” State Government (Spring,
1960), pp. 96-102.

 

20

by those concepts, it is certainly not difficult to understand why such

an unanimity of Opinion exists on this subject. The desirability of a
legislatively appointed auditor becomes even more apparent when one remem-
bers that the reSponsibility and authority of the auditor general cannot

be defined apart from the type of audit he is expected to conduct.

Traditional State Audits

 

Traditionally state auditors have been primarily concerned with the
legality of expenditures and the honesty of fiscal affairs. One writer,
for example, declares that "when properly used, the term 'auditor' desig-
nates a public official responsible for determining the fidelity and
legality of the manner in which money has been Spent," and he emphasized
the words as quoted.1 Speaking before the annual convention of the National
Association of State Auditors, Comptrollers and Treasurers, Billie S. Farnum,
who at the time was the Auditor General in Michigan, explained the situation
in these words:

Scrutinizing the handling of public funds seems to have

become an ingrained habit and tradition of the State auditor.

He has been preoccupied with following the trail of cash, in

one door and out another; from hand to hand and from pocket to

pocket. With an eagle eye he has followed the paper trail

wherever it has led. Were all receipts properly accounted for?

Was the expenditure authorized? Were the prOper Signatures on

the authorized documents in the right places? In the end, were

all expenditures made according to legal authorization? These

are the questions and the problems with which State auditors

have been chiefly concerned.

It is obvious that such an audit is not sufficient to meet the needs

of the legislature for an objective appraisal of executive performance.

 

1Russell W. Maddox and Robert F. Fuquay, State and Local Government
(Princeton, New Jersey: D. Van Nostrand Company, Inc., 1962), p. 391.

 

2Billie S. Farnum, "Performance Auditing,” an address presented to
the Annual Convention of the National Association of State Auditors,
Comptrollers and Treasurers, November, 1964. (processed)

21

If the executive is to be held truly accountable to the legislature as
required under'the present system of government, the report of performance
and the audit of executive activities must clearly go beyond a statement
that the funds were spent legally and honestly. One authority explains
it this way:

The post-audit function is crucial not only to insure

honesty among administrative officials but also to insure

that officials of the executive branch have made their expen-

ditures in line with policies established by the legislature.

Truly there is a vital need in state government for a legislative
post auditor with powers broad enough to conduct not only finarlcial
audits, as has been done in the past, but also to render a report on
executive performance and compliance with legislative policies. And
to some this may seem to be a point of minor significance, yet it repre-
sents in fact a major change in the perception of the role of the state
auditor and his authority in state government. Every state in the nation
is currently faced with growth problems and the resulting Shifts in the
balance of power between the legislative and the executive branches of
government, and most are trying to improve the Situation and preserve or
restore that balance while maintaining a powerful and effective chief
executive. But the state of Michigan is the only state which has recog-
nized in its constitution the need for a legislative auditor general with
explicit powers to conduct such ”performance post audits” of the executive
agencies and departments.

In the discussion of the development of this provision of the Michigan
Constitution which follows, it will be noted that the arguments and explan-
ations given to support this provision were for the most part identical

with those already discussed. Thus, while Michigan has a unique constitutional

 

1Model State Constitution, op. cit., p. 62.

 

22
provision, it has not been alone in its recognition of these problems or
in suggesting such a solution. It has, however, given constitutional

birth to the expression ”performance post audit.”

Nfichigm1lfistory

 

Since its inception as a state in the union, Michigan has always had
an official of the state bearing the title of Auditor General.1 The first
state constitution, adopted in 1835, provided for an auditor general and
Specified that he should be appointed by the Governor subject to the
advice and consent of the state Senate to a two-year term of office. In
1849, however, this provision of the constitution was changed and the audi-
tor general became a state officer to be elected along with the Governor
and other state officials in popular State elections, and this system was
continued unchanged in the constitution which was adopted in 1908. Thus,
for 115 years Michigan elected its auditor general.

From time to time over the years, special commissions and research
groups conducted Studies of Michigan government and made recommendations
for changes and improvements. Perhaps the most extensive of these studies,
and certainly the one with the greatest impact prior to the constitutional
convention in 1961, was known as the Little Hoover Commission study made
in 1950 and 1951. This study occurred immediately following the report
of the first Hoover Commission report to the Congress of the United States

in 1949,2 and undoUbtedly the federal report had considerable influence

on the state study.

 

1For a summary of this history, see: Staff Report to the Michigan
Joint Legislative Committee on Reorganization of State Government, 932:
eral Management of Michigan State Government, Report No. 30, Part 11
(November, 1951), pp. 55-56.

 

2The Hoover Commission Report (New York: McGraw-Hill Book Company,
Inc., 1949).

 

23

Out of this study came several important recommendations, one of which
was directly to the point of the subject being discussed here. In its study
on the legislature, this commission made the following comment:

Because the appropriations process involves the determin—

ation of policy, it is necessary that the legislature hold the

executive responsible not only for the honest expenditure of

all funds but also the efficient use of public money in accord-

ance with policies prescribed by law. This is known as an

operational audit or a performance audit, and it too Should

be undertaken by a Staff responS1ble to the legislature.

Following from this observation, the commission recommended "strength-
ening the legislature's means for effective control, particularly through
establishment of a legislative auditor general to be appointed by and
responsible to the legislature" whose responsibility it would be "to
undertake performance as well as fiscal audits of all state agencies."

Such an auditor, the commission argued, would "equip the legislature
with its own means to hold the executive branch responsible for the execu-
tion of the program prescribed by the legislature."2

This seems to be the first appearance of the term "performance audit,”
and there are some who feel that it was coined from the term "performance
budget" as used by the first Hoover Commission in 1949. Whether or not
that is true is unimportant. What is important is the recognition of a
need for something more than a fiscal audit, and this the commission
designated as a "performance audit.” The purpose of the performance
audit is to provide the legislature with an appraisal of executive per-
formance, and in that sense the term seems entirely appropriate.

Furthermore, it is Significant that the commission also called for

an auditor responsible to the legislature, for as noted above, these two

 

1Staff Report to the Michigan Joint Legislative Committee on Reorgan-
ization of State Government, The Legislature, Report No. 11, (March 1951),

p. 5.

2Ibid.

 

 

24

concepts both stem from the same underlying considerations and needs in
the legislative—executive framework. On this particular point, the commis-
sion specifically declared that ”the plain fact is that if any semblance
of balance between the legislature and the executive is to be retained,
the Michigan legislature must be greatly strengthened in its operations.”1
It is Significant also to note that the term ”efficient” was used in
the commission's recommendation. In another report the commission commented:
Audits Should not only be concerned with legal compliance
and fidelity but with efficiency as well. Efficiency of admini-
stration means not only that the activities are carried on at the
lowest possible cost. It means also that the State is collecting
all of the money to which it is entitled.2
These quotations are significant in that from them and others like them
in the commission's reports came the ideas that eventually resulted in the
constitutional provision.
Other than the Little Hoover Commission reports, the only mention of
performance auditing in reports used by the convention appears in two brief
reports made by the Citizen's Research Council of Michigan, and in both

cases, the similarity of these reports with those of the staff report are

striking. In the first, which was titled A Primer in State Government

 

Organization in Michigan, a brief and surprisingly Simple argument was

 

advanced calling for a clearer designation of executive responsibility

and accountability, and the explanation was made that under the system

then in Operation in Michigan, the legislature had "little means of checking
into the way in which laws were being carried out by executive agencies.”
The solution to this problem, the council declared, was to "give the legis-

lature authority to appoint a legislative auditor to oversee how well state

 

1Ibid., forward.

2Staff Report on the Michigan Joint Legislative Committee on Reorgan-
ization of State Government, Revenue Administration, Report No. 6 (December
1950) , p. 15.

 

25

laws were being administered, and to make fiscal and performance audits
of State agencies.”1 And then in summing up its argument, the council
made this significant statement:
The executive Should have the tools and the responsi-

bility. Your legislative representatives should have the

co-equal power to see that what is being done is what Should

have been done, in order to provide the results sought by

checks and balances.2 (emphasis in the original)

In the second publication of the Citizens Research Council, titled

A Legislative Auditor General, the Council briefly discussed a few of the

 

arguments in favor of having the auditor general reSponsible to the legis-
lature and then set out a classification of government audits, and in
doing 50, described the ”performance audit" in language almost identicle
to that of the Little Hoover Commission as quoted earlier.

A final report which seems to have had some influence in the consti-
tutional convention is an article titled "The Auditor General of Detroit,”
whidisayszhlpart:

The Office of the Auditor General Should be given power

to investigate the results of operations and the details of

administrative practices to such an extent and in such cases

as the Auditor General deems advisable. . . .Post-auditing,

even when restricted to financial transactions and position,

inherently is a review of the results of administrative peri
formance.4

The Michigan Constitutional Convention

 

With this background of constitutional theory and historical develop-
ments, one is prepared to look at the constitutional convention in context

with the events and circumstances in which it occurred. In doing so, it

 

1A Primer on State Government Organization in Michigan (Lansing, Mich-
igan: Citizens Research Council of Michigan, October 1960), p. 18.

21bid. 3

 

”A Legislative Auditor General,” op. cit., p. 2.

4Ralph W. Michener, "The Auditor General of Detroit," GRA Reporter,
Vol. 3, No. 9, (January-February 1959), p. 2.

 

26
is important that one remembers that the provision within the constitu—
tion concerning the office, power, and duties of the Auditor General is
but one of hundreds of matters treated in the constitution, and as judged
by the limited research and debate on this provision, it must have been
regarded as one of the less controversial issues of the convention. It
is doubtful that most of the delegates gave more than a cursory review
to this provision, and no major Study was made on this subject by the
convention or any of its committees. A few members, however, took a
very keen interest in this provision, and one of those who did was John
B. Martin, a former Auditor General in Michigan and the chairman of the
Committee on the Executive Branch in the convention.

In discussing the history of the convention, it is not the purpose
of this study to describe the mechanics or chronological history of the
various aspects of this provision. Rather an analysis will be made of
the supporting arguments to determine the intent of the convention dele-
gates who supported the various aspects of this provision. Many of the
minor details are necessarily omitted in the discussion, and numerous
Speeches and arguments are ignored Since they add nothing to the commit-

tee explanations or those of other delegates used in this discussion.

The Initial Proposal

 

The initial proposal to the convention on this subject was submitted
by Eugene G. Wanger and Walter DeVries, and it proposed in part that ”the
legislature . . . appoint an Auditor General who . . . Shall conduct com-
prehensive post-audit investigations, . . . into all matters relating to

. public funds, including the efficiency and legality thereof. . . ."1

 

1Eugene G. Wanger and Walter DeVries, ”A Proposal to Create the
Office of a Legislative Auditor General; to Provide for His Appointment
and Tenn; and to Describe His Powers and Duties," Delegate Proposal
1109, dated October 25, 1961. (processed)

27
This proposal was referred to the Committee on Legislative Powers since it
clearly involved legislative power, and it also was referred to the Committee
on the Executive Branch since the Auditor General under the old constitution
was a part of the executive branch of government. Testimony was heard in
each of these committees on the proposal. Representative of the testimony
before the Committee on Legislative Powers was that of Eugene G. Wanger,1
one of the co-sponsors of the proposal. First he distinguished between
the pre-audit and post-audit functions, and noted that ”the former includes
direct internal supervision of expenditures, budget control, and preparation
of an executive budget. This," he continued, “obviously is a function of
the Executive branch and should reside there.” The post-audit function,
however, including tests of efficiency and compliance with statutory policy,
properly resided in the legislative branch. He listed three reasons for
this conclusion:
(1) Because the Legislature bears the burden of raising
and appropriating the public revenues and is thus most
directly concerned in seeing that they are properly spent;
(2) Because those performing this "watch dog" function should
not be responsible to the Executive branch whose acti-
vities they must continually investigate;
(3) Because the Legislative branch must be strengthened,
within its prOper constitutional limits, as a check
and balance to an Executive branch whose power and com-
plexity has greatly increased in recent decades.2
Wanger then noted that in Spite of considerable support for a legis-

lative Auditor General, ”regrettably little consideration seems to have

been given to the vital question of what his status, duties, powers

 

1Eugene G. Wanger, "Testimony before SUb-Committee No. I of the
Constitutional Convention Committee on Legislative Powers Regarding the
Proposed Legislative Auditor," Michigan Constitutional Convention, 1961.
(processed)

21bid., p. 1.

28

and qualifications should be," and he proceeded to discuss some of these
details which were later to become the subject of debate on the convention
floor. Some of this testimony will be referred to later in this study.

In hearings before the Committee on the Executive Branch, the question
of shifting the office of the Auditor General to the legislative branch
was discussed with several witnesses, including the Governor then in office
and several former governors. In a memorandum to Wanger on this subject,
John Martin, chairman of the Committee on the Executive Branch said in
part:

Without exception this change in the constitution was

favored. Governor Swainson and former Governors Brucker,

Kelly, Williams and Van Wagoner were all in agreement on

the desirability of this action. . . .I should add that as

a former Auditor General, I am in full accord with this pro-

posed change which would strengthen the legislature and pro-

vide an independent post-audit of the Executive Branch.

Thus, the proposal for a legislative auditor came to the floor of
the convention with the full support of both of these powerful committees,
and in the process of debate on the floor, additional light was Spread
on the intent of the provision. Particularly was this true of the Specific

requirement of a performance post-audit and its dependence on the provi-

sion of a legislatively appointed auditor general.

Debate and Clarification

 

The proposal to provide for the office of‘a legislative auditor
general came to the floor of the convention for debate on March 15, 1962.
After the reading of the proposal, known as Committee Proposal 78, the
chairman of the committees on legislative powers and the executive branch

submitted jointly a Statement of reasons in support of the proposal. They

 

1John Martin, "Memorandum to Mr. Wanger re Testimony on the Subject
of a Legislative Auditor,” Michigan Constitutional Convention, 1961.
(processed)

29

noted that the State operating expenditures had increased from less than
$13 million in 1910 to nearly $1,200,000 in 1961, and that in the 25 years
prior to the convention, at least 30 additional executive agencies had been
created. They then made the following Significant Statement:
If any semblance of balance between the legislature and

the executive administrative area is to be retained, the

Michigan legislature must be greatly strengthened in its power

to oversee the conduct of executive operations. Giving the

legislature the oversight of the audit function both as it

reSpects dollars and cents and as it reSpects the performance

and efficiency of the conduct of services, would be one large

step in this direction. The legislature, in effect, now lacks

any effective means of its own for determining whether or not

the intent of the policy decisions it makes is being honestly

and effectively translated into action.1

They went on to argue that the independent elected office of auditor
general then in use did not, and in the ()pinion of the committees, prob-
ably could not, provide the legislature with the adequate and timely
tools which they felt it needed. They concluded that "A legislative
auditor general offers an effective solution to a serious problem of
maintaining a desirable, if not actually necessary, balance of power
between these two major coordinate branches of government."2

It should be noted that‘dfis proposal came to the floor of the
convention on the one-hundreth day of formal proceedings, and prior to
the introduction of this proposal, the delegates had worked many weeks
trying to streamline and improve the lines of executive authority in an
effort to provide more effective administration and better operating con-
trol in the executive department. In terms of the budget cycle, as one

delegate noted, the convention had already adopted "the executive budget

idea," granting broad powers to the executive branch in the area of budget

 

1Michigan, State of Michigan Constitutional Convention: Official Record,
1961, p. 1672.

 

21bid.

30
preparation and control. ”The question we are now debating,” he continued,
"is: who should appraise the results of this budget? Who shall determine
whether the program and financing were carried out by the executive as
directed by the legislature? Whose job is it? This is the issue.“1
Considerable debate followed the introduction of this proposal,
but in the final voting, the concept of a legislative auditor received

overwhelming support.

Performance Auditing Debated

 

Also in their statement of reasons supporting Committee Proposal
78, the chairmen of the committees on legislative powers and the execu-
tive branch defined the duties of the legislative auditor general stating
that they ”are to conduct comprehensive fiscal postaudits and performance
postaudits and to make investigations pertinent to the conduct of such
audits.”2 They went on to define a performance post audit as "an exam-
ination of the effectiveness of administration, its efficiency and its
adequacy in terms of the program of the departments or agencies as pre-
viously approved by the legislature."3

This definition of performance audits seems possible of multiple
interpretations when viewed by itself, and it is necessary to go beyond
this statement to understand more fully the precise grant of authority

intended in the provison.

Not Unlimited Authority

 

Today one of the immediate worries of executive officials, as it

was to many convention delegates, is the extent to which this provision

 

1Ibid., p. 1689. See Speech by Delegate Rajkovich.

21bid., p. 1672 3161a.

 

31
of authority permits the auditor to become involved in the management
function and to question policies and decisions which have always been
considered to be subject to management or executive discretion.

On at least two occasions, delegates in the convention introduced
amendments the purpose of which was to Specifically restrict the auditor
in these areas. The first was a minority amendment calling for the defeat
of the whole proposal on the grounds that the ”language is so broad that
it might permit such an auditor to interfere with the academic operations
of constitutionally established universities. . . .” Furthermore, they
argued, "A performance audit could include a review of the entire academic
operation of what, to date, has been Michigan's constitutionally indepen-
dent system of higher education."1

In response to this suggested amendment, Martin addressed the conven-
tion as follows:

The meaning of ”performance postaudit" is a look to see

whether the agency has performed in the manner in which it

presented its proposals to the legislature. It is not designed

to direct the body or the agency to do any particular thing;

it is simply to see and to report to the legislature whether

the agency has performed as it stated to the legislature it
would perform.

A second incident involved a proposed amendment to "exempt civil
service and judicial functions” from the performance audit.3 Speaking
for this amendment, one of the delegates explained that "if a juvenile
court were attempting a rehabilitation program or something like that,"
he "would not want the legislative auditor to use the performance concept
to review the rehabilitation function.”4

Once again Martin explained that "the performance postaudit relates

 

1Ibid., p. 1673. 21bid., p. 1674. 31bid., p. 2276.

4Ibid., p. 2777. See Speech by Delegate Downs.

32

only to whether the money was spent for the purposes for which it was
appropriated. . . .It does not have to do with whether the court is trying
the case correctly or not."1

On still another occassion, Martin was asked Specifically by another
delegate, "What does the term 'performance postaudits' . . . mean?” In
answering, Martin again referred to the definition given in the state-
ment supporting Committee Proposal 78 as quoted above, and then added:

In other words, the department or agency goes before the
legislature and presents its program and says, "This is what

we are proposing to do.” The auditor may make a fiscal audit,
as is provided, which is to determine whether the money which
is expended by the agency . . . is spent properly and for

proper subjects within the COpe of the bill. And, secondly,

he may take a look to determine whether the agency has carried

out its commitments to the legislature which were made when the

agency appeared before the legislature to ask for its budget

or its appropriation in the last preceeding year.

These Statements clearly relate the audit function to the area of
executive reSponsibility and accountability to the legislature, and
suggest another important point which will require additional attention
later in this study--the nature of executive promises to the legislature
and the correSponding determination of legislative intent. For now, however,
it will be assumed that such promises and intent are objectively determinable
by both the agency and the auditor, an assumption which will be questioned
later.

Also Speaking on the extent to which the auditor's authority per-
mitted him to become involved in the management function, Wanger reminded
the convention that the legislative auditor was Specifically limited
to the post-audit area. He further noted that "all of the preaudit

functions are left with the executive branch . . . where they certainly

belong,” and added:

 

1Ibid. 21bid. , p. 1681.

 

33
thus decisions made by executive officers in the

exercise of their discretion pursuant to value judgments which

they alone by application of expertise are capable of making

are not proper objects of the legislative auditor general's

scrutiny, and he may not conduct investigations the purpose

of which is to criticize such decisions. The wisdom of such

a discretionary policy decision may--if at all--be called

into question by the legislature alone.

Thus, it was clearly intended by the proponents of this provison
that there be some definite limits on the extent to which such a perfor—
mance audit could question management prerogatives. The clear intention
is that the authority is as broad as the requirement of accountability
by the executive branch to the legislature, and no broader. Clearly the
convention was after a procedure which would provide an objective evalu-
ation of whether or not what is being done by the executive agencies is
what the legislature wants done. Expressed Simply, the question is:

”IS the performance of the department or agency meeting the legislature's
expectation?”

In one's determination to emphasize the inseparability of the perfor-
mance audit concept and the legislative auditor, he must not overlook the
fact that the audit must be of benefit to the agency as well and must be
accepted and supported by agency management or else the whole effect and
purpose of the post-audit function will be lost. Thus, as Shall be dis-
cussed in detail later, the methods and procedures used in conducting a

performance audit and the nature of the performance audit report are

matters which deserve extremely careful consideration.

No Other Duties

 

It has become customary in many states for the legislature to assign
by law a number of duties to the auditor general which are unrelated to

state auditing. These include serving on various boards or commissions,

 

llbid., p. 1675.

34

controlling the sale of lands for delinquent taxes, approving plats, and
auditing counties and other local authorities.1 In addition, many States
require that the State auditor be responsible for prescribing uniform
accounting systems, installation of data processing systems, and preauditing
invoices for major purchases prior to payment. Clearly, the nature of
the legislative auditor's work should not include these items, and thus
the Michigan Constitutional Convention included the provision: "He shall
be assigned no duties other than those Specified in this section."

Also in this connection it is imperative thatone recognize that the
grant of authority to the Auditor General is Specifically confined to
the post-audit function. This fact Martin emphatically declared to the
convention when he said, ”The proposal comprehends that the auditor
general would not--and I want to emphasize thiS--wou1d not get into the
business of preauditing."2 He further contrasted the post-audit process
in business with that of the independent post-audit rendered by a public
accountant in industry, and noted that it was the responsibility of the
department of administration to see that the preaudit function was filled.
He also pointed out the need for internal auditors in the executive branch
to improve internal control and insure proper accounting, a subject which
will be examined in a later chapter.

This distinction is painfully obvious to an experienced public
accountant, but the point is very well taken in this case since one of

the major weaknesses in state government today is a failure to clearly

 

1Michigan, Department of Auditor General, Orientation Manual, 1965,
p. 1. Also see Michigan, State of Michigan Constitutional Convention:
Official Record, 1961, pp. 1672—1674.

 

 

 

2Michigan, State of Michigan Constitutional Convention: Official
Record, 1961, p. 1673.

 

35
distinguish between the pre-audit and post-audit functions.1 In this con-
nection, one authority argued that "undoubtedly the least defensible prac-
tice” concerning the state auditor and his duties "is a constitutional
provision or a statute providing for an independent . . . auditor to exer-
cise pre-audit and post-audit controls.”2 Yet a majority of the states
suffer from an organization and policy confusion regarding these matters,
as did Michigan prior to the convention. And the proponents of this
provision of the new constitution left no doubt of their intention to

correct the matter.

Independence

 

To provide a maximum of independence for the auditor general, the
Convention approved several additional provisions in the Constitution.
First, the term of the auditor general was extended from two years, as
provided under the previous constitution, to eight years. Three reasons
for this provision were noted in the convention record. First, it would
attract persons of high caliber; Second, it would provide for a "substan-
tial degree of freedom from extraneous influences in the performance of
his duties;" and third, it would "provide for a reasonable degree of
job security."3

A second provision to insure independence on the part of the auditor
was the provision that he can only be removed from office "for cause"

and then only "by a two-thirds vote of the members elected to and serving

 

1Wheeler, 0 . cit., p. 146.

2Public Administration Service, Constitutional Studies, a Study pre-
pared on behalf of the Alaska Statehood Committee for the Alaska Consti-
tutional Convention, 1955, pp. 32-33.

 

3Michigan, State of Michigan Constitutional Convention: Official
Record, 1961, p. 1672.

 

36
in each house.” Such a provision protects the auditor from the threat
of removal from office merely because of partisan bias or other such
reason, and allows him to conduct his audit fairly and competently with-
out fear of whimsical repercussions.

Still another provision designed to insure his independence is the
provision making him "ineligible for appointment or election to any
other public office in this state from which compensation is derived
while serving as auditor general and for two years following the termi-
nation of his service." This provision is designed to remove the tempta-
tion from the auditor to use his office to build and promote his own poli-
tical career within the State either through the abuse of his powers or
the neglect of his auditing duties in favor of other image-building
political activities.

A fourth provision to provide independence to the auditor is that
which permits him, upon direction by the legislature, to "employ inde-
pendent accounting firms or legal counsel and make investigations perti-
nent to the conduct of audits.” Perhaps the most Significant item in
this provision is that which permits him to employ independent legal
counsel. As Wanger stated in his testimony to the convention, "The
power to contract for legal counsel of his choice is essential to the
legislative Auditor General's independence from the Executive branch.
Otherwise he would have to rely upon the Attorney General to define the
extent of his powers.”1 Thus this provision clearly permits the Auditor
General to ignore the opinion of the Attorney General if that opinion
differs from the opinion expressed by his independently employed counsel.

There is thus no executive authority or official who has the power or the

 

1Wanger, ”Testimony . . .," op. cit., p. 5.

37

right to interfere in any way with the conduct of the office of the Auditor
General or to prescribe policy by which he is bound.

Finally, the convention considered the question of civil service status
for the staff of the Auditor General. As Martin explained, the committee
"felt that some independence by virtue of tenure Should exist in the staff

. because of the difficult job of making reports on agencies of govern-
ment. . . .We want them to make honest reports based upon their best judge—
ment as to what the facts and figures Show."1 The convention then adopted
the provision exempting the Auditor General, his deputy, and one other
member of his staff from classified civil service but requiring that all
other members of his Staff should have classified civil service status.

One proposal which was made to the convention and defeated there
would also have added significantly to the power of the auditor general,
and would probably have been of valuable assistance in the area of per-
formance audits. It would have provided that the auditor general could
not only contract for legal counsel of his choice, but could also, "after
public hearings establish minimum standards for annual reports to be
issued by any and all departments, offices and agencies of the State
government."2 Under this provision, the auditor general could have first
conducted hearings, thus guaranteeing that any department or agency affected
would have the fullest opportunity to be heard, and could then have set
minimum standards of reporting including the preparation and submission of
performance reports which would undoubtedly have facilitated the conduct
of the performance audit. In the absence of such a provision in the Con-

stitution, the responsibility falls to the legislature to provide by law

 

1Michigan, State of Michigan Constitutional Convention: Official
Record, 1961, p. 1674.

 

21bid. , p. 1673.

38
some means for requiring such performance reports if, in fact, the legis-
lature is desirous of receiving such reports from the executive departments

and agencies.

A Certified Public Accountant

 

The provision that the auditor general be a Certified Public Accountant
was first introduced in the convention in the original delegate proposal
concerning the office of the auditor general,1 but somewhere in the process
of the committee hearings it was deleted. It was again introduced on the
floor of the convention and was defeated there on March 15, 1962. Finally
it was introduced again on April 24, late in the convention, and was vigor-
ously defended by Richard Austin, a Certified Public Accountant himself and
a delegate from Detroit. At this time it passed with a large majority.

From the beginning, this proposal was advocated as a means of providing
the best qualified person possible for the office. This in defending his
original proposal, Wanger argued that the ”C.P.A. requirement is desirable
because (1) it establishes a minimum requirement of professional competence
for the office and (2) it sets out an objective Standard which will promote
public confidence in this vital area of public finance.”2 He further con-
tended that the auditor should possess great administrative skill and, in
addition, should have a thorough understanding of modern accounting. Only
then could he effectively supervise and evaluate the work of his Staff
and be held personally responsible for that work.

In his dramatic appeal to the convention, Austin reminded the dele-
gates that they had previously approved provisions requiring persons of

high professional standing for other important state offices. In part

 

1Wanger and DeVries, op. cit.

2Wanger, ”Testimony . . .,” op. cit., p. 4.

39

he said:
If we take the position that a legal background is neces-

sary for persons involved in the legal province in the state,

supreme court justices, state attorney general, prosecuting

attorneys, assistant prosecutors, city attorneys, is it not

inconsistent to hold that it is not necessary to require that

an expert in the field of auditing be the only person quali-

fied for the office of auditor general? And again, when we

consider that we expect the highway commissioner to be a high—

way engineer, is it not inconsistent to say that the holder of

the highest audit office in this state should not be eSpecially

qualified in his field.1

He continued to point out that a variety of "Specialists” could be
found in auditing such as Certified Public Accountants with law degrees,
with Ph.D. degrees, or with other Special qualifications if needed, and
he noted that there were 3000 Certified Public Accountants from which to
fill this one audit position as contrasted with 9000 lawyers from which
all of the above named legal positions must be fllled. He concluded by
arguing that the State would benefit by increased activity and participa—
tion of Certified Public Accountants in public affairs and noted that by
the nature of their training, they were already accustomed to the standard
of independence of mental attitude required in such an important office.

From the standpoint of this study, it is Significant that at no time
in the debate of the convention was the requirement that the auditor gen-
eral be a Certified Public Accountant ever linked to the Specific require—
ment of the performance audit. The performance audit was clearly something
which, in the view of those who Sponsored the provision, could be conducted

by an auditor who was not an accountant. In fact, both Wanger2 and Martin3

denied that these two provisions were ever seen as complementary to each

 

1Michigan, State of Michigan Constitutional Convention: Official
Record, 1961, p. 2775.

 

2Eugene G. Wanger, in personal interview, February 17, 1966.

3John B. Martin, in personal interview, February 25, 1966.

40
other, and had it not been for the personal prestige of Richard Austin,
the provision that the auditor general be a Certified Public Accountant

would never have become a part of the Michigan Constitution.

Conclusion

 

This chapter has traced with considerable detail the birth of per-
formancd auditing. The background which gives rise to the need for such
a provision has been noted, and the course of history which has brought
the issues into Sharper focus in recent years have been examined. The
constitutional convention of Michigan was then carefully and deeply anal-
yzed in an attempt to understand the intent of the provision of the con—
stitution requiring such audits, and several other factors which relate
to and clarify the issue have been noted. Clearly this provision is
unique but natural, for far from being a product of wild imagination, it
represents the explicit recognition of a basic and fundamental need of

moden1state government.

CHAPTER III

THE POST AUDIT IN A SYSTEM OF LEGISLATIVE CONTROL

Introduction

 

The Specific role of performance auditing in State government can
best be understood when viewed as a component part of a legislative
control system. Such a system is inherent in the structure of state
government which follows the concept of separation or balance of power
as outlined in the previous chapter. Furthermore, such a system of con-
trol is the Specific product of the patterns of responsibility which
result from such a structure of government. Thus to contextualize the
performance post-audit function and to Show it in relation to the other
components of this control system, it is necessary to have an understanding
not only of the conceptual or theoretical power relationships but also of
the actual legislative and executive processes in which such a system
operates.

Yet the purpose of this study is not to undertake an exhaustive exam-
ination of the politics or procedures of government. Indeed to allow this
discussion to wander into the many areas of difficulties and concern in
these governmental processes would defeat the very purpose for which they
are here examined. The purpose of this discussion is to provide an under-
standing of such processes sufficiently but only to the extent necessary

to determine the implications for post auditing which arise from them.

41

42

The Control System

 

Legislative control of administration consists of all of the methods
and procedures used by the legislature to secure faithful, efficient, and
effective administration of government programs. Although such control is
accomplished through a wide variety of methods and procedures, it is con-
venient to separate them into two broad categories.

The first of these categories is policy setting. Whenever the legis-
lature enacts a law, reviews a budget request, or authorizes a program,
it sets policy. Policy, as used here, is simply the expression of legis—
lative intent. It is the legislature's expression of its will through
the planning, programming, and budgeting processes. Policy is the planned
expression of the legislature's official attitude toward the range of
behavior within which it expects administrators to act. As such, policy
setting is not only important; it is imperative if legislative control is
to be established.

The second part of legislative control is administrative oversight.
All methods of reviewing the conduct of executive officials and agency
administrators are included in this oversight, including the performance
post audit. As noted in the previous chapter, the performance post audit
is intended to provide the legislature with an independent report on the
degree to which its policies are being followed and on the adequacy or
effectiveness of such policies and programs.

Thus, both parts of legislative control are dependent on each other.
Policies must be determined and expressed if administrators are to follow
them and if administrative performance is to be evaluated against them,
but so also must there be a feedback of information on the adequacy and
effectiveness of such policies if the legislature is to properly modify

and improve such policy expressions. Too often in the past, this important

43
fact has been ignored or forgotten, and the system of legislative control
has disintegrated into an uncoordinated series of activities and proced-
ures which have failed to achieve their desired effect.

The manner in which legislative control is achieved and the methods
used in its implementation are vitally important to its effectiveness,
its acceptability, and its survival. The legislature cannot undertake
a detailed supervision of every facet of administrative activity without
stiffling the initiative and creativity of administrative officials.
Effective administration requires that administrative officials be allowed
to exercise discretion and to apply expertness in pursuing the intent of
the law in circumstances which the legislature cannot possibly anticipate.
At the same time, however, a weak or inadequate system of control is
equally dangerous in that it allows for neglect of responsibility and
for inefficient use of public resources.

This chapter is an examination of both parts of the legislative
control system, for the examination of legislative oversight functions
alone would be inadequate to contextualize the role of performance
post audits.

In discussing the purpose for such a system of control, it is imper-
ative that one understands that the Spirit of such a system is positive,
not negative. The purpose is to improve and to give direction to adminis-
tration, not to restrict or to hinder it. The difficulty in such a system
is to devise and maintain methods which will preserve the proper balance
by keeping the activities of executive officials under effective scrutiny
and control while at the same time preserving the values of administra-

tive flexibility and discretion.

44

Evaluating the Control Methods

 

Before turning to the methods by which the legislature achieves
control of administration, it will be helpful to note some of the cri-
teria by which such methods themselves can be evaluated both for appro-
priateness and effectiveness.

In the first place, it is totally erroneous to assert that all that
is needed in the states today is mprg_legislative control of administration.
This misleading belief has led in some states and even in the national
government to the establishment of numerous and detailed restrictions
on administrative decisions, with the result that creative and effective
administration had often been stifled and program effectiveness has been
seriously restricted. Too often, more control is understood to mean more
restrictions.

The problem is not so much how legislative control can be increased,
but rather how the legislature may exercise appropriate kinds of control
without impeding administration or weakening executive authority. In
a system of balance of powers, an imbalance in favor of the legislative
branch can be just as serious a problem and perhaps more serious than
an imbalance in favor of the executive branch. The objective sought
by improving legislative control is to improve the quality and efficiency
of public programs, not to hold down executive officials. And control
methods which are appropriate in this sense are those which facilitate
administration while keeping the legislature fully informed on what is
tranSpiring.

Yet it is not easy to secure agreement on the appropriateness of any
control method, particularly from those involved. As Harris explains:

Although most executive officers recognize in principle

the essential role of the legislature and cheerfully accept
some limitations on their own discretion, their natural tendency

45

is to minimize the need for detailed control; and some offi—

cials frankly regard all legislative control as a necessary

evil, to be avoided or circumvented whenever possible. Legis-

lators, on the other hand, commonly look on control of admini-

stration as a legislative prerogative, to be extended whenever
feasible; they regard themselves as guardians of the public's
freedom and are not inclined to see constitutional problems

in extending their control of administrative detail. Those

who have risen to positions of leadership . . . are especially

likely to take this view. 1

Thus, in evaluating any type of control procedure or device, it is
necessary to have some criteria on which to base judgement. And for the
purposes of this study, the following criteria seem appropriate:

1. Is this control procedure constitutional? We have already
noted that in Michigan, performance audits are constitutionally required.
But a similar type of audit may be implied or permitted by other consti-
tutions. Thus the test of constitutionality not only asks whether or

not the control is required by the constitution, but also whether or

not it is permitted or Specifically prohibited by the constitution. In

 

this connection, Walker has observed that "as to State legislative powers,
it may be asserted categorically that they are nowhere listed and enu—
merated. Being residual in character, they include the authority to

solve problems yet unknown."2 He compares the State legislature to the
Congress of the United States, and asserts that ”the legislature does

not need, as does congress, to search for and discover a constitutional
peg on which to hang its ever act.” Rather it needs only to determine
that the Constitution of the United States neither grants the power to

the national government nor denies it to the States, and that the State

constitution does not deny it to the state legislature.

 

1Joseph P. Harris, Congressional Control of Administration (Wash-
ington, D.C.: The Brookings Institution, 1964), p. 11.

 

2Walker, op. cit., p. 99.

46

2. Does this control correspond to the pattern of responsibility
implied in the division of power between the two branches? The assign-
ment of the preaudit function to an official of the legislative branch,
for example, would generally be considered a violation of this test Since
preaudit is clearly a management responsibility and therefore rightly
belongs in the executive branch of government. This problem was dis-
cussed in the previous chapter.

3. Does this control provide the legislature with information which
it needs to discharge its basic responsibilities? In other words, does
it help the legislature do a better job? In this respect, the legislature
needs to know, for example, whether or not a certain program is having
its desired effect? Thus, a control device which requires that a report
of program achievement be submitted to the legislature may be an appro-
priate control device. Yet rarely do State legislatures today require
formal statements on program achievement other than a statement of expen-
ditures. Certainly the performance audit will be greatly facilitated
if performance or achievement reports are required by the legislature
from the agencies and departments subject to audit.

4. Does the control impede or promote administrative effectiveness?
In some ways, this may be a corrolary of test (3) above. A performance
report can be a valuable administrative tool as well, but if the legis-
lature undertook to prescribe accounting and information systems and to
set by law the exact procedures to be used in preparing such reports, the
result might well be to burden administrative officials with a cumbersome
set of rules that would neither prove satisfactory for the purpose inten-
ded nor permit the flexibility necessary for executivasto adjust and improve
such systems if and when it became desirable to do 50. Government is full

of such out-dated and bureaucratic procedures which have long since lost

47
their effectiveness as meaningful control devices.

5. Does this control strengthen and enforce the control systems

within the executive branch or does it duplicate and/or weaken them?

This question is particularly relevant to the performance post audit as

a control device. Within the systems of executive control and internal
control, provision should be made for an internal audit and administra-
tive policy review. Such reviews, if conducted effectively within the
executive branch, need not be repeated by the legislative auditor. Rather,
the independent auditor in government, as in business, has a function to
fulfill which does not include a duplication of the work of internal
auditors.

6. Finally, is this control device one that can properly be exer-
cised within the competence of the legislature or the legislative branch.
AS Harris explains, "A large portion of governmental decisions are of
the kind that can be made wisely and within an effective time Span only
by officers who have appropriate information, expertness, and experience."1
Executive officers are expected to have these Special qualifications,
and it is highly important that the legislature makes sure that they do.
However, such decisions themselves are not properly within the competency
of the legislature to make, and even if it did make them, it is not
organized to put them into action.

Unfortunately it is not always possible to determine whether a given
control technique violates any or all of these criteria. Often such a
determination involves a value judgement, and in most cases honest men
may have differing opinions. Yet competent, efficient, and effective

administration of state programs has never been more important, and

 

1Harris, op. cit., p. 13.

48
appropriate controls must be established which will continue to promote
such administration. Properly devised and applied, a system of legis-
lative control does not become an end in itself. Rather, it is one of

the means of ahcieving the ends described above.

Polipy Formation

 

AS noted earlier, policy formulation occurs within the planning-
programming-budgeting process. There is no policy expression in the
absence of plans or programs; in fact there is no policy. The purpose
of policy is to serve as a guide to the actions or decisions of reSpon-
sible people with respect to planning or executing programs with which
they are involved. Policy formulation itself is a type of planning.
Properly conceived, policies are extremely useful in decision—making
in that they provide a basis for relating actions to objectives, thus
helping to assure that administrative decisions result in successfully
coordinated activities and programs.

Yet in government, the legislature does not simply assemble and
formulate policy which it then communicates to the executive. Rather,
the legislature relies very heavily on the executive for the planning
of government activity and the deve10pment of meaningful programs as
well as for the preparation of the budget to achieve the desired objec-
tives. Planning and programming are management functions and are, for
the most part, left to administrators whose expertise renders them more
capable to accomplish these tasks. Theoretically, the legislature acts
as an intermediary or arbitrator between management and the public to
secure fOr the public in general the best programs possible and to pre-
vent abuse of executive power. As one writer stated, "Contrary to pop-

ular impression, modern lawmakers are not so much lawgivers as law

49
. "l
rev1ewers.
Thus, legislative policy to a great extent is the product of the
legislature's reaction ot executive proposals, a reaction which is based

on the idelogies of the various interest groups which legislators seek

to satisfy and on the personal opinions of influential legislators.2

The Legislative Process

 

The legislative process among the states differs in many reSpectS.
AS one former member of a State legislature writes, ”All legislatures
pass laws, respond to and resist interest groups, party leaders, gover-
nors, bureaucrats, and others who urge approval or rejection of parti-
cular measures. Yet the differences among state legislatures are striking."3
Legislatures reflect widely differing sets of social and political forces,
traditions and practices. And while the legislature is always the focus
of the law-making process, there is nothing inevitable about the character
of the demands made, the manner in which they are made, or about the nature
or kinds of maneuvering and bargaining that takes place in reSponse to
them.

One of the biggest difficulties in the legislative process is for
the individual legislator to become sufficiently informed to competently
judge the merits of proposed legislation. One problem is the volume of

proposals. One writer explains this problem as follows:

 

1Walker, op. cit., p. 98.

2For a very interesting discussion of how these ideologies are
formed and the roles they play, see R. Joseph Monsen Jr. and Mark W.
Cannon, The Makers of Public Polipy (New York: McGraw-Hill Book Com-
pany, 1965).

 

3Duane Lockard, The Politics of State and Local Government (New
York: The MacMillan Company, 1963), p. 272.

 

50
The very volume of legislative proposals and the wide

diversity of the subject matter are in themselves staggering.

Mastery of the meaning and potential consequences of much

prOposed legislation requires not only intensive study but

also technical competence that few but the Specialist can

hope to achieve. Ability aside, in terms of available time

it is impossible for the legislator to comprehend these pro-

posals, earnest as he may be in his desire to do 50.1

Most legislators are reasonably good men. Some of them are excellent
technicians, many are lawyers with excellent training and long experience
with the law, and others are experts in other fields. But in the overall
legislative process, they are, in the words of Clapp, ”merely babes in
the woods, called upon to pass technical legislation in a wide, wide
variety of fields."2 Obviously it is impossible to become an eXpert
in all areas, and the miracle of government is that legislatures do as
well as they do considering the complexity of their job and the diver—
sity of the demands on their time and attention.

Perhaps it is presumptuous to assume that there exists an identi-
fiable legislative policy or intent. Certainly there is seldom an
issue on which all legislators are able to express an informed opinion
and thus intelligently weigh tOgether the alternative policies and
programs and arrive at a majority intent. The more common practice
is for legislators to accept the advice of a trusted collegue when eval-
uating proposed legislation. This dependence on collegues for advice,
however, does not mean that the individual legislator thereby abdicates
his responsibility to reach his own decision regarding legislation or

to seek for himself to ascertain the facts relevant to that decision.

It is merely one method by which he attempts to meet that responsibility.

 

1Charles L. Clapp, The Congressman (Washington: The Brookings
Institute, 1963), p. 104.

2

 

Ibid.

 

51

Other sources of advice or infonnation are party caucases, interest
groups, outside authorities such as academicians or professionals, and
very importantly, members of the executive branch. On any given proposal
one of these sources may predominate or any combination of them may be used,
but the fact remains that on most issues, legislators are never able to
become very well informed. The consequence of this fact is that legis-
lative policy is difficult to determine and interpret. The complexity
of such policy is well described by Bailey in his discussion of this pro-
blem at the national level as follows:

Legislative policy-making appears to be the result of a

confluence of factors streaming from an almost endless number

of tributaries; national experience, the contributions of

social theorists, the clash of powerful economic interests,

the quality of Presidential leadership, other institutional

and personal ambitions and administrative arrangements in the

Executive Branch, the initiative, effort, and ambitions of

individual legislators and their governmental and non-govern-

mental staffs, the policy commitments of political parties,

and the predominant culture symbols in the minds of both

leaders and followers in the Congress.1

Truly, legislative policy formulation and expression is complex.
Yet its complexity, for all the problems it may cause, cannot be allowed
to serve as an excuse for failure to recognize its existence and its
importance and to devise means of making it more explicit, more effec-
tive, and better understood in state government. Without it, legisla-

tive control is virtually impossible, and the performance post audit is

difficult if not impossible to perform.2

 

1Stephen Kemp Bailey, Congress Makes a Law (New York: Columbia
University Press, 1950), p. 236. This book describes the story behind
the passage of the Employment Act of 1946.

 

2For an excellent discussion of the development of the legislative
process in the United States together with an examination of the many
proposed reforms relating to it, see Bertram M. Gross, The Legislative
Struggle (New York: McGraw-Hill Book Company, Inc., 1953).

 

52

Policy Enunciation

 

The legislature has several methods of communicating policy decisions
to administrative officials in the executive branch.

The predominant formal method is by writing into the statutes an
expression of its policy. Every law that is passed by the legislature
is an expression Of its intent. Some statutes, of course, are more
explicit in that expression than others. In some cases, the legislature
goes into considerable detail in expressing its will and in doing so,
sets down numerous detailed guidelines to direct and control administra-
tive activity and to limit or channel administrative discretion. On the
other hand, the legislature may prefer to leave much of the decision to
the administrator, recognizing in him an expertise not possessed by
the legislature, and the statute may be broad and general in its expres-
sion of policy. In such cases, the competence of the administrator,
as judged by the legislators, becomes an element of the legislative
control system.

The legislature may also enact statutes creating additional execu-
tive agencies, prescribing their form of organization, and providing for
their principle officers. In this way the legislature may express an
intent or policy which may continue unchanged as long as the agency
survives, thus rendering unnecessary the continual expression of policy
with each additional apprOpriation or authorization affecting the agency
or department. The implied policy in subsequent legislation is one of
continuing the present or established policy as formerly enunciated.

Still another method of securing legislative control is through formal
committee hearings on proposed legislation. It is the practice of most
legislatures to divide each house into several committees whose purposes

are to examine and investigate proposed legislation and administrative

53

activities in specified areas. In some states these committees are fur-
ther divided into subcommittees, similar to the system used in the federal
government. Representatives of the respective executive departments and
agencies are called before these committees or subcommittees to testify
on the proposed programs or budget requests and to defend such requeasts.
In the process of conducting such hearings, the committee, and indivi-
dually each of the members on the committee, may express an opinion on
the proposal or request being considered; and thus both formally and
informally, the administrator is made aware of the wishes of committee
members. The importance or significance of these committee hearings
cannot be minimized, for it is a well-known fact that with few exceptions,
legislators other than committee members seldom express publically or
privately an opinion on matters before the legislature.

Still another means of communicating legislative policy to the
administrative agencies is through the informal contacts between mem-
bers of the agency and members of the legislative committee reSponsible
for the agency. Through this mutual relationship much information is
exchanged and many ideas are communicated which not only influence current
action but Shape the boundaries or limits within which the agency is likely
to present its formal requests to the legislature for future programs or

budget requests.

The Inadequapy of Policy Expression

 

From the forgoing discussion, it would seem that all the auditor
would have to do to determine legislative intent would be to obtain
copies of all laws pertaining to the creation of each agency and the
authorization of its programs, read the minutes of the committee and sub-

committee hearings, examine the record of debate, and review the files of

54
correSpondence between the agency and relevant committees or committee
members of the legislature. Such is not the case. In fact, the limita-
tions and inadequacies are so great that in some cases it may be impossible
to do more than obtain a general idea of relevant policy or intent.

One of the biggest problems comes from the lack of a written record
of legislative committee or sub-committee hearings. An extensive inquiry
in connection with this study failed to reveal a Single state which
keeps a verbatum record of hearings and testimony given before legislative
committees. Furthermore, most States do not even provide a written sum-
mary or any other such indication of the action and will of the legisla-
ture as expressed by the committees or of commitments made by administrators
who present testimony. Usually the only record that can be located is
a roll-call record of those present and of the votes that are taken,
and some states do not even provide that. Yet committee hearings are
without doubt the single most significant element in the development and
expression of legislative policy or intent, for on a majority of the
issues that come before the legislature, most legislators ask the advice
of committee members whose opinions weigh very heavily in the final
decision of their collegues.

Another weakness in the legislative process is the lack of formal
debate on vital issues which come before the legislature. As one authority
noted, "It is most unfortunate that we cannot approximate real debate.
Under the rules it is absolutely impossible to have a case argued in a
manner approaching the way it Should be argued, even on important issues."1
Certainly the large number of bills that require the attention of legis-

lators over a relatively Short period of time constitute an important

 

1Clapp, 0p. cit., p. 124.

55
reason why debate is held to a minimum, but even if more time were avail-
able, legislators still disagree regarding the extent to which debate
affects the fate of legislative proposals. It is generally felt that
Speeches rarely influence many votes, that their main effect is to rein-
force views already held. And in many cases their purpose is to make a
record for the Speaker. Yet, for whatever the reason, this lack of debate,
together with the lack of formal expression of the issues, constitutes
another barrier in the path of the auditor who must determine legislative
intent.

Some authorities feel that the auditor should not attempt to go
beyond the written statute in attempting to determine legislative policy
or intent. These authorities argue that the statutes are the only
legally binding and enforceable expressions of legislative will. And
in a narrow sense this argument may be true. However, one cannot long
be associated with the realities of the government process without
realizing that the statutes, in most instances, do not ccn1tain an
adequate expression of legislative will. For example, one familiar
with the decisions of the courts will readily recognize that judges
and juries must frequently go far beyond the wording in the Statutes
to determine the intent of the legislature in passing a given law. If
administrators are to be held accountable before courts of law on matters
not wholly expressed in the words of the written statutes, they must
Obtain a clarification of the statutes either through committee hearings,
formal legislative debate, or informal contacts with members of the legis-
lature. And it is therefore only reasonable to argue that if the auditor
is to express an opinion as to whether or not an agency or its adminis-
trative officials have faithfully, efficiently, and effectively imple-

mented legislative policy or intent, the auditor too must go beyond the

56

words of the written statutes, as important as they are, and must more
precisely identify both legislative intent and executive commitments.

A final difficulty in determining legislative intent or policy
results from the fact that in many and perhaps most states the Governor
is so powerful that he dominates the legislative process. It is not
uncommon for the legislative intent on some bills to be recorded as
Simply agreement with the Governor or opposition to him. And Since the
Governor usually wants as free a hand as possible in administering state
programs, he is not likely to be any more Specific or detailed in the
expression of his will or intent than is necessary to secure legislative
approval of his programs. Even in those states with relatively strong
legislatures, the influence of the Governor in the legislative process
is considerable. One writer described this situation as follows:

The state legislature of today finds itself in a Strange
posture viS-a-vis the Governor. The Constitution describes

him as the chief executive, but often he is also the chief

legislator. This is due to many factors: (1) his uniqueness

as head of the executive branch, which makes him a prime source

of news; (2) his power of veto; (3) his power to send messages

to the legislature and to secure wide publicity for his recom-
mendations; (4) his exclusive power to convene special sessions

. . . and even to determine the agenda for such sessions; (5)
his power of appointment . . . ; and (6) his power to initiate
budget estimates. . . 1

In addition, the Governor is usually the leader of his political
party, and particularly if his party is the majority party in the legis-
lature, he may control the legislative process almost exclusively through
party caucases and partisan political maneuvering. In such cases, the
expressed legislative intent may be something quite apart from the under-
lying motives for some bills that are passed. In fact, throughout the
whole process of government, party politics plays an important role, a

role which cannot be ignored without distorting reality.

 

1Walker, Op. cit., pp. 99-100.

57

The Direction of Change

 

If State legislatures are to provide effective control of adminis-
tration, it is imperative that some improvements be undertaken in the
process of formulating and enunciating legislative policy. Since policy
formulation is largely a matter of reviewing executive proposals, and
Since executive proposals or requests result primarily through the plan-
ning-programming-budgeting process, a discussion of such policy formula-
tion will be deferred to the next chapter where these functions are
examined more carefully. However, based upon the above analysis, some
improvements in policy enunciation can be suggested. The importance of
these improvements to the performance post auditor will become even more
apparent as the audit function is more fully deveIOped.

First, a written record should be made of legislative committee
hearings and should include not only the testimony of witnesses but also
the expressions of Opinion by committee members. There is considerable
merit in recording the proceedings verbatum, but at least a summary of
the proceedings Should be made which must, as a minimum, include the
elements of justification advanced by proponents of legislative proposals,
the nature of all commitments made by administrative officials, the counter—
arguments given by other witnesses, the particulars of any instructions
given by committee members or the committee as a whole which are intended
to be binding on administrators, and formal votes and decisions made by
the committee together with a statement of the implications of such a
decision. Such a record would be extremely valuable to all parties con-
cerned, both in implementing legislative policy as well as in reviewing
program execution and in evaluating performance against such policy.

Second, to the extent that open and free debate is not possible on

all issues which come before the legislature, a clear Statement of the

58

recommendations of committees, together with any additional or alternative
positions openly and actively supported on the floor of the legislative
body, Should be made available for public record. Such a record would
provide a basis for reviewing any changes, modifications, deletions, or
additions which are voted on the floor of the legislative body.

Third, an expression of legislative intent should be made in every
statute affecting the conduct, organization, or programs of any govern-
mental agency. Such a statement of intent Should be sufficiently detailed
and Specific to permit exactness of interpretation on all major points
of any bill. Some states are at the present time attempting to move
in this direction. In Michigan, for example, a bill was introduced in
the Spring of 1966 which would require such an expression of intent on
every bill passed by the legislature.

Finally, and perhaps most importantly, it is important that the
legislature secure from the Governor and other executive officials a
written statement of intent for every program prOposed or budget requested.
And it is equally important that the legislature act Specifically to
accept such a statement of intent as being that of its own or state
clearly the nature and extent of its disagreement or desire for modifi-
cation. Such a statement would not only prove invaluable to the auditor,
but also to agency administrators, to executive officials, to judges and
juries, and to anyone else charged with the responsibility of interpreting
legislative will and judging performance against it.

In reviewing any such statement of policy or intent, it is imperative
that the legislature first agree upon the objectives sought by the program
being acted upon. Such objectives may be given in terms of productivity,
level of service, or State of condition. It is also important that the

Specific standards of achievement or standards of performance to be used

59

in appraising the results of program accomplishment be identified. It
is further necessary for the legislature to require a clear assignment
of reSponsibility, for programs to be clearly defined and properly
funded, and for a system to be established to provide adequate reporting
and secure accountability for each program and appropriation in terms
of the standards and objectives Specified. All of these standards and
specifications must, of course, be useful in giving direction to admini-
stration without in any way stifling initiative on the part of admini-
strators, interfering with proper management functions, burdening officials
with unnecessary paper work, or usurping the right of management to bring
to bear on their administrative problems the expertise they were hired
to bring to their jobs.

The process by which objectives are identified, Standards are set,
programs are developed, and accountability is secured will be treated
in the next chapter. Basically such functions are management responsi-
bilities and are properly carried out in the executive branch of state
government. The role of the legislature is to insure that such functions
are performed effectively, and this it can accomplish by approving and
reviewing these items and by holding proper administrative officials

reSponsible for them.

Legislative Review

 

So far, this chapter has been concerned with legislative controls
that should be operative primarily prior to the execution of programs,
and whose purpose is to give direction to such execution. Legislative
control, however, does not end with the acceptance of the objectives and
standards, with the enactment of specific programs, with the appropriation

of funds, or with the enunciation of policy. Legislative control includes

60

the oversight of administrative activity. This involves a comparison of
actual performance with the accepted standards and enunciated policies as
well as a review of the appropriateness of the methods by which such per-
formance has been accomplished. Harris explains this reSponsibility as

follows:

. . . The means of government are not politically or
philosophically neutral; they are closely related to, or
sometimes become, ends themselves. Therefore legislatures
must concern themselves with the ppp_as well as the what
of executive action. It is not enough for a legislature
to enact policies and programs into law; it must check to
see how those policies are being executed, whether they
are accomplishing the desired results, and, if not, what
corrective action the legislature may appropriately pre-
scribe.1

The methods by which the legislature seeks to accomplish its review
of the execution of programs includes formal hearings before the standing
legislative committees, informal contact by members of the legislature
with administrative officials, the requirement of financial and perfor-
mance reports, and the post audit. Legislative oversight, then, includes

every method used by the legislatUre to review administration of programs

after the fact.

 

The Objectives of Legislative Review
AS previously defined, legislative control of administration consists
of all of the methods and procedures used by the legislature to secure
faithful, efficient, and effective administration of State programs. Con-
sistent with this definition, the following seems to be an appropriate
summary of the objectives of the review function:
1. To determine the extent to which legislative policies are being

faithfully, efficiently, and effectively implemented by administrative

 

1Harris, Op. cit., p. 1.

61
officials. From this step will come the information necessary for the
legislature to take corrective action with reSpect to administration or
to revise legislative policies if they are found to be inappropriate or
inadequate.

2. To determine whether state programs are achieving their desired
objectives. This step will provide information on the need for changing,
deleting, or modifying programs or program elements through additional
legislation.

3. To review both the administrative control and executive control
systems as established by the agency or department heads and by the chief
executive reSpectively, to determine that such systems are adequate and
effective in accomplishing their objectives. Through the review of the
control systems the legislature will be better able to judge whether or
not an agency is organized and administered in such a way as to be able
to competently carry out its reSponsibility.

4. To hold reSponsible executive officials accountable to the
legislature for their use of public funds and other resources put at
their disposal. This step involves not only an examination of the fin-
ancial statements and of the legality of expenditures but also of the
prudence of expenditures and the efficiency of the use of all resources
including the elimination of wasteful practices.

5. To ascertain that laws are being administered in the public
interest, and to encourage diligence on the part of administrative offi-
cials. In a politically explosive environment, it is often extremely
difficult to determine when the public interest is being served, for
"public" is usually defined in terms of certain interest groups or seg-
ments of the total population. Nevertheless, neglect of duty, clear

abuses of discretion, arbitrary actions, and gross errors of judgement

62
must be brought to the attention of the legislature for proper review

and investigation.

The Role of the Legislative Auditor

 

The Auditor General is, in reality, the legislature's arm for on-
the-spot reviews of administrative performance. His role is one of
reviewing administrative activity and of reporting his findings to the
legislature. The purpose of his review is to assist the legislature
by providing competent and timely reports to the legislature containing
information relevant to its decisions and responsibilities. Thus, areas
of state activity properly subject to his review include all areas on
which the legislature needs information to more knowledgeably perform
its duties, and which fall within the competence of the auditor to
review.

Admittedly this role is much broader than the traditional financial
audit, but it cannot logically be viewed any other way. To argue that
the audit should be confined to financial transactions is to deny that
the legislature is in need of information other than that of a financial
nature or to assert that the auditor is incompetent to perform an exami-
nation and render an opinion on performance in non-financial areas.
Neither of these positions can logically be supported. The function
of the legislature includes a review of all administrative activity.

The role of the auditor is to help the legislature perform such a review,
and this he cannot do without extending his review beyond theiinancial
area to include an examination of factors as outlined below. As stated
by the Auditor General of Illinois, "The audit\of a State agency has

multiple objectives, only one of which is the opinion on the financial

63

statements."1 By calling attention to strengths and weaknesses, and by
identifying problem areas, even though he may not always be able to com-
petently recommend solutions, the auditor performs an invaluable service

to the legislature whom he is constitutionally required to serve.

The Functions of an Auditor

 

Before looking at the scope of the post audit, it will be helpful
to note the Specific functions of an auditor and to point out some func-
tions which are not those of an auditor. A clear understanding of these
functions will greatly facilitate the determination of the extent or scope
of the audit effort.

Basically the functions of the auditor are to examine and to evaluate
the records and controls of an organization for the purpose of rendering
a report on the condition and the performance of the organization, and to

make recommendations for improvements where they are found to be needed.

 

The function of the auditor is not to impose the will of anyone on the
organization or to enforce any rule or policy. Neither is it the function
of an auditor to establish and maintain systems of accounting or control
or to interfere in any other way with the decisions and prerogatives of
management except as such decisions are influenced by the recommendations
made by the auditor.

The purpose of the examination is to discover sufficient competent
and relevant evidence upon which to base an objective evaluation and
render a fair opinion. The purpose of the examination is not to see how
many errors can be found or to discover every evidence of fraud. Rather,

the examination is made to render a judgement on the control system, the

 

1Illinois, Office of the Auditor General, Instructions to Indepen-
dent Certified Public Accountants Performing Audits of State Agencies,
April 30, 1965, p. 7.

 

64
financial statements, or the operation as a whole. The finding of a sub—
stantial number of irregularities does of course influence the decision,
and may in some cases require a more substantial inquiry into the possi-
bility of fraud or deliberate dishonesty. However, since the examination
is performed in the nature of a test of the system, it is entirely possible
that some errors or irregularities may escape detection, and readers of
the auditor's reports must recognize this fact. Particularly in govern-
ment activity, audits are too frequently looked upon as a means of assuring
that no defalcations occur undetected and that public officials are kept
dollar honest. The more important role of the auditor is to provide a
review of the control system as a whole to determine that even honest
mistakes are minimized and that operations and activities are oriented
toward the desired objectives.

Once the examination has been made and an evaluation of the evidence
has been completed, the responsibility of the auditor is to communicate
such information in the form of formal reports to the legislature. A
copy of the report should also be given to the Governor and other offi-
cials responsible for the agency or department audited to inform them of
the findings and recommendations of the auditors, but the primary purpose
of the report is to inform the legislature. Once the report has been
filed with the legislature, the auditor's responsibility is completed.
His authority is confined to examining and reporting, and it should carry
no administrative power except to conduct the affairs of his own office.

Recommendations may take several forms, but they should always be
confined within the limits of the auditor's area of competence. As a
result of his examination, for example, he may feel that a different type
of'study is needed, one requiring expertise in areas that he does not

possess, and he may properly recommend that such studies be made. But

65
he should not attempt to render opinions or make recommendations in
those areas. To do so would not only open him up for severe criticism
in the event that his recommendations were inappropriate or ill con-
ceived, but it would also cost him the confidence of those whom he audits.
And without their cooperation and confidence, his work is much less effec—

tive and far more difficult if not impossible to perform.

Scope of Audit Inquiry

 

The scope of the audit inquiry is difficult to define, since in any
given situation the extent of the auditing which should or can be per-
formed is a function of (1) the will of the legislature, (2) the extent
and nature of the internal audit work done, (3) the competence or quali-
fications of the auditor, (4) the relevance of the inquiry to the legisla-
tive process, and (5) the existence of certain pre-requisits in some
areas. In no case is the scope of the audit conditioned by the will of
the Governor or of agency officials unless the expression of such will
results in corresponding instructions to the auditor from the legislature.
In this reSpect the state auditor general is different from the indepen—
dent commercial auditor who is engaged by the organization which he audits.
Since the auditor general is reSponsible only to the legislature, a third
party, and is therefore not engaged by the agencies he audits, he is, in
the words of Ellsworth Morse, "completely independent of them in estab-
lishing the scope of his examination.”1

Being responsible to the legislature, the sc0pe of the auditor's
work is subject to the will of the legislature. This is not to imply

that the legislature should determine what items are to be examined and

 

1Ellsworth H. Morse, Jr., "GAO Audits of Management Performance,”
The Journal of Accountangy (October, 1961), p. 44.

 

66
what items are not. In conducting the audit, the auditor must be as
free from legislative influence as from executive influence. He must be
permitted to carry out his profeaional responsibility in accordance with
accepted professional auditing standards and in all ways to conduct his
investigation within the framework of the ethics of the profession. No
legislator or group of legislators has a right to interfere in any way
with the procedures used, the evaluation of evidence on which the opinion
is based, or in the formation of the Opinion itself. Independence on
the part of the auditor must be complete in these matters.

However, the legislature does have the clear right to request that
the auditor undertake Special investigations which may be substantially
different in nature from that of the normal audit. Such investigations
may be requested for the purpose of looking into specific activities of
selected agencies or officials or to examine alleged irregularities,
misappropriations, defalcations, and misrepresentations in financial
or performance statements. It may also consist of Special studies to
determine the financial implications of proposed legislation. But in
any case, the investigation, to be properly assigned to the auditor
general, must fall within his area of competence. He is not a highway
engineer, for example, and an investigation to determine how long it
would take to build a highway of given size and quality is undoubtedly.
beyond his area of competence. However, an investigation into the reasons
why it took two years to build a highway that was to have been built in
one is an inquiry which he could properly be expected to conduct. Like—
wise it is beyond his competence to determine what it should cost to
operate an English Department at a state university, but he certainly
could be expected to determine why one such department spends twice as

much as another.

67

The Competence of the Auditor

 

Basically, State auditors are trained and experienced primarily as
accountants. And that is as it Should be, although it is helpful if
such auditors also have some training and/or experience in management,
organization theory, systems analysis, statistical sampling, and public
administration. The specific qualifications of auditors will be discussed
more fully under staffing problems in Chapter V. For now, however, the
fact is admitted that auditors are and will in all hkelihood continue
to be primarily accountants, and the question that must be answered is:
What is their area of competence?

In answering this question, the term accountants will be used in a
broad sense. It will be assumed that the auditor general is able to
surround himself with a well-trained and experienced staff of capable
individuals. Thus the quality of his staff will not be a major consider-
ation at this point. It will, however, be discussed later in this study.

There is no question concerning the auditor's ability to review
financial Statements and accounting records. If he does nothing else,
he at least does this in every state where such an officer exists.
However, even here the matter of what constitutes the financial area
is not entirely clear. Certainly it includes an examination of cash
transactions to determine that such transactions are properly authorized
and recorded, but it includes much more. As defined by the General
Accounting Office, an agency's financial responsibility includes "the
administration of funds and the utilization of property and personnel
for only authorized programs, activities, or purposes, and the conduct of

. . . . . . . . 1
programs or act1V1t1es in an effective, eff1c1ent, and economical manner."

 

1U.S., General Accounting Office, Functions of the General Accounting
Office, A report prepared at the request of the Committee on Government
Operations, United States Senate. May 29, 1962, pp. 11-12.

 

68

Thus even a financial audit becomes a comprehensive review of administra-
tion.

The auditor is also a Specialist in control. Even before he con-
ducts an audit of financial matters, he must satisfy himself as to the
adequacy or inadequacy of the management control system. Yet control
is a very comprehensive matter too. As professor McFarland explains,
"Control is the process by which an executive gets the performance of
his subordinates to correspond as closely as possible to chosen plans,
orders, objectives, or policies,” and it includes, "the process of eval-
uating results, comparing them to established standards, and taking Steps
to correct discrepancies which appear."1 Thus, to review control, it is
necessary to review organization structure, operating procedures, policy
statements, accounting and reporting systems, and the internal audit or
review program. All of these items are within the competence of the auditor
to review and evaluate.

The extent to which the auditor can review compliance with legis-
lative intent or policy is directly related to the degree to which the
legislature makes its intent and policy formally known. The auditor
cannot take it upon himself to assume legislative will; neither can he
judge administrative performance by what seems to him to be reasonable
guidelines and standards. Yet, there is no question but what the review
of legislative intent, both for compliance and for adequacy, is an impor-
tant function of the auditor. This theme has been well deveIOped in this
chapter. A review of the faithfu1ness of the implementation of legisla—
tive will can be effectively and objectively achieved only when such will

is expressed and the commitments of executive officials are explicitly

 

1Dalton E. McFarland, Management Principles and Practices (New
York: The MacMillan Company, 1959), p. 229.

 

69

set out.

One of the purposes of legislative review, as previously defined,
is to determine whether or not programs are achieving their desired
objectives. And the question of whether or not this matter is a proper
subject for inclusion in the auditor's review is one which must be ans-
wered conditionally. To the extent that programs have been developed
and related to Specific objectives, and to the extent that useful perfor—
mance Standards have been established, the auditor can competently perform
an examination of program achievements. However, it must be clearly
understood that the auditor can only judge performance in relationship
to some established standard. In the absence of Specific standards for
a given situation, it may be possible for him to use standards developed
and used in similar situations by other states or groups. It may also
be possible to use prior years' results or historical trends as standards.
And in the absence of any other generally accepted standard, the auditor
can often compare the performance of one organization, such as a hospital,
with another Similar organization. But when it comes to rendering an
opinion on the question of whether or not such performance or achieve-
ment is in fact that which was intended by the legislature when the pro-
gram was authorized and funds were appropriated, the auditor must decline

such an expression of opinion unless adequate standards exist.

Audit of Efficiency and Economy

 

Throughout the review of the literature as well as in the inter-
views connected with this Study, the frequency with which the terms
efficiency and economy were used is striking. Almost as if they had
been joined in marriage, these two terms are seldom separated and almost
never distinguished. Yet, in Spite of the frequency of their use and

their apparent wide popularity as co—equal ideals, they are not equally

7O

desirable objectives of an audit, and for this reason they have not

been used together in this study to define the functions or objectives

of either the legislative control system as a whole or of the performance
audit in particular.

The problem arises primarily with the term "economy" or "economical."
Whenever "economy” in government has been defined by those contacted in
this study as being different from efficiency, it has been used synono-
mously with a "reduction in expenditures.” Used in this sense, the
term implies that if the auditor were to test for economy, he would merely
be looking for ways to cut expenditures, and this cannot be supported as
a desirable objective. Certainly the citizens of the state would be
happy to see expenditures cut so that taxes could be lowered, but are
they willing to accept a corresponding cut in the services rendered by
the state? That is the question of real substance, and that question
involves a matter of efficiency.

Efficiency, as used here and as used by most authorities contacted
in this study, implies something about an input-output relationship.
Whenever a greater output can be achieved with a given stock of resources,
efficiency can be improved. Similarly, whenever the same output can be
achieved or the same level of services rendered while lowering the cost,
the operation becomes more efficient. Thus, the auditor can and should
become involved in testing for efficiency in both senses. He certainly
Should watch for opportunities to cut state expenditures, but he must
always relate the cut to its impact on output. To recommend a cut merely
to reduce total expenditures is completely illogical, for it carries the
clear implication that such reductions are desirable regardless of their
consequences. Yet some audit groups, including the General Accounting

Office, profess to adhere to this policy quite closely.

71

Another sense in which the term economical may be used is to describe

whether or not a given output of goods or services is worth the cost of

 

inputs. Here again, however, is a question beyond the competence of the
auditor to judge. ”Worth” implies a set of values against which the input-
output relationship can be measured or compared. If such values are
stated as standards and are generally accepted as valid, the auditor can
use them and make the analysis. However, here he is once again relating
performance to standards, which is his proper function. In the absence
of such standards, the auditor can make comparisons between two similar
operations, pointing out which seems to be most efficient. But he can-
not state that one or the other is ”economical” in this sense. That
judgement must be left to the legislature whose responsibility it is

to make such judgements and decisions.

The same is true of any other value judgement of this nature. For
example, the auditor does not judge whether or not the accounting and
reporting system is ”good” or “proper;" rather he examines the system to
determine whether or not it is carried out according to generally accepted
standards and principles and whether or not it is meeting the objectives
for which it was established. Similarly the auditor reviews the system
of internal control to determine its adequacy and reliability in meeting
the objectives for which such a system is set up, not to judge whether
or not it is "good" or "proper" as such.

Likewise there are areas of cost analysis which are beyond the area
of competence of the auditor. For example, not being an engineer it is
beyond his competence to determine how much a bridge of given length and
quality should cost. However, it is not beyond his competence to conduct
an examination to determine why the construction of such a bridge actually

cost more than it was originally intended to cost. Similarly, it is

flflv

‘Hv

72
beyond his area of competency to determine what it ”should" cost to treat
mental patients or to rehabilitate prisoners, but it is not beyond his
competence to determine why costs differ between Similar mental hospitals
or correctional institutions or to make recommendations based upon such
comparative studies.

A final way in which the term "economical” is sometimes used is
to describe the impact of certain expenditures on the economy of the
state or local area. Once again, however, such a determination is clearly
beyond the competence of the auditor and is not a proper subject for his
investigation. Thus in all three senses in which the term is used, econ-
omy is not a desirable objective of the auditor.

Efficiency, on the other hand, is always subject to audit review.
However, even here there are some problems. The output of government
occurs primarily as services to society--services which are difficult
if not impossible to quantify in any meaningfu1 fashion. Thus efficiency
in government does not lend itself to measurement as readily as does effi-
ciency in an industrial plant. And the problems here for the auditor are
many.

First, unlike a commercial enterprise which measures efficiency in
terms of profit or contribution to profit, a government agency such as
the conservation department must relate cost inputs to trees planted,
to wildlife preserved, or to parks maintained. Thus efficiency cannot
be measured in financial terms. As one writer points out, however, "This
does not mean necessarily that figures cannot be developed which will
indicate a measure of efficiency. It means only that figures developed

. . . . . 1
according to the conventional pattern are Simply not valid for this purpose.”

 

1W. Lynn Fluckiger, ”A Philosophy of Fund Accounting,” The Journal
of Accountangy (August, 1963), p. 70.

 

73

Some writers have suggested that unit costs be deveIOped, such as cost
per patient day, cost per credit hour, cost per full-time equivalent
student, or cost pernfile of highway services. Obviously these measures
have serious deficiencies too, but they do represent what seems to be
the most promising approach yet suggested for developing standards of
judging efficiency in government. Much progress has been made in some
areas, such as hospitals, but much more needs to be done before such
unit measurements will be fully effective. And even if such unit costs
are developed on a wide basis, the auditor will still need to be extremely
careful in applying them to a given agency or institution since there
exists a wide variety both in size and type of activity among agencies
of different states and locations.

Using dollar costs as inputs and dollar sales as output, a commer-
cial interprise can meaningfully ask the question, would the resources
of this branch of the company be more efficiently used if gidgets were
made instead of gadgets. But in government the same is not true. There
is no way of determing whether or not funds could be more efficiently
used if transferred from education to mental health or from conservation
to public safety. Nor is there any way to determine whether or not funds
would be used more efficiently if used to hire teachers rather than build
school buildings. All of these questions depend on a complex set of com-
munity and social values and on the judgement of which output is to be
maximized. Furthermore, the analysis of whether an agency is more or
less efficient this year than last has the same value problem in most
cases, and even if such problems could be eliminated, there is Still
the fact that when one compares total input to total output, the effi-
ciency ratio will be lower the larger the operation becomes, simply

because of what the economist calls the law of diminishing returns.

74
Beyond some point, every additional increment of input results in a
proportionately smaller increase in output, and thus the total ratio
falls. This fact is unavoidable in any organization.
Nevertheless, in Spite of the difficulties, the test of efficiency
is one with which the auditor must be concerned. It is a far different
and more desirable objective than the test for economy under any of the

described circumstances.

Relationship_to Management Responsibility

 

Since the performance audit is a review of management performance,
it is desirable to clearly set forth the functions and responsibilities
of management which are proper subjects for review. Certainly the audi-
tor should not assume the role of the omniscient judge and pretend to be
qualified to review and challenge everything that management does. Yet,
in some ways, virtually every decision and action of any administrator
eventually comes under audit review. To understand and illustrate how
this occurs, it is first necessary to clearly understand what management
is expected to do.

Basically, the management function can be broken down into three
components: planning, executing, and reviewing. The planning phase
consists of selecting desirable objectives, developing programs to
achieve the Objectives, identifying standards with which to evaluate
performance against the objectives, and the establishment of a control
system to insure that all individuals and activities are oriented toward
the effective accomplishment of the objectives in an efficient manner.
Such a control system includes the formulation and enunciation of execu-
tive policy, the development of methods and procedures of operation
consistent with such policy, the establishment of an organizational

structure and the assignment of administrative reSponsibility to carry

75
out the programs, and the implementation of an effective accounting and
information system to record performance and to provide effective commu-
nication within the organization. This whole planning function will be
described and analyzed in Chapter 4.

The execution phase includes all of the direct and indirect effort
expended by members of the organization to execute the plans and carry
out the programs. It includes all decisions made, both at the manage-
ment and at the operating level, which affect the results of operations.

The review function includes the preparation and receipt of reports,
the internal audit, and the follow-up by management to take corrective
action where necessary. Information received in this phase becomes prime
material for the next round of planning. Thus the management function
consists of a three-phased cycle, no part of which is complete without
the other.

Now, if the auditor is to review administrative performance, it is
clear that his review cannot be confined just to the execution phase,
although that will undoubtedly constitute a major portion of his exami-
nation. He must also review both the planning and the review processes.
He must examine not only what happened but also what was expected to
happen, and he must question the adequacy of the plan as well as the
propriety of the execution. This does not require that he attempt to
second-guess management either in terms of the objectives sought or the
programs developed. But he must ask the questions: Is the control sys-
tem adequate to insure that the objectives will be met? Are the Standards
relevant and useful? Are the programs internally consistent? Is respon-
sibility and authority clearly defined? Have alternatives been fully
explored? Do old programs continue to serve their intended purposes?

Are the budgeting and accounting systems consistent with the patterns

76

of responsibility and the programs deveIOped? These and other similar
questions are within the competence of the auditor to judge.

In the area of management review the auditor clearly must concern
himself with the nature and the extent of the internal audit program,
as discussed below. He must also review the adequacy and timeliness of
reporting procedures and the use to which management puts such reports.
Finally, he must review the extent and the effectiveness of management
follow-up to insure that proper corrections are being made. To the extent
that an effective management review function exists along with an adequate
control system, the work of the legislative post auditor will be substan-
tially reduced.

Thus, the auditor's role goes far beyond an inquiry to determine
the financial results of operations for a given period, and includes an
examination in one way or another of virtually every management function.
Because of this fact, it is understandable why management people in state
government are somewhat apprehensive about such a comprehensive audit

program.

Again the tremendous responsibility of the auditor to make the
audit a constructive and positive program becomes abundantly clear. In
his instructions to Certified Public Accountants who are engaged in con-
ducting audits within the state, the Auditor General of Illinois had this
timely advice:

Each individual auditor . . . has an obligation to

conduct himself . . . in such a manner that he promotes the
over-all constructive objectives of the post-audit program.
The surest way . . . to hurt the program is to give agency

personnel the impression that the auditor is part of a "Gestapo”
or Spy organization or that he will try to pillory them for
every small error in judgement or departure from the statutes
and regulations. While the audit reports must include disclo—
sure of any instances of wasteful procedures, improvident
expenditures, ineffectual controls, and unbusiness like methods
in carrying out programs, each auditor should not forget that
agency personnel are the individuals that will in most cases

77

have to take the necessary action to correct deficiencies
and . . . to place recommendations for improved procedures
into effect. An antagonistic attitude on the part of agency
personnel, even with an honest purpose behind such antagon-
ism, may negate the best of suggestions. If it can at all
be avoided, agency personnel should not be put into a defen-
sive position where they feel so compelled to justify past
actions that they are blinded to the positive aSpects of

an auditor's recommendations.1

Relationship to the Internal Audit

 

Implicit in the above discussion is the fact that the achievement
of faithful, effective, and efficient operations is a basic management
responsibility. The system of organization and control within each agency
should be designed to achieve this end, and it is the responsibility of
agency management to see that such is the case. Furthermore, it is the
responsibility of executive officials to provide a system of control
and to establish a framework of executive policy to insure proper coordi-
nation of programs and utilization of resources within the executive
branch. Such a system of control, whether within the agency or encompas-
sing the entire executive branch, requires proper accounting for dele-
gated responsibility and complete reporting of the results of operations.
To be fully effective, such a control system must include a competent and
effective internal audit program.

Thus, the audit conducted by the auditor general is fundamentally
an audit of management control systems. To the extent that the findings
of the independent auditor reveal effective and competent internal audit
staffs functioning within well-designed control systems, the scope and
depth of the independent audit can be substantially reduced. On the
other hand, if a weak and ineffective control system is found with insig-

nificant or no internal audit review being performed, the Scope and depth

 

1Illinois, Office of the Auditor General, Op. cit., p. 6.

78

of the independent audit must be broadened to include many of the tests
otherwise not needed. Thus the extent of the auditing properly performed
by the auditor general is to a great extent a function of the nature and
scope of other audit work within the state. The work of the auditor
general will not only be reduced but will also be considerably more effec-
tive if a good system of internal audit and review iS'operative through-
out the state.

Ideally, internal audit work should be carried out at two levels
of state government. The first and primary responsibility for such
work lies with the agency or department. This fact is expressed in an
excellent study on the subject of internal auditing prepared by the
Office Of the Auditor General of California which concluded that "internal
auditing is essential to the proper fulfillment of the agency concept,
and the preponderance of such auditing within the executive branch should
be done at this level."1 The purpose of such an internal audit function
is to provide agency management or department heads with timely and rele-
vant reports regarding the status and operations of their reSpective
organizations so that proper control can be exercised and corrective action
can be taken. Thus in a real sense, the internal auditor is the adminis-
trator's arm for effective review in the same way that the auditor general
functions inthis capacity for the legislature.

Much discussion has centered around the scope of the internal audit,
and while it is not the purpose of this paper to develop that subject,
it does have important implications for the auditor general which should

be noted.

 

1California, Office of the Auditor General, Report on a Review of
Internal Auditing within the Executive Branch of the California State
Government, 1962, p. 10.

 

 

 

79

Basically, the scope of the internal audit is as broad as the scope
of management responsibility, and it is limited only by the competence
of the auditor and the will of management. In recent years the scope of
internal auditing has broadened considerably from the traditional review
of financial controls and statements, and now many internal audit staffs
are performing what are known as "operational audits."1 Such audits are
literally performance audits conducted at the agency level, and as such,
are cpncerned with everything that such a designation implies. It is
prOper to include within the scope of the internal audit a review of
every activity or function of the agency which falls under the respon-
sibility of the administrator and which is not outside the area of the
competence of the auditor. His function is to audit agency performance,
financial and otherwise, and to report his findings and recommendations
to management.

The second level of internal auditors should be responsible to the
Governor and other top-level executive officials. Their duties should
include the oversight of administrative performance throughout all of
the departments and agencies of the executive branch of the state. This
group of auditors need not be large if effective internal audit work is
carried out at the agency level, since the work of this group would
include a review but not a duplication of the work of the agency internal
auditors. This senior audit group would also be reSponsible to see that
financial and performance reports are timely and properly prepared in
accordance with executive policy and accepted reporting standards. In
addition, this small, well-trained and experienced staff would be avail-

able for Special Studies and investigations as requested by the Governor

 

1See, for example, Bradford Cadmus, Operational Auditinngandbook
(New York: The Institute of Internal Auditors, 1964).

 

80

in the same way that the legislature would use the auditor general for
its special studies and investigations. Thus, what has come to be known
as the management survey or management audit,1 if conducted by personnel
within the state, could well be performed by or under the direction of
these top-level internal auditors. Certainly the scope of their audit
authority would be as broad as the reSponsibility of the executives they
serve, limited once again to the competence of the auditor and the will
of the chief executive.

The implications of such an audit program are obvious. To the
extent that competent internal auditing is performed at both levels
of management control, management reports will be timely, complete, and
accurate. And matters such as organization, operating procedures, policy,
and performance will be reviewed for adequacy and efficiency by an inter-
nal staff close to and familiar with the problems involved. Once the
auditor general can assure himself of the quality of the management con-
trol System and of the internal audit program, he can procede to evaluate
the other matters on which he is expected to render an opinion with con-
siderably less work and detailed analysis. While the scope of his audit
inquiry would remain just as broad as ever, the depth and detail of his
examination of evidence would be substantially reduced.

The corrolary of this fact is that it becomes the first concern of
the auditor general to examine the systems of management control and
audit review and to make sufficient recommendations to improve their

quality to the point where they effectively provide the type of control

 

1See William P. Leonard, The Management Audit: An Appraisal of

Management Methods and Performance (Englewood Cliffs, New Jersey:
Prentice-Hall, Inc., 1962); and Stephen R. Michael, Appraising Mana-
gement Practices and Performance (Englewood Cliffs, New Jersey: Pren-
tice-Hall, Inc., 1963).

 

81

described.1 In the absence of such internal controls and internal audit
Ixrograms, the field of performance auditing is too broad and the demands
are too great for the auditor general to even hope to do more than spot-
Check performance and review those aspects suspected or thought to require
correction or improvement.2

Finally, the best assurance that legislative policy will be carried
out by executive Officials is to have a well-established and effectively
operating system of management control, where responsibility is defined
and accountability is secured. If internal auditors are checking perfor-
mance against executive policies and legislative intent, it becomes much
easier for the auditor general and his staff to identify deviations and
to pin point reSponsibility for them. Moreover, the internal audit func-
tion should not be thought of as something in addition to the auditor
general's audit, but rather as a vital element of management control
that is needed in state government regardless of its relationship to
the work of the auditor general.

Certainly there is nothing which is more clearly within the area
of the competence of the auditor general than a review of the adequacy
and effectiveness of the internal audit program. The only difference
between the performance audit conducted by the auditor general and
that conducted by the internal auditors arises from the nature and

scope of their reSpective reSponsibilities. They all must go beyond

 

1Consistent with this idea, the first general audit program under-
taken by the Auditor General of California after the creation of his
office and his appointment to fill it was an over-all study of internal
control in state agencies to determine how much reliance could be placed
on the reports of these agencies. See California, Joint Legislative
Audit Committee, First Report of the Joint Legislative Audit Committee,
December 31, 1958, pp. l8- 23.

2This is basically the approach of the GAO. See U.S. General
Accounting Office, Pugpose and Objectives of Independent Audits,l96l,p.3.

82
financial areas if they are truly to function as broad review elements in
their reSpective control systems. Furthermore, before the performance
post-audit review, as conducted by the auditor general can become fully
effective, it must be accompanied by a similar extension of the scope

of internal auditing at both agency and top-executive levels.

Legislative Support of the Auditor

 

If the legislative post audit is to become an effective control
element in state government, it must have the full support of the legis-
lature whom it is intended to serve. Such support must come in four
important areas .

First, the legislature must make every effort to provide the auditor
general with the necessary authority to carry out his work. He should
have the power to examine all records and documents which he deems
necessary to examine in order to render a competent Opinion on the finan-
cial position and results Of operations of state agencies. He should
have the power, as does the Michigan Auditor General, to obtain indepen-
dent legal counsel, and to employ independent accounting firms to make
investigations pertinent to such audits. He must also be permitted to
employ competent and experienced personnel for his staff.

Second, the auditor general must be given adequate funds 11) perform
the job he is expected to do. Occassionally state legislatures have looked
upon their own auditors with suSpicious eyes and have cut their budgets
as a means of punishment for having disclosed information in an audit
report which proved to be embarrassing to some public officials, even
though such disclosures were prOper and resulted in substantial savings
to the state and the correction or elimination of imprOper and/or illegal

practices. In other cases, legislatures have actually expressed a

83
willingness to receive “skimpier” audits rather than provide funds suffi-
cient to enable the auditor general to perform the work constitutionally
or legally required of him.

Third, the legislature must make a conscientious effort to provide
the auditor general with a clear expression of its will, concerning
both the audit policy which he is expected to follow as well as the
instructions and policies prescribed for agencies and departments sub-
ject to audit.

Finally, the legisalture must assume the reSponsibility for review-
ing audit reports and enforcing audit recommendations. It does little
good for the auditor to conduct an audit and file a report if that report
is never used and the auditor's recommendations are ignored. TOO often
the only reports that receive the attention they need are those which
report illegal conduct, material defalcations, or some other sensational
finding. The legislature must realize that following through on a
recommendation to improve a control system is far more valuable to the
welfare of the state than calling for an investigation into alledged
defalcations after the fact, for it is by strengthening the control
system that such defalcations are prevented or at least minimized.

Yet it is presumptuous to expect that every member of the legislature
will have time, or will take the time, to read every report that is pre-
pared by the auditor general and his staff, or that if they did so they
would all understand fully the significance of the statistics and infor-
mation given. Because of this fact, it seems desirable for the legis-
lature to establish from its members a joint, bi—partisan, audit committee
or commission to receive and review the reports of the auditor general
and to make recommendations to the legislature as a whole on the appro-

priate response to be taken in each case. A few states presently have

84

such groups established and functioning, and perhaps a brief description

of one of them will illustrate the nature and value of their work.

The Case Of the Illinois Legislative Audit Commission

 

The Illinois Legislative Audit Commission was created by statute
in 1957 as part of the reformation of the state audit program following
the Orville E. Hodge scandal and subsequent invetigation.1 The commis-
sion is composed of five members of the Senate, appointed by the Presi-
dent Pro Tem of the Senate, and five members of the House, appointed by
the Speaker of the House. In both the Senate and the House, at least
two of the appointees must be of the minority party,and appointments are
made for a two-year term of office. The commission is required by sta-
tute to "ascertain facts, review reports and take action thereon, and
make recommendations and reports to the General Assembly and to the
houses thereof concerning the audit . . . and such related matters as
may be directed by the General Assembly."2

The Commission is required to receive the reports of the Auditor
General and other financial statements and to determine what remedial
measures, if any, are needed. If the Commission feels that Special
studies or investigations are necessary, it is authorized to direct the
Auditor General to undertake them.

The Commission has the power to summon and compel the attendance

before it of any person directly or indirectly connected with any

 

1See Lloyd Morey, Albert E. Jenner, Jr., and John S. Rendleman,
Report and Recommendations to Illinois Budgetary Commission, with res-
pect to investigation on behalf of the Commission as to operations of
the Office of Public Accounts of Illinois under Orville E. Hodge;
December 4, 1956.

 

2Illinois, Legislative Audit Commission, Ninth Annual Report of the

 

Legislative Audit Commission, submitted to members of the 74th General
Assembly of the State of Illinois; February 28, 1966, pp. 57-59.

 

85

transaction involving state agencies, or any other persons having informa-
tion concerning the conditions and affairs of the management or administra-
tion of fiscal matters, and to examine such persons under oath. It may
also secure the possession of any records or documents pertinent to such
matters or transactions. Failure of any person to obey such a summons

or to surrender such records, without reasonable cause, may be brought

by the Commission before the court for prosecution.

In this manner, the commission is fully able to investigate and
review audit findings and to satisfy itself as to the reasonableness of
audit recommendations. When a disagreement arises between an agency
responsible to the Governor and the Audit Commission concerning a report
or recommendation made by the auditor, the Commission is required to
promptly advise the Governor of such area of disagreement. The Governor
is then required to render a report within sixty days expressing his
views on the area of disagreement and indicating what corrective action,
if any, has been taken by his office or setting fOrth the reasons why
no action was taken if that is the case. The same sixty day rule applies
to all other state officials if the agency in question is under their
jurisdiction, whether Executive, Legislative or Judicial.

The Commission is required to report its activities to the General
Assembly (state legislature) including a report of all remedial measures
which it deems necessary based upon the audit reports, its own hearings
and investigations, and the replies from the Governor and other state
officials should they be necessary in the event of disputed matters.

A copy of the report of the Commission is to be given to each member of
the General Assembly at least annually.

Such a system certainly provides the machinery to make the audit

report a very effective and instrumental control device. When agency

86

officials know that they are going to be called before the Audit Commis-
sion to report on their progress in implementing the recommendations of
the auditor or to explain why they disagree with such recommendations,
they are not prone to ignore such recommendations and leave problems
uncorrected year after year. Most recommendations are readily imple-
mented directly by the agency, and only when administrators feel they
can build a strong case in their own defense do they allow items to go
unchecked until brought before the Audit Commission for review. Knowing
that the Governor will become involved if they fail to comply with the
Audit Commission's decision, agency administrators usually work out

some compromise with the Commission or ultimately comply with the ini-
tial recommendation.

One of the distinguishing features of the Illinois system is the
sixty-day rule, and it certainly has considerable merit. By bringing
audit recommendations up for quick review, this provision insures that
such changes in procedures, organization, operations or policy as are
felt needed will be timely and effectively implemented throughout the
state. It also provides for a thorough review of each problem by every
responsible official so that every argument both for and against the
recommendation can be heard, and through this process, those recommen-
dations which have little or no justification or merit may be eliminated.

Generally the Legislative Audit Commission has been very effective
in Illinois. In a brief report on the work of the Commission, Dr. Lloyd
Morey, who perhaps more than anyone else was reSponsible for its creation,
stated in 1960 that the Commission "has clearly substantiated its useful-

ness and importance and has given an impressive record of performance

87

and high interest."1 From the beginning, the Auditor General has attended
all of the meetings of the Commission, and thus has been available to
assist in interpreting the audit reports. Also, the Commission has
employed an executive director who recieves all audit reports and, to-
gether with comments submitted by the agencies, prepares a review of the
prOblems for the commision. This review has greatly facilitated the effec-
tiveness of the commission in being able to focus attention directly on
the prOblems requiring its attention and decision. Furthermore, agency
personnel are invited to attend the Commission meetings when reports of
their agencies are.involved, and every effort has been made to look at
both sides of disputed issues. The result, according to Dr. Morey, ”has
been almost without exception a favorable reaction among the agencies to
the policies of the Commission, as well as to the entire post audit pro—
gram."2

Finally, the recommendations of this commission to the legislature
have resulted in new laws and statutory revisions to improve the Opera-
tions and controls within the state.

In at least one area, however, the success of the commission has
been grossly overstated, and that is the area of dollar savings to the
state. In its annual report of 1966, the commission lists all of its
alleged savings to the State over its nine-year history and compares
that total to the total expenses of the commission to date. It says,
". . . the Audit Commission to date has caused to be collected or reco-

vered for the State a total of more than $1,800,000. In Sharp contrast

 

1Lloyd Morey, A Review of the Post Audit Prpgrams of the State of
Illinois, a report prepared for Frank H. Whitney, Auditor General, State
of Illinois; November, 1960, Part III, p. 6.

 

21bid., p. 3.

88

the Commission's operating expenses have totaled only $250,000 in this
same nine-year period."1 A careful analysis of the list of "funds caused
to be recovered," however, shows that of the $1,805,919 listed, $1,609,183
represents (1) the transfer Of Special funds to the general fund in the
amount of $823,863, (2) an advance from the Road Fund to the Illinois
State Toll Highway Commission of $321,059, and (3) cancelled outstanding
warrants totaling $464,261. The net effect of these actions was to
transfer funds from one hand to another, which in every case allowed them
to be Spent more quickly and in no way resulted in a "recovery" for the
state. Thus over 90 percent of the alleged saving involved only book
entries on the accounts of the states, and of the remainder, $62,400
represents increased revenues resulting from rate changes and fee adjust-
ments which had future application and in no way constituted a recovery
of past losses.

This example points up one of the major problems in trying to
quantify in dollars the savings resulting from an audit or review acti-
vity. The real saving, and it may well have exceeded the $1,800,000
listed by the commission, are the funds either collected or retained by
the State that otherwise would have been lost due to weak controls, inef-
ficient procedures, or lack of proper information had the audit or review
not occurred. Such savings can never be measured or even estimated, but
assuredly it is substantial.

In Spite Of this problem, the Illinois system has much to commend
itself to other states. Such a legislative audit commission is needed
in every state to complement the legislative post auditor in making

the audit function viable and effective in state government.

 

1Illinois, Legislative Audit Commission, op. cit., pp. 4-5.

89

The Audit Advisory Board

 

A few States have also established audit advisory boards designed
to provide a professional review and explanation of the Auditor General's
reports. One state which has such a board is Illinois, so again it will
serve as an example of what might be done.

As is the Legislative Audit Commission, the Advisory Board in
Illinois is authorized by Statute as part of the post-audit function
in the state.1 The board is composed of five members, no less than
three of whom must be Certified Public Accountants and no more than three
of whom may be of the same political party. Each member is appointed by
the Governor for a term of six years, and no member of the board receives
compensation beyond necessary expenses.

The duties of the board consist of (l) examining and establishing
standards of audits performed by or for the Auditor General, (2) advising
the Governor, the Auditor General, the Legislative Audit Commission, and
the Illinois Budgetary Commission on problems relative to audits of state
agencies, (3) working in cooperation with professional accountants and
accounting organizations for the improvement of state audits, and (4)
assisting the Governor and members of the General Assembly in understan-
ding and interpreting audit reports submitted to them by the Auditor Gen-
eral or other professional auditors. Thus, several important functions
are served by this board.

First, it provides a competent and professional body to assist the
Auditor General in developing and using professional audit standards in
government audits. Furthermore it insures a broad range of acceptance

and understanding of such audit standards both in and out of state

 

1Morey, loc. cit., part II, p. 1-5.

90

government. It also provides for a continual review or examination of
such standards and for their modification and improvement through the
years. The value of such a service is tremendous.

Another function of such a board is to provide the Governor and
members of the General Assembly, including members of the Legislative
Audit Commission, with a consutling body to whom they may go for inter-
pretation and explanation of technical matters of a financial or accoun-
ting nature which they otherwise would not understand. It is always pos-
sible for these officials to call in the Auditor General, but it is equally
important for them to be able to confirm the opinions and interpretations
of the Auditor General with an outside professional group also familiar
with the problems. Such a check provides an additional benefit to the
Auditor General because it removes all doubt concerning the professional
nature of his Opinion or interpretations, and, in effect, preserves the
integrity and effectiveness Of his department.

Third, such a group provides a badly needed liason between govern-
ment auditors and professional accounting groups. This is particularly
important in a state such as Illinois where the bulk of the state audit
work is actually conducted by independent public accounting firms, but
it is also important in states where such firms are not greatly involved
in state audit work. Unfortunately the Illinois Advisory Board has not
been able to be very effective in providing this liason, and efforts
are being made to improve the Situation. Both the state and the accoun-
ting profession stand to gain from a mutual exchange of ideas and infor-
mation.

While this example of the Illinois situation is an excellent one
in theory, in actual practice there seem to be some problems which require

additional attention. One of these is the fact that since all members

91

of the committee are active professional men, they have insufficient time
to devote to the numerous problems that require their review. Further-
more, the fact that they receive no financial compensation other than a
reimbursement of necessary expenses makes their work a voluntary contri-
bution, and the attention given sometimes reflects this fact. Finally,
while the size of the board (five members) is adequate for the review

and analysis work that is required, it has not been adequate to conduct
the investigations or penetrating examinations into the problems of stan-
dards and practices that are needed to make the function most effective.
Neither has it permitted effective working relationships with professional
groups or with governmental groups as was originally intended.

The solution to these problems may not come easily. Nevertheless,
the Advisory Board and its function represent another important element
in an effective post audit program which merits the careful consideration
of every state. Some such organization is needed, whether it be organ-
ized similar to the one in Illinois or in some other way. Its potential

contribution to the audit program certainly seems Significant.

Summary and Conclusions

 

A few years ago a television documentary on state legislatures
asked whether or not the legislature still serves the purposes for which
it was intended, and Duane Lockard, in attempting to answer the question,
pointed out that the answer depends upon what the legislature was intended
to do. He adds, "If it was 'meant' to be a well-spring of public policy,
a primary initiator of rules, a master of the public purse, then it is
not unreasonable to say that it no longer serves its intended purposes

fully."1

 

1Lockard, op. cit., p. 274.

92

Certainly state legislatures, like other political institutions,
are to a great extent the product of evolutionary processes. Their his-
tory is filled with trial and error, with contest and compromise, and
with change over time. Perhaps the intent of the originators of the
system has little meaning for modern society which is well over a cen-
tury removed from that early beginning. In any event, as Lockard con-
tinued, ”it is obvious when one examines the duties of and the powerful
role played by the state legislatures.of the 19th Century that the legis-
lature of today represents a striking contrast."1

In this chapter an attempt has been made to describe a theoretical
system of control which is consistent with the original purpose of the
legislature, yet which reflects the realities of modern state govern-
ment. Certainly no state has such a system fully developed, but almost
without exception, every State is moving in this direction on at least
one or more of the issues. Legislatures are both a part and a reflection
of the political, social, and economic changes and circumstances which
surround them, and they therefore move in the same direction as do other
institutions in society. The use of sophisticated and scientific manage-
ment techniques within the framework of government will come just as
surely as in business, and the strengthening of the control systems in
government will likewise parallel that which is being developed in
commercial enterprises.

Many factors have conSpired to produce the current status of the
state legislature, and this chapter by no means discusses or proposes
remedies for even a small portion of them. However, one of the respon-

sibilities of the legislature which has lost much of its effectiveness

 

1Ibid., p. 275.

93
over time is its ability to control and review administrative performance.
In this area the material in this chapter offers considerable hope for
improvement.

The legislative process has been briefly analyzed,including the expres-
sion of legislative policy, intent, or will. It was noted that in most
cases there is great need for improvement. The system of legislative over-
sight or review was discussed including not only the use of performance
post auditors but also the need for a legislative audit committee and an
audit review board, and the dependence of independent auditing upon the
system of management control and internal audit was emphasized.

The role of the auditor general and the scope of his audit were
discussed and related to the system of legislative control. It was
found that the traditional financial audit is by no means adequate to
permit the auditor's review to be of great value to the legislature.
Viewed in the context of the legislative control system as a whole, the
performance post audit becomes more than a possibility; it becomes a
necessity. Furthermore, it is within the competence of the auditor to
conduct such an audit, providing he is not required to go beyond the point
where he can make valid comparisons or use accepted standards in rendering
his Opinion on performance. Faithful fulfillment of executive commitments
and compliance with legislative policy, effective administration and con-
trol of programs and activities, and efficient use of all resources in
Operations are all proper subjects for audit review. However, "economy"
was found to be inappropriate as an objective of the audit.

In Chapter IV which follows, the management function and the areas
of executive and administrative responsibility properly subject to audit

review by the auditor general will be more fully developed and analyzed.

CHAPTER IV

THE MANAGEMENT FUNCTION AND THE PERFORMANCE AUDIT

Introduction

 

If the Auditor General is to audit the area of executive performance,
it is essential that he understand the function and reSponsibility of
executive Officials. Basically, that function is similar to what one
would expect to find in industry. As noted in the previous chapter,
it consists Of planning, executing, and reviewing the activities of the
state. In this chapter, these broad areas will be further subdivided
and analyzed, and the implications for the auditor will be noted.

It is important to state at the outset that this chapter does not
treat in depth any of the numerous responsibilities and activities of
administrators. It i§_pp£_the purpose of this study to tell management
how to perform its functions. Neither is it the purpose of this study
to propose changes in the management system. However, numerous changes
have been suggested, many of which seem inevitable given the progress
and evolution of state government. Thus, this study takes a forward
look and attempts to describe these functions not so much in terms of
what actually has been done but what theoretically is done and ultimately
will be done if the proposed reforms and improvements are fully adOpted.

In this reSpect this description of management reSponsibilities will
seem to some as being too idealistic and perhaps too Optimistic. Yet it
is no more idealistic to talk in terms of program budgets, for example,

94

95

than in terms of performance audits. The purpose of this study is to
identify the direction of change and to expose the picture that lies on
the horizon of expectation and possibility and progress, not to lament
the current situation.

Although the expression may be made in this chapter that certain
things are needed before the auditor can fully perform his function in a
meaningful manner, it Should never be understood that such reforms are
being prOposed because they will facilitate the audit. In almost every
case, and the exceptions will be duly noted, reforms or changes are needed
because they permit or help management to better perform its own functions
and carry out its own reSponsibilities. And the position of this Study
is that the better informed management is in its decisions and the better
the control is that management exercises over operations, the easier
and more useful the audit becomes. Thus, improvement in management
methods leads to better auditing, and the fact that something is needed
befOre a meaningful audit can be performed usually implies that it is
needed by management to fully be able to conduct its affairs effectively

and efficiently.

The Management Function in Brief

 

The essence of management is decision-making and control, and the
functions of management are planning, executing, and reviewing.

Every organization is presumably ordained to fill a mission, which
mission is conceived in terms of long-range‘ggals. Such goals are bro-

ken down into immediate objectives which seem reasonably attainable by

 

the organization. In a government where organization structures already
exist, the first function of management is to identify the Objectives

and to define them in workable terms. Once these objectives have been

96
defined, planning can occur, for planning is the process of charting the
most effecient and effective course for achieving the objectives within
a specified period of time. Planning, if rational, involves a weighing
of alternatives and the selection of the most appropriate alternative in
light of the objectives sought.

Programs are the means by which objectives are achieved. Thus a
program is characterized by the organization of activity and resources
toward the achievement of an objective. Several alternative possible
programs may exist each of which could achieve the objective, and the
management function is Uirationally choose from among them that program
which will produce the most efficient and effective result. Several
programs may exist within an organization, but ideally no single program
involves more than one organization.

In developing programs to achieve Specific objectives, management
must also detail the performance standards by which it will know when
such objectives have been achieved or by how far such objectives were
missed. Such standards are needed for each program. These standards,
to be most useful, should be objective, measureable, and consistent.

They should detail the conditions that will exist when the objective has
been achieved.

Once programs have been formulated, specific assignments of reSponsi-
bility can be made. It is the reSponsibility of management to deploy all
personnel and equipment and to establish the internal pattern of responsi-
bility. It is further the duty of management to dictate policies for the
purpose of giving direction to and controlling activity within the organ-
ization so that all effort and decisions combine to produce the desired
results. Consistent with this policy and with the assigned patterns of

reSponsibility, performance standards need to be set for each job or

97
activity so that management can determine and appraise the quality of
individual performance at every level of the organization.

Budgeting is the process by which scarce resources, usually expressed
as funds, are allocated among competing demands. Budgeting, to be most
meaningful, must follow program patterns and lines of responsibility.

In fact, since the selection of any one program from among several alter-
natives includes the consideration Of input-output or cost-benefit rela-
tionships, the allocation of resources occurs among programs at the time
each program decision is made. Within a given program, budgeting is the
process by which funds are assigned to the acquisition of specific
resources, both human and non-human, and both capital and Operating.

The responsibility of management includes the budgeting function at both
levels.

It is also the reSponsibility of management to provide a system of
accounting and reporting to record actual expenditures and obligations
incurred. Such a system should provide for program accounting consistent
with program budgeting and with the patterns of responsibility as assigned
within the organization. Reports should be made in terms of areas of
responsibility and program achievements, and should permit comparisions
with the designated performance Standards. Internal reports Should facili-
tate rational management, and external reports should provide relevant
performance statistics in terms of program achievements. It is not suffi-
cient to provide only statements of source and use of funds. Such funds
statements, to be meaningful, must be related to performance criteria.

Finally, it is the responsibility of management to review actual
performance and to take corrective action when needed to preserve the
integrity and effectiveness of the organization in achieving its objectives.

Such a review is accomplished in a variety of ways, including the post

98
audit by an internal auditor. Such reviews permit competent and accurate
representations by management on the performance of the organization in
terms of programs and objectives, both financially and otherwise.

In every agency or department of the state, however great or small,
management reSponsibility follows this pattern, including the responsibi-
lity of the Governor to the whole executive branch. However, in State
affairs, executive officials have additional responsibilities to the
legislature which tie into the functions above but which in no way inhibit
or detract from such functions.

First, it is the responsibility of management to present to the legis-

 

lature an estimate of the financial needs of the state over the next
fiscal period. Such an estimate usually is made in the form of the execu-
tive budget, which details state expenditures in terms of organizations
and programs. As support or justification for the budget presented,
the programs must be identified with specific objectives and must offer
the most efficient and effective alternatives available to achieve such
objectives. Furthermore, executive officials muSt demonstrate an ability
to carry out the programs in the manner prescribed. Thus it is necessary
to identify each program with a Specific organization and to designate
the responsible official. It is further necessary to demonstrate that
the necessary talents and resources are presently or potentially available
and that an adequate system of management control exists within the organ-
ization to insure that effort and decisions are oriented toward the proper
objectives.

It is also the responsibility of executive officials to report to
the legislature the results of operations. Thus, when plans are proposed
to the legislature in support of budgetary requests, it is important that

executive officials identify appropriate standards by which performance can

99
be measured and reported, and it is important that reported performance
correspond with and relate to such Objectives and standards.

Thus, in theory, the legislature is able to review executive planning
and approve proposed programs as well as to check actual performance
against such plans and proposed programs. In this reSpect, the legisla-
ture serves as the guardian of the public interest to insure that every
reSponsible administrative Official of the state is held accountable for
his use of public resources.

Unfortunately, no state today operates entirely in the manner
prescribed above, although some are much closer than others. There are,
however, encouraging indications that most states are moving in this
direction. In the sections which follow, the major items of this system
will be noted. But first, this theoretical system will be related to the

work Of the auditor general.

Implications for the Auditor

 

It is important that the auditor be familiar with the whole manage-
ment function, not just with a few segments of it, if he is to render
an informed and competent opinion on performance. There are several
reasons why this is so.

First, actual program performance is a product of the planning func-
tion. Poor performance results either from poor planning or from devia-
tions from plans. Thus, while it is helpful to know actual performance
for a given period, it is perhaps equally important or more so to know
whether or not such performance agreed with or deviated from planned per-
formance. Only then can corrective action be taken, for only then can
the source of difficulties be determined.

Second, legislative policy is a reflection of the legislatures's

100

reaction to proposed plans and programs as presented by the executive
branch. Thus to fully understand legislative intent and to test to see

if legislative policy has been effectively and faithfully followed in the
execution Of programs, it is necessary to know on what basis such policy
was formed and intended. Furthermore, executive commitments to the
legislature are,or at least should be, based upon planned activity and
planned programs, and thus it is necessary for the auditor to be familiar
with the planning function to understand such commitments and to determine
that they have been faithfully kept.

Third, it is in the planning process that performance standards are
identified by which management is able to determine if programs are achieving
their desired objectives. It is likewise by means of these same standards
that the legislature and the auditor general are able to determine whether
or not performance has met expectations. Thus it is important not only
to know what standards are being used or how they are being used but
also whether or not they effectively serve the function for which they
are established. Without adequate standards an objective evaluation
of performance may be impossible, both for internal management and its
internal auditors as well as for the auditor general and the legislature.

Fourth, it is one thing to report that performance did or did not
conform to accepted plans and quite another to pinpoint the problems
and take responsible corrective action. Thus, the auditor general must
examine the internal review function to determine that responsibility
for performance is established by management and that proper corrective
measures are taken to improve it in the future. Such a review includes
not only a test of the adequacy and effectiveness of the internal auditors
but also of management's reaction and follow~up to internal audit recom-

mendations. It also includes an examination to determine that each responsible

101

official effectively reviews the area of his own jurisdiction, including
the performance of all persons directly responsible to him. The corrolary
of this requirement is that the auditor must determine if authority has
been properly defined and responsibility properly assigned consistent
with the proposed organizational plan to carry out and implement the pro-
grams.

The same is true for the whole system of executive control, from
the initial plan to the final action taken. In addition to the areas men-
tioned above, the adequacy and effectiveness of policy must be examined.
The accounting system must be tested in terms of adequacy and appropriate-
ness to insure that information is recorded and reported in terms of
programs and areas of responsibility. And an effective review of oper-
ating procedures is essential to insure continued efficiency in the use
of funds and other resources available to management.

A final purpose for these reviews is to provide the legislature
with information relative to its responsibility and to implement legis-
lative control through the auditor's review. Legislative control is
affected in part by the degree of executive control, and the more effec-
tively management reviews and strengthens its own control system, the
less need there is for a penetrating and detailed legislative audit
review of operations. Thus, ideally the auditor general need not be
so much interested in testing for efficiency as to see that management
does it, for efficient operations come not so much from recoveries and
corrections after errors have been found as in the careful control of
such matters in the planning and reviewing processes as performed by
management. And the same is true for most of the other tests of perfor-
mance. Truly the more effective the auditor general is in recommending

and securing improved management controls and reviews, the more he reduces

102
the extent of the need for his own audit work. Thus it is essential that
he fully understand the management function from beginning to end so that
he can appropriately test the whole executive control system and make

appropriate recommendations for improvements and adjustments.

Planning

Planning is the most basic characteristic of executive action. As
Dimock says, "The executive may not consciously use the term, but all
his work, whether he knows it or not, is in some way concerned with the
unfolding of a plan."1 The essence of planning is making decisions.

Planning is the means by which rational choice is brought out of
chaos and purpose is given to action. Yet planning itself can be chaotic
and confusing if it is not undertaken systematically or if it is not
based on sufficient or reliable information.

Before a decision can be made, two or more mutually exclusive alter—
natives must be available. And if the decision is to be rational, full
information must be available regarding the consequences of choosing
either alternative. Thus the biggest difficulty in planning is Obtaining
sufficient competent information on which to base the decision.

Planning is always concerned with action that will occur in the
future, and since the future is always uncertain, planning is always
subject to uncertainties. Thus, no plan can guarantee success, although
’the safest formula for achieving success is still the admonition familiar
to most executives: Plan your work and work your plan. Through planning,
an organization becomes better prepared to face the uncertainties as they

become realities and to respond or react appropriately. Changing conditions

 

1Marshall Edward Dimock, The Executive in Action (New York: Harper
and Brothers Publishers, 1945), p. 124.

 

103
are inevitable, but through planning, management seeks to influence and
control the nature and direction of change and to determine how desired
change can be brought about. Thus, as McFarland declares, ”The ability
to plan successfully sets the adept executive apart from those who are
"1
merely average.

Planning in the state involves every level of state organization
and administrwation. It is not just an activity for top-level executives.
This fact is illustrated in the following instructions in Illinois:

Since each Agency is required . . . to present its plans,
programs, and requirements for approval, there should be esta-
blished in each Agency, a planning function, directly super-
vised by the Agency head and charged with the duty of develo-
ping future plans and requirements of the Agency. This function

. should be clearly assigned andstaffed . . . in order
that the programs developed are the most effective and econo-
mical for achieving Agency objectives.2
In reviewing the planning function, the auditor is not charged with

the responsibility of questioning the decisions themselves. What he is
charged with is determining whether or not the planning function is
explicitly recognized, staffed, and performed. He may also review the
adequacy or completeness and the reliability of the information upon
which plans are based, and most importantly, he can certainly determine
whether or not alternatives are being considered and evaluated or
whether tradition and habit dictate the choice. In no way does the audi-
tor become a consultant in the planning process. Such professional help
is available within the executive branch or can be secured independently

by management,but the auditor general Should in no way become involved

in making decisions or dictating policy that is the responsibility of

 

1McFarland, Op. cit., p. 70.

2Illinois, Department of Finance, Reguirements for Internal Control
and Recordkeeping in State Agencies (State of Illinois: December 27,
1963) , p. 2.

 

 

104
management.

The elements of planning include selecting objectives, setting stan-
dards, formulating programs, allocating resources, determining policies,
and assigning responsibility. Each of these elements of planning will
be considered below as separate items, although it is obvious that they
correlate with each other very closely and in fact are almost identical

problems in many cases.

Objectives

 

The first step in planning is the clear determination of objectives,
for as Dimock explains, "you cannot make valid detailed plans for either
your program or your strategy until you know just where you are going.”1
This fact is supported by Schultze who said, "The first and most difficult

of these tasks is defining program objectives in specific terms capable

 

of being ana1yzed."2 (emphasis in the original)

Not only is it important that Objectives be Specific, they must also
be associated with definite time periods within which the Objectives are
expected to be achieved. For unlike long-range goals or missions, objec-
tives represent achievable results within a Specified time period. Stated
in another way, objectives are the immediate contributions which the organ-
ization expects to be able to make toward its long-range goals or mission.

Presumably the objectives result from the desires and needs of society
as reflected in the demands on the state. Thus, broad Objectives for
each organization must be determined or defined by top management, and
for state organizations which have had a long history of activity, such

objectives are to a great extent influenced by custom, tradition, and

 

1Dimock, op. cit., p. 54.

2Charles L. Schultze, ”Needed: New Approach to Expenditure Evaluation,"
Tax Review (August, 1965), p. 32.

 

105
law. Once organizational objectives have been defined, they must be
broken down into program objectives. That is, each program of the state
should contribute in some way toward the achievement of one or more objec-
tives.

Objectives may be viewed in a hierarchical pattern. The achievement
of several small objectives with limited programs may be necessary before
a higher order of objectives may be sought, and the achievement of several
higher-order objectives may be necessary to achieve the overall objectives
of the organization. For example, an Objective of the Conservation
Department may be to improve fishing conditions in the state. Before
this can be done, however, fish must be raised in fish hatcheries in
sufficient quantities to provide for planting of additional fish in the
lakes and streams of the state to improve the fishing conditions. But
even before the fish can be raised, trout farms must be secured and
hatcheries built, so this becomes the objective of the first order.

Its achievement permits the second objective to be tackled, and its
achievement in turn permits the final objective to be undertaken. The
important thing to recognize is that at every level, programs and acti-
vities are oriented toward the achievement of an objective which is Speci-
fic and identifiable.

It is the function of management not only to define and identify
such objectives but also to communicate them effectively to reSponsible
members of their organization, and even to involve the members of the
organization in defining and refining the objectives. Each member of
the organization should be able to answer the question: What are we trying

to accomplish? As the planning function is basic to each agency, so also

is the identification and clarification of objectives.

For any agency, there are numerous objectives which could be sought.

106

Rational planning requires that they each be considered and carefully
analyzed and that from among them those objectives be selected which are
most urgent, are in the greatest public demand, and are within the
immediate capability of the organization to achieve. This selection
of Specific objectives is subject to certain restraints as represented
by the limited resources which are available to carry out such objectives.
As Arthur Smithies explains:

Governments, like private individuals or organizations,

are constrained by the scarcity of economic resources at

their disposal. Not only the extent to which they pursue

particular objectives, but the character of the objectives

themselves, will be influenced by the resources available.

On the other hand, the extent to which the government desires

to pursue its objectives will influence the resources it makes

available to itself by taxation and other means.

Thus, from the very beginning, planning involves compromise and
choice, and nowhere is this more evident than in selecting and defining
appropriate objectives. No state, whatever its resources, can prevent
all crime, maintain perfect public or mental health, or fully educate
all of its citizens. Each state takes certain risks in public safety
in order to provide better public education. It is impossible to avoid
compromises of this nature. Likewise, it is necessary to compromise
between the present and the future. Maximizing public education today
may mean putting Off until tomorrow the improvement of the state's high—
ways, thus perhaps delaying the state's economic growth.

As a result of the limitations and compromises inherent in the
selection of objectives, it is important that those objectives be desig-

nated in terms of priorities. There will always be a surplus of needs

and demands beyond that which can be accomodated within the current means

 

1Arthur Smithies, ”Conceptual Framework for the Program Budget,"
Prpgram Budgeting, ed. David Novick (Washington: U.S. Government
Printing Office, 1965), p. 2.

 

107
of the state, but as Maurice Stans said, "This does not mean that such
unmet needs have been dealt a fatal blow. In time, if they have genuine
merit and the support of public opinion, they will have their day."1

It is not the reSponsibility of the auditor to question Objectives
chosen by administrators. This is the reSponsibility of the legislature.
Once approved by the legislature, the auditor has the right to determine
that such objectives are being pursued. In the event the auditor finds
that the legislature has not fully understood the implications of pursuing
a given objective, he may suggest to the legislature that it inquire
further into the matter. But it is not the auditor's duty to interfere
in any way with management's right to choose from among the alternative
objectives that are possible.

In the event the auditor discovers that objectives have not been
clearly identified in an agency, he can make recommendations and sugges-
tions concerning their establishment. And under certain circumstances
as discussed below, determine whether or not the objectives are being

achieved.

Programming

 

Programs are the means by which objectives are achieved. Programming

 

therefore, is the process of determining the means of achieving Objectives,
and it involves two important steps.

The first step is to determine every possible way to achieve the
objective sought. It requires that new programs be analyzed for all of
their implications and that Old programs be evaluated to determine whether

or not they continue to serve their original purpose, or if there is now

 

1Maurice H. Stans, "The Federal Budget: The Deeper Issues," The
Journal of Accountancy (May, 1959), p. 36.

 

108
a better way of doing the job. As one writer noted, "it Should be recog-
nized that identification of programs must change from time to time as
services change.”1 The formulation and evaluation of programs at this
point is done strictly in terms of effectiveness. It requires an anal-
ysis in terms of results only. In this step alternative programs are
formulated and ranked in priority according to their effectiveness in
achieving the objective.

Programs, like objectives, vary widely both in Size and type. And
there is nothing inevitable or characteristic about a program except
that it must represent coordinated and organized effort oriented toward
the achievement of an objective. This leaves a lot of lattitude for
variation. For example, the major programs of a hospital may be developed
in terms of the age of the patient, such as child care, old—age care,
etc. These major programs may be divided into smaller programs, or
what some prefer to call sub—programs, based on the type of treatment
required for each of the selected age groups. On the other hand, the
major programs may be designed in terms of type of treatment required
with the minor programs determined by the age of the patient receiving
the treatment. Or some other breakdown may be possible. The important
thing is that the programsbeaconsistent with the objectives specified
and be designed in such a way that they can be identified with and
evaluated in terms of the objectives.

Ideally, each program is conducted within only one organization;
however, more than one program may be conducted by a single organization.

In the latter case, one individual would probably be charged with the

 

lCitizans Research Council of Michigan, "Proposal for a Grant in
Support of the Design and Installation of Program Budgeting for the
State of Michigan," 1964. (processed)

109
Specific reSponsibility for each program. Thus programming has direct
implications for organization structure and for the assignment of respon-
sibility within the organization structure.

The second Step in programming is to compare alternative possible
programs with the available resources of the state. The state, like any
other organization or institution, has limited resources available to it.
This is true of both human and non-human resources.

Human resources are limited both as to quantity and Skill. Not only
is it difficult and sometimes impossible to hire enough doctors or
teachers to fill the needs of the state hospitals and public schools
respectively, it is also difficult and often impossible to find needed
skills or leadership ability even among those inidviduals who are
available. And in formulating and evaluating state programs, it is impor-
tant that such programs be developed within the limits imposed by the
degree of competence and skill of present and potential state personnel.

Non-human resources are likewise scarce, and thus in evaluating
alternative program proposals, efficiency becomes vitally important.

In fact, in the long run all matters of efficiency eventually come down
to program decisions. Thus it is first necessary to determine the
minimum cost of conducting each proposed program. The relevant cost

in this case is incremental or differential cost. That is, the planner
must determine what additional costs will be incurred if the program

is undertaken that can be avoided if it is not undertaken. These added
costs must then be compared to the added benefits expected from the

program. This is cost-benefit analysis.1 At this point it is possible

 

1For a more detailed analysis of this process, see Gene H. Fisher,
"The Role of Cost-Utility Analysis in Program Budgeting," Program Budgetipg,
ed. David Novick (Washington: U.S. Government Printing Office, 1965), pp. 33-
48. See also Ruth Lowens Mace, Municipal Cost-Revenue Research in the United
States (Chapel Hill, North Carolina: The University of North Carolina, 1961).

 

 

110
to compare alternative programs to determine which one is able to achieve
the objective most efficiently. This process does not automatically pro-
vide the answer to the question of which program should be selected, but
it does provide a rational basis for that choice by showing the implica—
tions of the available alternatives.

In theory, this process of analysis is simple to describe. Pro-
gramming seems to offer no major conceptual difficulties in either of
the above two steps. However, in practice, programming has proven to
be far more difficult to accomplish than is suggested here. In fact,
after several years of study and hard work on the part of many indivi-
duals, there is still no system in existence in any state that is program-
med on this basis.

Since programs are designed to achieve specific objectives, it
becomes the responsibility of the performance auditor, internal or inde-
pendent, to conduct an examination to determine if in fact the programs
are accomplishing the objectives designated. This test requires the
use of performance standards, as discussed below. It is also the reSpon-
sibility of the auditor to determine that relevant cost figures and other
suCh information is used in the programming process and to compare the
actual costs incurred to the estimated costs. Any testing that the audi-
tor doeS for efficiency and effectiveness of operations ultimately ties
back to the programming process, for it is in this planning step that
operating procedures are determined.

One fact Should not be overlooked, however. The ultimate decision
to conduct program A rather than program B includes a number of factors
other than considerations for efficiency and effectiveness as described
above. Right or wrong, political considerations also are given consider-

able weight in the selection of one program over another; and tradition,

111
custom, personal opinions or preferences of executive Officials, and
many other such elements influence any final program decision. However,
the point of this discussion is that the state can determine its basic
policies and programs most effectively if it chooses among alternative
courses of action with a knowledge of the implications of the alternatives
involved, and even political choices can be improved if politicians are
aided by comparative information and technical analysis of the probable
consequences of each alternative choice available to them. Frequently
such information and analysis is lacking at both the state and the fed-
eral level of government. As Schultzaexplains:
At present, problems often come up for decision at the

highest political levels in a form which prevents the making

of sensible choices. The objectives may be unclear, the

contribution of particular programs to these objectives

Obscure, the costs highly uncertain, and most commonly the

relevant alternatives missing.1

Thus, in his examination, the auditor can render a valuable service
by testing the planning-programming system to determine if it provides

the needed information and analysis on which to make a rational and

informed choice.

Prggram Budge ting

 

Of all the subjects relating to the fiscal affairs of state govern-
ment, none has been more debated or discussed in recent years than has
the subject of program budgeting. The term is familiar to virtually
every employee of every governmental ageny in the United States; yet
few if any of them understand its meaning and significance. For this
reason, the term has not been used in the deve10pment of this study up

to this point.

 

1Schultze, Op. cit., p. 33.

112

Program budgeting means a variety of things to a variety of people.

As Mosher explains:
Tia student of politics and of legislative bodies, it

means perhaps a reduction of appropriation items, a rational-

ization of the appropriation structure in terms of programs,

a presentation and review of budget requests in such a manner

as to emphasize issues and make possible more effective choices.

To a top administrator, it means these things and also greater

flexibility and descretion in his operations, plus better con—

trol and accountability with regard to subordinates. Down the

line of an agency, it may mean a single source of funds, an

enlargement of authority, flexibility, and responsibility in

the use of the funds, and a mechanism for relating program

planning with financial planning. To the accountant, it means

accrual accounting, cost accounting, segregation of capital

from operating accounts, working capital funds, and many

other techniques.1

Yet even this explanation fails to fully identify the multifarious
connotations of the term. Thousands of pages of print have been devoted
to a discussion of various budget concepts, including program budgeting,
performance budgeting, cost-based budgeting, line-item budgeting, and
many others, and to lengthy discussions of the relative merits or weak-
nesses of each of these systems. A representative sample of this lit-
erature is included in the bibliography of this study. For purposes of
this discussion, ”program budgeting" will be used simply to define the
process of allocating available state funds (revenues) to state agencies
on the basis of programs and expected program achievements, not on the
basis of objects to be purchased. Thus, budgeting is an integral part
of the planning process and is consistent with the other phases of plan-
ning. Indeed, as noted above, programming cannot occur without considering
the cost implications, and neither can budgeting be rationally accomplished

without considering program implications and objectives. A program budget

is literally the dollar expression of the program plan.

 

lFredrick C. Mosher, Program Budgeting: Theory and Practice (New
York: Public Administration Service, 1954), pp. 80-81.

 

113

The term program budgeting has frequently been used to describe
the whole planning process from the setting of objectives to the estab-
lishment of program accounting systems. Its use in this study, however,
is not so broadly conceived. The purpose for this restriction is to
avoid the common misconception that the inadequacy of the budget is at
the heart of the state's financial and control problems. Certainly
improvement in budget formulation and preparation is needed, but the
budget is merely a reflection of the planning process. And the basic
prOblems of the state lie in planning and programming, not in budgeting.
If objectives were defined and programs were properly developed, the
budgeting would reflect these changes. TO mask these planning problems
under the name of program budgeting seems somewhat inappropriate and
misleading. In recent months a better expression--”planning-programming-
budgeting"--has begun to be used which expresses the problem more as it
exists.

Programming and budgeting need to be distinguished in another
respect. Programming involves planning over a longer period of time
than does budgeting. Programs can seldom be Started and completed in
one fiscal period. Usually programs must be projected several years
in advance, and while long-range program projections certainly have bud-
get implications, the budget is prepared and authorized anew each fiscal
period, which is one or two years depending upon the state. Thus the
budget document itself only reflects current program needs.

In Spite of the theoretical arguments favoring a program budget,
no state in the United States has yet developed such a budget. Several
states have made some progress in this direction, as noted below, but
none have yet succeeded. Most state budgets are still prepared on the

basis of objects of expenditure. Consequently budget authorizations

114
detail the funds to be spent for tires or uniforms or light bulbs, and
the financial reports give detailed descriptions of where the money went.
Such a system, as Burkhead explains, ”shows p§e£_government purchases but
not HEX} accordingly, it does not show the nature of governmental pro-
grams, or accomplishments under those programs.”1 As a result, agency
administrators are held accountable for the supplies they buy and the
people they hire but not for the achievement of program objectives.

Charged only with spending the funds allotted for acquiring supplies
and personnel, administrators have little incentive to economize on the
use of funds. Funds found to be in excess of current needs are often
Spent for additional supplies or other items such as sidewalks and land-
scaping. The measure of successful administration is frequently based
on how much can be Spent rather than on how much can be achieved. Further-
more, : few major attempts are made to review continuing programs to
determine whether they continue to need the sum of funds normally allotted.
Only new programs and incremental changes in old programs are given care-
ful scrutiny. In brief, efficient and effective use of the state's
resources is not fostered by a line-item appropriation budget.

Program budgeting, on the other hand, Offers such incentives. Under
program budgeting, administrators are granted Specific funds to achieve
Specific results. Budgetary control results not from determining that only
authorized items have been purchased, but whether funds granted have been
used efficiently and effectively in achieving the program objectives.

Thus, management is motivated to improve operating procedures and methods,
to economize in the purchase of supplies and in the hiring of personnel,

and to combine the resources at its disposal in such a way that the output

 

1Burkhead, op. cit., p. 133.

115
of the organization is optimized.
Another advantage of program budgeting is that it provides a con-
txrol over the kinds of things government does. AS one writer noted:
Line-item budgeting without other planning or program
stipulations can also favor extensive administration leeway.

Diminution of one program may free manpower and supplies for

another. When this goes unstated and unaccompanied by bud-

getary reductions, the . . . officer working within admini-

strative rules and a statutory framework that he well under-

stands may undertake major new programs, or even traditional

ones that had been most scrupulously vetoed previously.1

Many other advantages and disadvantages of each method could be
noted, and a discussion of the obstacles to the development of program
budgets might well constitute a subject for dissertation research in
itself. But the point of this discussion is that rational planning and
effective control require that fund allocations be based upon programs
designed to achieve specific objectives. Budgeting must be oriented
toward output, not supply. Only then can costs be effectively identi-
fied and compared with program achievements and responsibility for
waste and inefficiency secured.

Responsibility for developing such budgets falls at two levels of
the state. Since planning and programming are agency responsibilities,
it is also the responsibility of each agency to determine the estimated
cost of the resources needed to carry out the programs. The agency also
has the responsibility to see that there is a consistent relationship
between budget preparation and budget execution, for the planning which
is done in the preparation of the budget request provides the basis for

the management of the programs that are authorized. Thus if program

execution is to be efficient and effective, programming and budgeting

 

1Henrik L. Blum and Alvin R. Leonard, Public Administration--A
Public Health VieWpOint (New York: The MacMillan Company, 1963),
p. 185.

 

 

116
must be planned with these Objectives in mind by the agency who will
carry them out.

At a higher level, the central budget office Of the state has two
responsibilities, according to Burkhead. They are "program review and
management improvement."l Program review is concerned with evaluating
not only the operations and programs of individual departments and
agencies, but also with the comparison and coordination of programs of
all agencies relative to each other. It must review the benefits to be
derived with one program as compared to another. It must further insure
that program planning and budgeting follow the broad objectives of the
state. And finally, it must determine that funds are available or will
become available to support the proposed programs.

The second responsibility of the central budget office is management
improvement. "Management improvement,” says Burkhead, "consists in the
Optimization of a given program-~the effective allocation of resources
for the achievement of objectives.”2 This requires that the central
budget office be concerned with program efficiency, the appropriateness
of the methods by which the program objectives are to be accomplished,
and with the effectiveness of organizational structure and executive
policies to control and give direction to the performance of the program.
Both program review and management improvement, as a practical matter,
are accomplished simultaneously, and both are important in effective

management planning and control.

Progress in Program Budget Development

 

As noted above, no state at the present time has a program budget

that is operative, although several states have made some progress in

 

1Burkhead, op. cit., p. 278. 2Ibid.

 

117
that direction. The following discussion of this progress is intended
to provide a brief position report and does not constitute either a
critical evaluation of such progress or a full coverage of all states
who have experienced such development. It is, however, sufficient to
indicate that progress to date is small compared to the vast amount
of work still to be done.

A careful review of the literature in the early stages Of this
study seemed to indicate that substantial progress had been made in
a number of states and cities in developing program or performance
budgets. As each of the claims was checked out, however, it was found
that in most cases the actual progress made was substantially less than
that claimed in the article or other publication reviewed.

For example, several articles indicated that the State Of Maryland
had affected a substantial revision of their budget procedures and had
fully developed a performance or program budget, which was reported to
offer substantial improvements not only for managerial decisions and
control but for legislative review as well.1 George A. Bell, for example,
states in his monograph that "among the states, Maryland is a pioneer in
program budgeting. . . . The Maryland system is significant because of
its comprehensiveness."2 He also listed some other states that he claimed
had utilized this concept, among them Illinois and Michigan. These state—
ments were made in 1957, yet in 1966 Michigan is just presenting its first

sample of program budgeting (see below), Illinois denies having used a

 

1See John A Donaho, "Performance Budgeting in Maryland,” Municipal
Finance (November, 1955), pp. 69-77; and John Wood Logan and John A.
Donaho, ”The Performance Budget and Legislative Review,” State Govern-
ment (July, 1953), pp. 185-187.

 

2George A. Bell, State Budget Administration in Maryland (College
Park, Maryland: Bureau of Governmental Research, University of Mary-
land, 1957), p. 14.

 

118

program budget, and an examination of the Maryland budget document for
fiscal 1966 reveals no program breakdown, no identification of program
Objectives, no program justification in terms of services rendered or
Iiroducts produced, and no evidence that any of these items are contained
in any other documents.1 What is found is a budget prepared in terms
of broad functional activities, which is certainly an improvement over
line-item expenditures. But it can hardly be termed a completed and
operative program budget.

Likewise, one budget officer of New York indicated in 1960 that
New York State had conducted a vast study to program all of the activi-
ties Of the state.2 This study followed an earlier one at Homer Folks
Hospital which supposedly served as a pilot study. However, a visit to
New York in the Spring of 1966 failed to locate any broad development of
programs of the type and scale indicated. It was found, however, that
in the last couple of years a great effort has been made to program the
activities and budget of one department--the Department of Taxation and
Finance, and work is currently being started in others. Correlated with
the program budget development, a Joint Statewide Accounting Improvement
Committee was set up which deveIOped a program accounting system consis-
tent with the activities and budget of the department.3 AS a result of

the progress in the Department of Taxation and Finance, its budget for

 

1See Maryland, Fiscal Digest of the State of Maryland, for the fis-
cal year 1966, including Revenues and Appropriations with Explanatory
and Supplemental Statements.

 

2See Daniel Klepak, ”Efficiency and Economy through Program Eval-
uation," Municipal Finance (August, 1960), pp. 59-63.

 

3See New York, Joint Statewide Accounting Improvement Committee,
Accounting_Improvement Program of the State of New York, Third Progress
Report of the Joint Statewide Accounting Improvement Committee, Sep-
tember l, 1965.

119
fiscal year 1966-67 is presented on a program basis in the executive
budget submitted by the Governor to the legislature.1

Based upon the experience gained with the programming of this first
department, the state prepared and issued to the remaining departments
of the state an instruction booklet on planning—programming—budgeting
which outlines the basic policy and approach to be used by other depart-
ments in the development of their own program budget systems.2 Also,
the accounting systems in the State Education Department and in the
State University of New York are being converted to a program basis.
Certainly the work of the state is commendable and is perhaps as far
advanced as any State in the nation. Yet as New York State Officials
themselves are quick to admit, they are just getting off the launching
pad.

In Michigan, all agencies and departments of the state were recently
reorganized into 19 major departments as required by the new Constitu-
tion. Recent budget emphasis, as a result, has been placed primarily
upon the problems associated with the reorganization. However, two
departments were selected for initial programming, and their budgets
were prepared and submitted to the legislature in 1966 on a program
basis.3 The two departments involved are the State Department and the

Conservation Department. An analysis of the budgets prepared indicates

 

1New York, The Executive Budget, for the fiscal year April 1, 1966,
to March 31, 1967, submitted by Nelson A. Rockefeller, Governor, to the
New York State Legislature, 1966 Regular Session.

 

2See New York, Executive Department, Division of the Budget, and
Executive Chamber, Office for Regional Development, Guidelines for
Integrated Planning, Programming, Budgeting. 1966.

3See Michigan, The Executive Budget, for the fiscal year 1966-67,
including the Supplement to Department of State 1966-67 Recommended
Budget, and Supplement to Department of Conservation Recommended Budget;
prepared by the Budget Division, Bureau of the Budget, 1966.

 

 

 

120
that substantial progress has been made in identifying the major activi-
ties and functional areas of these two departments. However, considerable
work still needs to be done in program planning before the full objec-
tives of program budgeting can be met. Nevertheless, the progress to
date is certainly encouraging.

In 1964, an article in State Government which was co-authored by

 

the Governor of Wisconsin1 reported that programming in Wisconsin would
be completed so that the budget for the fiscal biennium of 1965-1967
could be put entirely on a program basis. Once again, however, the

actual budget prepared seems to have fallen short of the expected develop-
ment. In California, the Governor smeitted to the legislature in 1965

a report entitled Sample Pregram Budgets.2 It contains examples of such

 

sample budgets for twenty one state agencies and authorities. While
these budgets are by no means fully deveIOped and refined, they do
represent a start in breaking down some of the complex activities of
the state into reasonably well defined components. Much more work will
be required before the sample budgets are able to fill fully the needs
of the state in this area, but again the progress is encouraging.
Undoubtedly the most notable progress in programming has occurred
in the Defense Department of the United States.3 Yet for all its
noteriety, very little has been written to describe the details of

the system used, perhaps because of the classified nature of the

 

1John W. Reynolds and Walter G. Hollander, "Program Budgeting in

Wisconsin," State Government (Autumn, 1964), pp. 210-215.

 

2California, Sample Program Budgets, for the fiscal year July 1,
1965 to June 30, 1966; submitted by Edmund G. Brown, Governor, to the
California Legislature, 1965 General Session.

38ee Robert J. Massey, ”Program Package and the Program Budget in
the Department of Defense,” Public Administration Review (March, 1963),
pp. 30-34; and Charles J. Hitch, "Management of the Defense Dollar,"
Federal Accountant (June, 1962), pp. 33-44.

 

 

 

121
information involved. But it seems that substantial help could be rendered
to other governmental bodies if more detail were known both of the achieve-
ments and the limitations of that system. The satisfaction on the part of
leading Washington officials with the Defense Department system is indicated
in its endorsement by President Johnson who issued a memorandum dated
August 25, 1965, to the heads of all Federal Government departments and
agencies, stating in part:
At the Cabinet meeting today, I announced that we would

begin to introduce a new planning-programming-budgeting sys-

tem in the Government. This will be a large and important job.

I want all of you to devote personal attention to it.

You Should begin at once to develop plans for the creation

of your program planning staffs. I want you to get the best

people possible for these staffs both from within your organ-

izations and from outside of Government.1

To assist the departments and agencies in complying with that order
from the President, the RAND Corporation, which has been working on a
comprehensive study of program budgeting, prepared an ”abridged version"
of that Study and made it available to the departments and agencies of
the Federal Government.2 This report constitutes undoubtedly the most
advanced and penetrating study yet available on the subject. But even
here, the problems identified are far more numerous than the solutions
suggested. In fact, the point is made time and time again in the study
that it is designed to provide thought-provoking discussion and analysis
and to stimulate ideas in the further development of the subject, not
to present answers and solutions.

Certainly program budgeting is no easy task. And those who have

tried and fallen short are not to be criticized for their failure to

 

1Quoted in David Novick (ed.), Pregram Budgeting, A RAND Corpora-
tion Study (Washington: U.S. Government Printing Office, 1965), preface.

 

2David Novick (ed.), Program Budgeting, op. cit.

 

122
complete the process. Every inch of progress requires weeks and months
of dedicated hard work by many individuals. And over the years as the
states, along with the Federal Government, work together in attacking
the problems that remain, effective systems will undoubtedly be developed.
Such systems will make major contributions to increased efficiency in
the allocation of resources, thus improving and expanding the benefits
society derives from the state's many activities. And equally important,
such systems will provide the necessary information and analysis to
improve the ability of executive officials to make rational choices

among the alternatives Offered.

Organiz at ion Planning

 

Program planning and budgeting are not sufficient by themselves to
insure effective and efficient operations or the achievement of state
objectives. It is necessary in addition for management to provide for
an organization structure within which the programs can be effectively
and efficiently carried out. Since state governments,and the agencies
of which they are composed, have existed for many years, it is not pos-
sible to start anew in developing a state organization based on current
plans and programs. Within the existing organizations, however, the
need to clearly assign reSponsibility and to define the limits of indivi-
dual authority clearly exists, and this is part of the management function.

Organization planning is not a separate or isolated responsibility
of management; rather, it is inseparably connected with the other basic
elements of planning. Organizational considerations permeate the planning
process from the selection of state objectives to the allocation of the

last dollar in the state budget. Its main purpose, according to Lukens,

123

is simply "to fix responsibility and accountability."1 Thus it includes
the process of identifying the various activities of the state which are
necessary to accomplish specific program Objectives, and of combining
these activities into jobs which may be performed and assigned to Specific
individuals. In the words of Zimmerman, organization structure ”is really
nothing more than a managerial device to assure that the unit achieves
its desired goals."2

Organization planning certainly has implications for program plan-
ning. AS noted previously, each program is ideally conducted within only
one organization. Thus organizational limits become program limits, and
if planning is to be effectively achieved, the organization structure
must be flexible enough and sufficiently dynamic to permit it to change
with changing objectives and to adjust to program needs. Furthermore,
only if program planning and organization planning are effectively coordi—
nated is program budgeting possible. Program responsibility and organi—
zational responsibility are then identical, and budgeting as well as
accounting and reporting are more easily accomplished on a program basis.

Finally, organizational planning is the chief way in which manage-
ment establishes its control system in the agency. Its importance to the
control system is no better indicated than by its prominence in the defi—
nition of internal control given by the American Institute of Certified
Public Accountants, which says:

Internal control comprises the plep_of grgenization

and all of the coordinate methods and meagures adopted
within a business to safeguard its assets, check the

 

 

1Matthias E. Lukens, ”Organizing to Achieve Program Objectives," in
Guidelines for Administrative Action, ed. Frederick C. Irion and Eleanor
Rosenthal (Albuquerque, New Mexico: Division of Government Research,
The University of New Mexico, 1961), p. 10.

 

2Robert R. Zimmerman, "Auditing the Organization Structure," The
Internal Auditor (Fall, 1965), p. 59.

 

124

accuracy and reliability of its accounting data, promote

Operational efficiency, and encourage adherence to pre-

scribed managerial policies.1 (emphasis added)

Certainly organizational planning is a vital and basic responsibility
of management for which management must account. Management performance
cannot be fully evaluated without considering how well this reSponsibility
has been met. And in addition, an understanding of the organization
structure and how it works will enable the evaluator to better understand
the programs and activities that are carried on within the department

or agency, for it is in organizational planning that the basic patterns

of responsibility and accountability are defined.

Performance Standards

 

Throughout the preceeding discussion, reference was frequently
made to performance standards. It was noted that performance standards
are necessary to determine whether or not objectives have been achieved
or by how far they were missed. Performance standards were also found
to be essential to determine whether each activity is contributing to
the program and each program to its proper objective. Thus, the evaluation
of program output requires performance standards. In fact, performance
standards are used in every evaluation of performance or achievement made
by every person in or out of the organization, whether that evaluation
relates to a single person or a group of people or to an activity or
program carried out by such persons. NO measurement can occur in the
absence of standards, and measurement of ”performance” requires "perfor—

mance standards . "

 

1Committee on Auditing Procedure, American Institute of Certified
Public Accountants, Internal Control (New York: American Institute of
Certified Public Accountants, 1949), p° 5. Also see Maurice B. T. Davies,
"Organization as a Basis for Control," The Internal Auditor (Winter,
1963), pp. 40-53.

 

 

125

These facts are very basic. Before one can measure distance he must
have acceptable standards of distance, such as yards or miles. Before
weight can be determined, weight standards such as pounds or tons must
be Specified. Without such units, measurement is impossible and commu-
nication is vague and imprecise. Even to express distance as "a long
way" or weight as "quite heavy” is meaningless unless related to some
norm or standard. The same is true if performance is expressed in terms
such as "reasonably well" or'Wbt too good.” These expressions, however
vague, connote the idea that intuitively or inherently the reader will
be able in his own mind to relate such concepts to some Standard or
norm. This fact is even more true for expressions such as ”better than
average" or ”below expectation,” for this type of expression clearly
implies that an average can be determined and that some level of expec-
tation can be Specified, each of which then serve as a standard for eval-
uating the performance or achievement described.

Standards can be Specified in a variety of terms and can relate to
an infinite number of different situations. This discussion, however,
will be limited only to those which relate to the evaluation of perfor-
mance in state government. The development of such standards is a
management responsibility. Standards of performance should be set by
top administrators and executive officials including the Governor in
cooperation with the members of the agency or department involved. It
is not a responsibility that (unlbe delegated to the accountant or budget
officer, although both may render valuable service in assisting in the
development of the standards. In short, performance standards are the
responsibility of the same people who are reSponsible for planning pro-
grams and setting objectives.

Two kinds of standards are particularly relevant: standards of

126
effectiveness and standards of efficiency. Standards of effectiveness
are those which permit judgement concerning the achievement of objectives,
whereas standards of efficiency relate to the manner in which men and
resources are used to pursue objectives. In the first case the relevant
statistics concern program output; in the latter the relevant statistics
concern program composition. In both cases, the specification of stan-
dards is an integral part of the planning process and shofld.be Specified
at the time objectives are chosen and programs are designed.

Performance standards always relate to peeple, and thus such stan-
dards have important implications for organizational planning. Virgil
Rowland, in his excellent book on standards, explains this fact: ”Every
managamam person needs to know how well he is expected to perform the
various segments of his job." He adds that "regardless of his level in
the organization, each management person needs to know what Standards his
immediate superior is using and what that superior looks for in the per-
formance of his subordinates."1 Whenever an assignment is made to an
individual, that individual has a right to know how well he is expected
to perform. And the "how well," for that individual, is his standard.

Thus, performance standards can be defined as a statement of the
conditions that will exist when a job is well done. At the program level,
the "job" is achieving the objective. Thus program Standards are state-
ments of conditions that will exist when the objective is achieved. And
for every activity or job assignment within the composition of the program,
equally appropriate standards are applicable. Fixing responsibility for
each individual for efficient performance according to established plans

is a fundamental concept of management control. If such individuals are

 

'1Virgil K. Rowland, Manegerial Performance Standards (New York:
American Management Association, 1960), pp. 31—32.

 

127
to be held accountable for performance, they must know precisely for what
and to whom they are accountable. And their performance must be reviewed
by management and evaluated in terms of the standards set. This is the
essence of effective and efficient performance.

The purpose of standards is to improve performance. This improve-
ment results from two things. First, the standards give the person
responsible an objective criterion by which he can measure his own
performance and make adjustments where he feels they would help. This
is the most important benefit to be derived from standards. Standards
should be incentives not clubs, and they can only become incentives when
they are established primarily to serve the person or group to whom they
relate. Furthermore, to the extent that such standards are effective
in motivating the individual to better performance, they will also serve
their second purpose, that of providing a means of performance review
by that person's superior. Thus performance Standards are the key to
effective organizational control and management review.

It would be extremely naive to suggest that it is possible to set
simple standards to measure how well the state does in providing educa-
tion or health or public safety, for the objectives in these fields are
complex. And the standards will likewise be complex. Yet as Schultze
says, such standards are "essential if we are to understand how our
programs contribute to our objectives."1 In discussing the same point,
Jerome argues that the difficulty in developing satisfactory performance
criteria ”results mainly from neglecting to define rigorously what we

. . . . 2
mean in a given Circumstance by successful or effective performance."

 

1Schultze, Op. cit., p. 33.

2William Travers Jerome, III, Executive Control-~The Catalyst (New
York: John Wiley G Sons, Inc., 1961), p. 55.

 

128
He contends that it is hard to define success because most people are
more failure oriented than success oriented. That is, it is much easier
to determine when something fails or goes wrong than to determine the
extent of success. Yet the standards that are needed to measure effec-
tiveness in government are precisely those that can give an indication
of the degree of success. They must answer the question: How successful
was the program in achieving the objective sought?

Two methods of selecting performance standards are often suggested
as appropriate for government. The first is based on the end products
produced, and the second is based on activity or work performed.

There are a number of government programs where the end products
are identifiable, measurable, and significant. Tax returns processed,
gallons of water provided, and number of trees planted are examples.
Others include miles of highway constructed and number of students grad-
uated. In each case, however, problems of homogeneity appear. Were the
trees planted on hills or level ground? Were the highways built in the
city limits, in mountainous canyons, or across arid wasteland? A single
statistic is not always enough to tell the whole story. Other factors
must also be considered.

Another weakness in output statistics is the inability in most cases
to include quality statistics that can be objectively evaluated. It is
sometimes possible to include size statistics or weight in addition to
the quantity, but most quality measurements cannot be expressed in size
and weight. Judgements of quality usually require the skill of an expert,
and even then they must often be based upon a set of values which may
or may not conform to those of other persons. Quality of education can-
not be measured by the number of graduates. It is true that it may be

determined in part by a combination of statistics derived from test scores

129
and student performance. But even these statistics must be evaluated by
one who knows and understands the education process and can bring to bear
on the evaluation problem the expertise which he possesses. The same is
true of the quality of medical treatment, the quality of public safety,
and the quality of criminal rehabilitation, to name only a few examples.
In each case, however, it must be recognized that someone can make the
quality judgement if he has the right combination of statistics. And the
jOb of management is to establish performance standards in light of this
fact and require that actual performance be related to the standards by
one competent to render such an opinion. Then not only the question
"How much are we doing?" but also ”How well are we doing?" can be ans-
wered.

It is important to note at this point that end—product statistics
can in no way determine the value judgements regarding what government
"should” do. The facts of performance are not judgements about the value
of a program and Should not be regarded as such. Judgements of this type
are made in the minds of men and are related to their social, political,
religious, economic and moral values in a way which makes it impossible
to determine them by means of such Statistics. The unit of output is
meaningful only as it relates to predetermined standards of what that
unit was expected to be. Its actual qualities can be compared to its
expected qualities. But this does not Specify whether or not its actual
qualities or its expected qualities are those qualities which it "should"
possess, nor does it determine that the unit "should" have been produced
in the first place.

The second type of performance standard is that which is based upon
activity or work performed. And even though this method is theoretically

inferior to the end-product method, it is nevertheless the one most likely

130

to be used in most agencies of the state for the simple reason that mean-
ingful output statistics are simply not available in very many cases.
Thus, instead of trying to measure education by the number of graduates
or some other such statistic, education is evaluated in terms of equiva-
lent full-time students taught, number of credit hours taught, or number
of classes held. Thus the relevant standards in this case are based on
what is done, not on what is accomplished. And the difference is sig-
nificant. As Burkhead explains, "Measuring accomplishment and measuring
work performed are not the same thing. Work performed is the process or
the activity; accomplishment is the end product. ."1

Even under the general category of work—load statistics, there
are at least two different types of standards. One type can best be
described as unit standards, the other as activity standards. Examples
of the first are unit costs and man-hour per unit ratios. Cost per
student fed in a school lunch program (or cost per meal) is this type
of standard. 80 also is cost per student educated or man-hours per
insurance claim processed. Situations which are not adaptable to such
unit-cost statistics or other unit standards must be classified under
activity standards. Rehabilitation programs, personnel training and
recruitment, and civil defense and preparedness programs are of this
variety. There are no meaningful unit statistics in these cases. Thus,
standards relating to the activities or programs must be related to the
whole activity or program, whichever the case may be. Yet even in this
case it is possible to state the conditions that will exist when the
objectives have been met, and this statement of conditions, however
brief or involved it may become, constitutes a statement of standards

which is useful in evaluating performance.

 

1Burkhead, op. cit., p. 142.

131

Each of these types of standards are relevant in some cases. And
some situations may require standards deveIOped in several ways. Edu-
cation is one such area. Yet it Should be obvious at this point that
true measurements of performance in terms of effectiveness and efficiency
can only be made when some output or achievement statistics are avail-
able,for only then is it possible to accurately determine whether or not
the program is accomplishing the ultimate objective of the state and is
doing so in an efficient and effective manner.

The conclusion of this discussion is simple. If management is going
to intelligently direct an organization, it must know (1) what it is
expected to accomplish, (2) what it does accomplish, and (3) what the
cause and significance of the variance between the two is. Only by set-
ting up adequate performance standards can any of these items be known
with exactness. Furthermore, while performance standards are useful for
outside review of managerial performance, their greatest utility is
their ability to assist management personnel in the performance and con-
trol of the operations for which they are responsible.

In spite of the obvious advantages of such standards, very few of
them formally exist in state government. As a matter of good management
practice, most managers formulate in their own minds certain standards
by which they judge the performance of their organizations. What is now
needed is a more precise and penetrating analysis of all programs and
objectives and the formulation of formal performance standards on a
broader and more objective basis. In a few cases, Special studies of
this nature have been undertaken. One notable study concerns standards

. . l . . .
of prison operations, and another involves the operations and serVices

 

1Roland W. Wood, "Standards for Correctional Agencies," State

Government (Winter, 1960), pp. 48-52.

 

132

of state libraries.l Certainly much more needs to be done. And until
it is, program budgeting and most of the other popularly proposed fiscal
reforms will continue to remain undone.

As will be discussed below, the development of such standards is
not only vital to management and its responsibilities, but also in justi-
fying proposed programs and budgets before the legislature as well as
in conducting the performance post audit, both internally and by the

auditor general.

Executive Poliey_

 

Pervading the whole planning process from the setting of objectives
through programming, budgeting, organizational planning, and setting
standards, is executive policy. This policy is the expression of the
will of the executive official who is ultimately responsible for the plan
or program. The purpose of this policy is to give direction to the plan-
ning of activities as well as to the execution of the plans or programs.
It is therefore the responsibility of executive Officials from the
Governor on down to clearly establish policy guidelines within the exec-
utive branch of government and to take all necessary steps to insure that
such policy is followed both in planning and in executing state programs.

Executive policy sets the boundaries within which administrators
and other responsible personnel are expected to act. It is therefore
similar to legislative policy as outlined in the previous chapter. And
just as legislative policy is effective as a guideline to executive action
only when it is developed within an effective system of legislative con-

trol, so also executive policy is only effective when formulated and

 

1Phyllis I. Dalton, "Standards for Library Services in State Govern-
ment," State Government (Spring, 1964), pp. 129-131.

 

133
implemented as a part of a system of executive control.. Consistent with
the pattern of responsibility in the executive branch, such a system of
executive control requires that the chief executive provide direction
and establish policies for the guidance of administrative officials, and
that the administrators in turn be reSponsible to the chief executive
and account to him for all activities and programs in terms of the policies
established. An important consideration in this pattern of responsibility
is the fact that while the chief executive may delegate responsibility
for program administration to other administrative officials within the
state, he can never escape the ultimate reSponsibility which is his to
see that programs are prepared and implemented in accordance with the

policies set by the legislature.

Accountipg_and Reporting Systems

 

If management control is to be effective, executive officials and
agency administrators must be able to compare actual performance to plan-
ned performance. This requires that actual performance be recorded and
reported in the same terms as planned performance. As one writer said:

When one desires evaluation, the things that connote

success or failure must be indicated on the record; the num-

bers, intervals, and kinds of efforts made must also be a

planned part of the record. Records good enough for these

purposes must have been part of the initial program planning.1

Therefore, the designing and installation of the accounting system
is part of the planning process, and Should be consistent with the other
elements of planning. Program planning requires program accounting just
as much as program budgeting, and this fact has important implications

for the design of such accounting systens.

First, accrual accounting is a must. The purpose of accrual

 

1Blum, o . cit., p. 294.

134
accounting is to match the cost of operations with the results of Oper-
ations. In industry, this means recording expenses in the same period
as their resulting revenues. In government, since expenses are not incur-
red to produce revenues, the relevant items in the matching process are
the expenses of Operations and the resulting benefits to society. Such
benefits, since they are often impossible to measure and quantify, are
sometimes expressed in terms of work performed or activities conducted.
But the important fact remains that if any input-output comparison or
evaluation is to be made, accrual accounting is a necessity.

Second, program accounting is necessary. As Homer explains, "The
success of a program budget will depend upon the sufficiency, accurate-
ness, and relevancy of a suporting system Of program accounting and
reporting. Without such a system any . . . program budget is a hollow
Shell.”1 Based upon the earlier sections of this chapter, this fact
should be fairly obvious. Unless accounts are kept and reports are
prepared on a program basis, it is impossible to relate program activity
to program objectives, and the efficiency and effectiveness of program
performance cannot be determined.

Third, responsibility accounting is imperative. Responsibility
accounting requires that costs and results of operations be related to
the organization structure in such a way that each reSponsible official
can determine the efficiency and effectiveness of the operations under
his direction. As Cohrs explains, "Management must be in a position to
evaluate the performance of the personnel with whom they have placed

responsibility. Accounting, therefore, must help to establish measurements

 

1Porter W. Homer, "Program Accounting and Reporting," Municipal
Finance (November, 1955), p. 83.

135
of performance and report the results obtained at various levels of
the organization.”1 Thus the development of the accounting system is
an integral part of organization planning. ReSponsibility for its
development and its effectiveness belongs to the same level of manage-
ment responsible for the assignment of responsibility within the organ-
ization.

Fourth, cost accounting or some comparable system is needed. Much
has been written about both the merits and the limitations of cost
accounting systems in government. For the most part the arguments on
both sides of the issue have tended to be narrowly conceived and inade—
quately related to the other elements of the accounting and reporting
process. Certainly an extreme position either for or against such a
system on an over-all state basis is subject to serious question. Yet
there does seem to be considerably stronger arguments in favor of such
a system than against it. For example, how can one measure efficiency
without knowing the cost of inputs relative to Specific outputs? Unless
costs are accumulated and classified in terms of units of production
or service, it is impossible to analyze or compare efficiency. Further-
more, one of the most useful standards by which performance can be
measured in many agencies and institutions is standard cost per unit of
production. In these cases, certainly cost accounting is indiSpensible.
In those areas where standard costs do not serve as effective performance
indicators, the man-hour approach to work measurement has gained consider-
able attention. In this case, input is recorded in terms of man-hours
rather than dollar cost, but the principle is still the same. Here,

man-hours must be accumulated and classified in terms of units of

 

1James C. Cohrs, "The Accountant's Responsibility for Effective
Management Control," The Texas Certified Public Accountant (July,196S),
p..46.

 

136

production or service rendered in order to check'performance against
the pre—determined standard and there—by make any type of performance
evaluation. The key to the development of an adequate accounting system
lies in the ability of those who design the system to define performance
units or measures that can be recorded and reported. Most accounting in
state government is done in terms of funds spent and funds received.
Funds Spent, however, is not a measure of performance. As Homer declares,
"It must be remembered that the expenditure of funds is only a means to
an end. The end is performance, not expenditure. Therefore, to account
for only the means and to ignore the end is incomplete and meaningless
accounting."1 The key to program accounting and performance statistics
lies in the development of useful performance standards as described
above. If standards are measureable, Objective, and Significant,
performance measurement is possible. And to the extent that performance
measurement is possible, records can be kept in one way or another to
record and report performance on both a program and a reSponsibility
basis.

Thus the type of accounting system needed in the state is one
which serves several purposes. It not only measures program accomplish-
ment and matches such accomplishment with program cost, but it also
records and reports the costs and achievements based upon areas of
reSponsibility. It differs from traditional accounting in that program
accounting records and reports on the basis of cost effectiveness,'
whereas traditional accounting uses only revenues and expenditures.
Program accounting in the state is much closer to cost accounting as
used in industry, where costs are related to units of production. The

difference here, however, is that in the state, productive units are

 

1Homer, op. cit., p. 84

137
frequently not available and thus output or accomplishment must often
be measured by statistics based on work performed or activities conducted.

The responsibility for seeing that such accounting improvements
are made belongs to top management, but it should now be apparent that
a uniform accounting system throughout the state is not the answer.

Since each agency or department is engaged in a different type of service
or activity, each department must have an accounting system based upon

its own organization structure, its Own program plans, its own performance
standards or indicators, and its own particular management needs. Undoub-
tedly there will be great similarity in the systems used throughout the
state, but failure to decentralize the accounting function and to Speci-
alize the system in terms of individual agency needs will leave the

state with only half a loaf.

A performance reporting system cannot be separated from a program
or performance accounting system. TO discuss them as though they were
separate is inconsistent. However, there are some important reporting
standards which must be observed if the reports are to serve their inten—
ded Objectives. And in the establishment of the accounting system,
these standards are very important considerations.

First, the information that is contained in reports must be relevant
to the decisions and responsibilities of management and facilitate
rational management. This requires that the reports be timely prepared,
that they be based upon accepted standards and principles, that they
be consistent with management needs and expectations, and that they be
competently prepared and factually reliable. They must fully disclose
ever material fact relevant to the decisions and responsibilities of
the person for whom the report is prepared and issued. And they must

clearly indicate deviations from planned performance.

138

A very important concept is responsibility reporting. This concept
has been mentioned above in connection with responsibility accounting,
but a closer look at the specifics is helpful. Basically, responsibility
reporting requires that each responsible official be able to determine
the results of operations for which he is responsible. Such a reporting
system, as one writer notes, "should meet the requirements of all levels
of supervision and provide for the integration of reports at the lower
levels into reports for top management control.”1 It requires that each
person receiving a report be able to determine the results which occurred
as a result of decisions he made, or failed to make, and that he be able
to identify those areas requiring corrective action.

Another important concept is reporting by exception. For effective
management control to exist and for management personnel to be able to
determine what corrective action is needed in the case Of poor performance,
the reporting system must show those specific areas where variances
from planned performance occur, as well as the magnitude of the variance.
This is a common feature of a standard cost system as used in industry,
and when performance standards are effectively formulated in the state,
such reports of variances and variance analysis are equally possible and
effective in the state. Until and unless such reports are provided for
state officials, timely and appropriate corrective action on irregulari-
ties will continue to be difficult, and executive control will be weak
in this important area.

Existing accounting and reporting systems in the states do not
conform to all Of the above Specifications. For example, while several

states use accrual accounting to some extent, most states continue to

 

1Joseph Pelej, "Budgeting and the Corresponding Modernization of
Accounting," The Journal of Accountancy (June, 1958), p. 67.

 

139
use a modified cash basis for most accounting and reporting. The biggest
difference, however, between the systems currently used and the one
described here stems from the lack of performance standards and respon-
sibility accounting. Almost without exception, the reporting systems
used throughout the states are strictly financial systems which contain
little or no elements of program accomplishment. Performance indicators
are limited to those relating to the handling of funds or to the control
and preservation of assets and other resources.

Undoubtedly one of the things that has impeded progress in this
area as much as any other is the traditional concept of accounting as
merely a control device over funds and expenditures. The accountant's
primary function has frequently been seen as that of preventing fraud
and the illegal use of state funds. Only in recent years has there been
a Significant departure from that thinking. Now, however, legislatures
and executive officials alike are beginning to recognize that a greater
potential contribution of accounting is its service to management, a

service which can be accomplished effectively and efficiently without

in any way sacrificing the control aSpects of the system.

The Case of New York State

 

An excellent example of the recent Shift in emphasis to managerial
accounting systems is the work currently being done in the State of New
York.1 On December 22, 1960, Governor Nelson Rockefeller and Comptroller
Arthur Levitt issued a joint statement establishing a Joint Statewide
Accounting Improvement Committee, hereafter referred to as the Joint

Committee. It was composed of two high—ranking state officials--a Deputy

 

1The discussion which follows is based largely upon New York, Joint
Statewide Accounting Improvement Committee, op. cit.

140
Comptroller and a Deputy Budget Director. Also a representative of the
New York State Society of Certified Public Accountants was designated to
serve as an advisor to the Joint Committee. Subsequently, a Departmental
Advisory Committee, composed of a representative group of departmental
Officials with experience in financial affairs, was set up to work closely
with the two members of the Joint Committee. In addition, working com-
mittees were established in the Division of the Budget and in the Depart-
ment of Audit and Control, whose purpose was to actively assist the Joint
Committee in its work and to help in the installation of new procedures
in the departments and agencies of the state.
In the initial statement establishing the Joint Committee, it was
charged with considering each of the following items:1
1. The feasibility of delegating certain accounting
functions to the departments and agencies within the Comp-
troller's legal responsibility for providing accounting
systems and procedures.
2. The development of an accounting system which will
provide cost data necessary for review and comparative analysis
of programs and operations for purposes of improved budgeting
and day-to-day management.
3. The proper uses of cash and accrual accounting.
4. The coordination of financial reporting with the
budget process.
5. The provision for property accounting on a mone-
tary basis as an integral part of the accounting system.
6. The further application of electronic data proces—
sing and related techniques to the state's fiscal operations.
7. The training needs of state personnel in the
accounting field.
A full statement of the progress and achievements of this committee
since its inception would run well beyond what is possible to discuss
here. However, some Significant items are worth noting.

First, it was recognized by the Joint Committee that accounting

improvements could not be divorced from improvements in budgeting. AS

 

1Ibid., Exhibit B.

141
stated by the Committee, "one of the first decisions of the Committee
was the establishment of the basic requirement that any system evolved
must serve equally well for the purposes of budgeting, accounting, and
reporting.”1 Furthermore, the program of the Committee “emphasizes the
integration of budgeting, accounting, and reporting in a unified process
for the State Government as a whole, with recognition of the need for
flexibility in meeting the varying requirements of individual depart-
ments.”2

After intensive study of the state's financial Operations, the
committee undertook a pilot study in the Department of Taxation and
Finance.

The committee first studied in depth the existing budgeting,
accounting, and reporting system for the department. In New York, as
in most states, that system has been characterized by line—item appro-
priations for personnel and other objects of expenditure. Following
this study, the committee formulated some basic principles to guide the
development of a new or revised system and identified the purposes the
new system was expected to serve.

First, it was agreed that the accounting and reporting system should
facilitate informed decision-making at three levels of state government.
First, it should serve as a basis of informed legislative appropriation.
Second, it should facilitate executive budget preparation and control.
And finally, it should assist internal departmental management in the
decisions for which it is responsible. In addition, such a system was
seen as an aid to the performance of the audit by the Department of

Audit and Control. Since New York does not have a legislative auditor

 

1 2

Ibid., p. 3. Ibid.

 

142
general, no mention is made of the assistance such a program would be
to the conduct of his audit, but such assistance is implied in the fact
that the system would aid the internal post auditor in the fulfillment
of his function.

TWO significant features of this system are its emphasis on respon-
sibility accounting and upon program achievement. In fact, one of the
original statements of intent of the committee was that ”the emphasis of
the revised system was to be placed on the purposes to be accomplished
rather than on the kinds of expense to be incurred."1 Furthermore, the
system was to be Specifically designed in such a way as ”to hold every
supervisor responsible for projections and the results accomplished."2

Following the implementation of the pilot study in the Department
of Taxation and Finance, the department's budget was prepared and sub-
mitted to the legislature on a program basis, and the legislature auth-
orized it on that basis. This represents a significant mile-stone in
the actual implementation of concepts that have long been discussed and
considered desirable but seldom attempted successfully in practice.

Based upon its experience in the Department of Taxation and Finance,
the Joint Committee issued a set of instructions and explanations to
other departments and agencies outlining the system developed and
explaining the significance of the various concepts and developments
in terms of other agencies' needs.

It was pointed out, for example, that the Department of Taxation
and Finance has no institutional accounting requirements or capital
construction accounting needs. Thus, matters relating to these problems

would have to be further developed in future studies. Currently such

 

11bid., p. 6. 21bid., p. 7.

143

Studies are nearing completion both in the Department of Education and
in the State University of New York. The plan of the Joint Committee
is to continue such studies on a case-method basis until all problem
areas have been fully analyzed and revised. Once such an area is com-
pleted, general principles and methods are established which are then
expected to be adapted and used by Similar departments and agencies within
the state. Such an approach has succeeded very well to date and promises
to continue to meet the expectations of state officials in the future.

In conclusion, the system adopted by New York meets every major
criterion outlined above for a state accounting system, so far as it
has been developed. It is based upon responsibility accounting and
reporting concepts, and the major emphasis is placed on the purpose or
objective to be accomplished rather than on the nature of the goods or
services acquired. In the words of the Joint Committee, "accounting
by programs has been emphasized, while accounting for Objects of expense
has been given considerably less importance.”1 The remaining problems
may take several years to resolve, and the system undoubtedly will yet
need considerable refinement. This is expected, and it Should be. The
goal is not to have half a loaf today or tomorrow, but a fully revised
and effective system developed as soon as possible. Certainly the state

is to be commended for its progress to date.

Executive Proposals to the Legislature

 

As discussed in Chapter III, executive officials have no authority
to spend State funds or to undertake programs involving state resources

without the express or implied consent of the legislature. All decisions

 

1Ibid., Exhibit c, p. 2.

144
that are made and actions that are taken are expected to conform to the
will of the legislature as expressed in the apprOpriation acts and other
statutes. Walker expresses this fact as follows:
While the executive and the judges make many decisions

in the course of their daily work in rendering service to the

public, all of these must be made within the framework of the

basic decisions enacted as laws by the legislators. Without

laws creating Executive departments, and assigning them the

broad duties which they are to carry out, they could have no

existence or function. Every expenditure is made within

limits imposed by legislative appropriations. Truly, all

administration and ajudication is dependent upon legislation.1

Yet it is evident that legislative policy or intent is to a great
extent a product Of the legislature's reaction to executive prOposalS.
As Burkhead declares, "Legislative review Of“the budget depends first
and foremost on the way in which budget programs are presented by the
executive. . . .Clarity in budget presentation carries over to clarity
in appropriation structure.”2 The more explicit the intent of the exe-
cutive is expressed in proposals made to the legislature, the more expli-
cit will be the expression Of legislative will in response to the proposal.

Most executive proposals, if based upon a rational and comprehensive
planning process as outlined in this chapter, will be made in the form
of complete programs or modifications of existing complete programs.
Such program proposals should represent the final product of the execu-
tive planning process and should be related to specific Objectives, be
identified with specific standards, be conceived within a specific organ-
izational framework, and be formulated in accordance with established
executive policy. Each such program proposal should, in the Opinion of

administrative officials, represent the best possible alternative avail-

able for achieving the stated objectives. That is, it is a basic

 

1Walker, op. cit., p. 97. 2Burkhead, op. cit., p. 311.

145
responsibility of executive officials to be able to fully justify to the
legislature the selection and formulation of the Specific program proposed.

Budget requests detailing necessary expenditures for the coming
fiscal period can then be related to specific programs and can be justi-
fied on the basis of program needs. In this manner, both the legislature
and the executive can more easily determine the consequences of all
cuts or additions to budget requests, for such adjustments can then be
rationally analyzed in terms Of their program impact. Budget authori-
zations, based upon program justification, assist both the legislature
and the executive in the fulfillment of their responsibility. The legis-
lature is better able to control the types of programs conducted within
the state, while the executive is free to use the funds and resources
at his disposal in a variety of combinations to achieve efficiently and
effectively the programmed Objectives, depending upon the needs and the
developments of the operations as they occur. He is not required to
purchase Specific items when in his judgement alternative resources would
accomplish the Objectives more effectively or efficiently. Rigid itemi-
zation, which stifles administrative initiative and creates mountains of
work for legislative committees, is replaced in appropriations with
program authorizations and stauhrds, and control is exercised by both
executive and legislative officials in terms of output or performance
rather than on the basis of inputs or sources of supply.

When the legislature receives a proposal or request from the execu-
tive, it has not only the right but the duty to fully review the planning
process underlying the proposed program. This includes approving the
objectives sought, challenging the ability of the department or agency
to competently administer the program proposed, and reviewing the stan-

dards by which both the executive and the legislature may know when the

146

objectives have been achieved. The legislature may question the accounting
system, the reporting process, the organization structure, and all other
elements of executive control. In the event that the legislature desires
to change the proposed program, it has the full right to do so and to
require such change by law. Thus, virtually every action or program
decision of executive officials in some way depends upon legislative
will either as expressed in policy statements or by law.

In the absence of legislative exceptions to executive prOposalS,
it can be reasonably assumed that the legislature in effect concords
with executive intent. In most cases, even though the legislature may
whittle at the corners of program proposals, programs are usually approved
and budgets are generally authorized substantially as they are presented
and requested. And this is particularly true when both the legislature
and the Governor are of the same political party or where inter—party

differences are small.

Program Execution

 

Once programs have been approved by the legislature and funds
have been appropriated, it is the responsibility of management to carry
out the programs in accordance with its representations to the legis-
lature, and to do so in an efficient and effective manner. All program
execution is a product of program planning or deviations from such plans.
Good performance results from good planning and effective control of
Operations, whereas poor performance results either from poor planning or
poor control of operations or both.

The implications are clear. It is not only the responsibility of
management to effectively plan, but also to effectively control. More-

over, the first step in evaluating the quality of executive performance

147
is to test the adequacy and effectiveness of management control. Such
control is the product of the organization structure, of executive policy
statements and the enforcement of such policies, of the system of
accounting and reporting, and of internal audit and review. In fact,
the whole planning and review processes are designed to give direction
and control to the execution of programs and to promote efficient,
effective, and faithful performance.

Efficient execution of programs requires that management constantly
keep an eye on costs. When prices change, when equipment becomes worn
and obsolete, if operating procedures or methods are cumbersome or over-
lapping, if employees are frequently absent from work or generally inef-
ficient, or when supplies and inventories become excessive, management
is reSponsible to see that prompt and appropriate action is taken to
correct the problem and reduce the costs.

Effective execution requires that management always be conscious
of the output Of the agency or the service performed. It requires that
constant attention be given to the quality of teaching, to the results
of rehabilitation programs, to improvements in mental-health patients,
and to the training and preparedness of national guard trOOps. Effective-
ness is a measure of management's ability to maximize the achievement of
planned Objectives and to control the quality of performance throughout
the organization.

Faithful execution of programs means two things. First, it means
that legislative intent is effectively implemented in the operations of
the state. Second, it means that agency personnel effectively follow
the policies set down by top administrative officials. In both cases
it is a matter of reSponsible Obedience to higher authority and it

follows the basic patterns of responsibility that characterize the system

148

of government based upon the concept of separation and balance of powers.

In all of these matters relating to execution of programs, each
administrative official is expected to bring to bear on all of his
decisions and actions the expertise which he along possesses relative
to the operations with which he is charged. It is also his responsibility
to hire and train competent personnel with which to staff his organiza-
tion, and to insure that each individual is capable of the level of per-
formance his job requires. Finally it is the responsibility of executive
officials to account to the legislature for the use of state resources
and to report on the progress made in achieving the goals and Objectives
of the state. Such reports can be readily prepared if a program accoun-

ting and reporting system is operative as described above.

Management Review and Report

 

Effective, efficient, and faithful performance of authorized pro-
grams is a basic management responsibility. To insure that such per-
formance actually occurs and to enable management to render reliable
performance reports to the legislature concerning its stewardship, it
is important that an effective system of management review be Operative
in the state. Such a system consists basically of three parts: personal
review, internal audit, and corrective action.

The personal review is an individual management responsibility. It
requires that each person charged with supervising the activity or work
of other persons evaluate the work performed. It involves the comparison
of individual performance to individual performance standards. Such
reviews result from good organizational planning and must be performed
at every level of management.

The second step is the internal or management audit. This respon-

149

sibility was described in some detail in Chapter 111, but it deserves
special mention again here, not only as a vital element of the review
function, but also because of its significance in light of the above
discussion of the entire management function. The scope of the internal
audit is as broad as management wishes to make it. It need not be limited
to an audit of financial records. Indeed, the internal audit can become
just as much an audit of performance as can the audit of the auditor
general. The scope of the audit comprehends an examination of actual
performance as compared to planned performance and includes tests to
determine the effectiveness of the control system in all its parts,
including the efficient and effective administration of programs. The
Specifics of such an audit will be discussed in detail in the next chapter.

The third phase of management review is the follow-up or corrective
action taken in light of revealed deviations and variances from standards.
It does no good to develop an elaborate system to plan, control, and audit
program performance if no use is made of the reports prepared and no
action is taken on the disclosures made. Just as it is essential that
the legislature take action to insure the effectiveness of the auditor
general's reports, so also it is the responsibility of internal manage-
ment to take all necessary steps to insure that prOper corrective action
is taken in light of disclosures arising from the internal audit report
or other review activities. Such corrective action must be timely as

well as appropriate if it is to be truly effective as a control function.

Relationship to the Auditor General

 

A detailed analysis of the audit as required of the auditor general
will be made in Chapter V. However, some important implications from the

abOve discussion should be noted at this point.

150

First, an audit of management performance comprehends the whole
management function and is not restricted to the financial accounts or
any other such narrowly defined area. It includes a review of planning,
execution, and review, for all of these are included in the definition
of management performance.

Second, the auditor is in no way a member of the management team.
This independence precludes his participation in any part of the manage-
ment function. It is not his responsibility to participate in selecting
objectives, setting standards, formulating programs, preparing budgets,
specifying organization structure, or developing accounting and reporting
systems. All of these items are management responsibilities which are
subject to audit review. Based upon such audit review or examination,
the auditor may make recommendations both to the legislature and to
management concerning any one of these areas, but he does not partici-
pate in either the decision or the control process of management.

Third, it is not the responsibility of the auditor to enforce his
recommendations. His duty is to examine and report the results of his
findings and to make recommendations both to management and the legis-
lature. It is then the reSponsibility of management to consider and
implement the recommended changes, and it is the responsibility of the
legislature to enforce such recommendations unless they are found to be
inappropriate, in which case the legislature may excuse management from
the responsibility of adopting them. But the moment that the auditor
begins to enforce his own recommendations, he assumes unto himself the
role of a manager, and he violates his independence.

Fourth, the basic responsibility for reviewing and reporting
administrative and program performance is management's. The role of

the auditor is to determine that such review and report is made

151
consistent with accepted standards and principles. His duty is to insure
that the legislature is made fully aware of the implications of management
performance and of deviations from planned performance. Thus, his respon-
sibility includes the rendering of an opinion on the fairness Of the finan-
cial and performance reports as prepared and filed by management, and
an investigation and report of the adequacy of management controls through-
out the executive branch Of government. In the event his examination
discloses apparent weaknesses and inefficiencies, he is charged with
investigating those areas. But to the extent that his examination reveals
adequate control and effective internal review of Operations, the need
for in-depth investigations is removed. Thus, the auditor general liter-
ally is charged with the responsibility of auditing by exception.

Finally, the more explicit the legislature is in its examination of
executive proposals and in its expression of intent concerning such pro-
posals, the better the auditor can determine whether or not performance
complies with legislative policy. In this respect, the auditor is
charged with bringing to the attention of the legislature anything of
Significance which the auditor feels wquld influence the policy or intent

of the legislature.

Summary and Conclusion

 

The purpose of this chapter is to discuss the functions and reSpon-
sibilities of executive management officials in order to determine the
areas in which management performance can be identified and evaluated.
The system described here is not based upon an empirical analysis of the
things that are actually done in any state. Neither is it a description
of how planning, executing, or reviewing actually works out in practice

among the states today. Rather, it is a'description of a theoretical

152
system based upon ideal conditions and is consistent with the thinking
and philosophy of noted Officials who are now and who have long been
studying these problems in government.

There is neither empirical proof nor refutation of the principles
enunciated here. Yet virtually every state in the nation is moving in
this direction, some faster than others. AS program budgeting becomes
increasingly popular, as program accounting systems are developed, and
as legislative and internal audits become more sophisticated, this
outline of the management function will increasingly become a better
description of reality rather than of theoretical concepts.

From the standpoint of the auditor, it is imperative that he under-
stand the model system, for only then can his recommendations and reports
provide relevant motivation to move the state system closer to that ideal.
Only by comparing present management practices to a model system which
in effect serves as a standard, can the auditor, the legislator, or the
executive official determine the direction of change needed and the
magnitude of the change required. The purpose of this chapter has been
to describe in rough outline such a model system.

In the chapter which follows, the conduct of the audit itself will

be examined in light of the findings of this and preceding chapters.

CHAPTER V

THE CONDUCT OF THE PERFORMANCE POST AUDIT

Introduction

 

The approach to performance auditing that is deveIOped in this
chapter is based upon the theoretical discussions and empirical find-
ings noted in the preceding chapters. It is impossible here to
describe a ”correct” or ”best” method of conducting a performance
audit. It is only possible to identify the major elements of such
an audit and to suggest a reasonable or logical approach based upon
the discussion thus far. In the deve10pment of the chapter, as
in those which precede it, considerable assistance has been received
from many state and national authorities1 who have contributed ideas
and insights. This is a vast new area which will require years of
attention by numerous individuals before the audit approach is refined
to the point where it serves its maximum benefit. However, any future
development is likely to take the form of a further breakdown of
the components of this system into finer parts and thereby prescribe
in more detail the appropriate actions and inquiries to be made.

The performance audit can conveniently be divided into five
parts: (1) preliminary planning, (2) initial survey, (3) evaluation

of management controls, (4) analysis of exceptional areas, and (5)

 

1A list of the persons interviewed in the process of this study
is contained at the end of the bibliography to this Study.

153

154
report and recommendations. The relative weight to be given to each of
these parts is a function of the circumstances and conditions of the audit,
including whether or not it is the first such performance audit conducted
in the agency, the SOphistication of the management control system, the
wishes of the legislature, the competence of the auditor, and the nature
of the agency's operations. The one over-riding consideration in deter-
mining the extent of audit effort to be allocated to each phase is the
potential contribution to the improvement of administrative and legis-

lative performance.

Preliminary Planning

 

The effective and efficient performance of an audit requires
appropriate advanced planning in the same manner that effective
administration of programs within the executive branch requires
such planning. The audit plan should define the work to be done,
identify the specific objectives sought, outline workable programs
to accomplish the Objectives, and assign reSponsibility for each
phase of the work so that audit performance can be evaluated and
controlled.

The purpose and the Objectives of performance audits have
already been defined in the preceding chapters of this study. Briefly
summarized, the purpose of the audit is to provide the legislature
with an independent and competent evaluation of the manner in
which executive officials are discharging their responsibilities to
faithfully, efficiently, and effectively carry out the programs of
the state. For each audit engagement it is important that specific
objectives be set and that the audit be planned to achieve those

objectives. To facilitate and make possible such planning, the

155

following information should be Obtained by the auditor.

Legislative Intent

 

First, it is necessary to determine legislative intent. All
laws and legislative history pertinent to the agency or department
being audited Should be examined to determine the original intent
of the legislature in setting up the agency and authorizing its pro—
grams. To the extent possible, a complete history of every Signifi-
cant bill should be assembled, from its introduction and initial
justification through the hearings and the debate up to the final
vote. Particularly is this true for recent bills and budget auth-
orizations which have direct impact on current operations. In
some cases where legislative intent cannot be clearly defined, it
may be necessary to ask the legislature to clarify its position by
issuing a summary statement or declaration of intent.

In the absence of formal records of hearings and debate, it
may be necessary for the auditor general to assign members of his
own staff to attend the legislative hearings and floor debates and
to record the instructions given and commitments made. This is cur-
rently being done, for example, by the Auditor General of Michigan,
and it promises to provide invaluable data on the nature of executive
commitments and the expression of legislative will.

The auditor must always be careful to distinguish legislative
advice or individual intent from the official will or request of the
legislature concerning the programs and activities of an agency. He
must also be alert for areas which have an implied intent even though
not formally expressed.

Finally, the auditor should give Special consideration to those

156
areas in which the legislature expresses particular interest. Since
the purpose of the audit is to provide the legislature with information
to better enable it to perform its reSponsibilities, its needs and desires

should be closely watched and noted.

Other Legal Factors

 

The auditor needs to assemble information in other areas, such
as court decisions, constitutional provisions, legal opinions by the
Attorney General or other comparable authority, and rulings by governing
boards and commissions established for the purpose of giving direction
and control to institutional activities. In most cases, these factors
are as binding on administrative conduct as are the laws passed by the

legislature.

Pregrams and Budgets

 

The auditor should know in advance the Specific programs which
the agency is required to administer and the amount of funds and other
resources that have been placed at its disposal. In part, this informa-
tion can be assembled as part of the review Of legislative intent and
other legal factors. However, it also requires that a brief history of
agency activity be compiled so that traditional programs may be noted
and the basis of budget requests can be understood. This is particularly
true for "non—controllable" expenditures, which are those funds that are
spent in current periods because obligations were incurred in prior periods.
Conversely, the auditor needs to know the obligational authority that has
been granted to the agency, for under such authority, considerable program
activity can occur even without a great sum of current appropriations.
Finally, all authority to borrow money, to enter into contracts, or in

any other way to incur long-range commitments should be known in advance.

157
Again, however, these items will likely come to light in the review of

legislative intent and other legal factors above.

Administrative Manuals

 

Still another important area for preliminary review is administra—
tive policy and procedures manuals. Where written manuals exist, they
should be reviewed to determine (1) what policies have been established
to direct the activities and decisions of each administrator, and (2)
what Operating procedures have been prescribed by top officials. Policies
that are relevant to the audit, of course, are those which have been set
by Officials at a higher level than those whose performance is being

directly evaluated.

Prior Audits

 

When the auditor returns to an agency which he has previously
audited, one of the greatest sources of information available to him is
the audit working papers and reports from the previous audit. This is
true even if the previous audit was only a brief inquiry into a Special,
restricted area or confined only to financial records. Of course, the
more comprehensive the previous audit was, the better will be the infor-
mation which is available for the current audit. This should be eSpecially

true for successive performance audits.

Permanent File

 

All Of the pertinent information gathered in the planning process
prior to the actual audit engagement should be summarized and filed in a
"permanent file” where it can be referred to by the auditor at any time
during or following the conduct of the audit. Such a file should contain

a background history of all relevant facts which the auditor needs to

158
consider in setting up his initial plan of attack. The first time a per-
formance audit is conducted in an agency or institution, the preparation
of this file will take considerable time, but once compiled, it needs only
to be up-dated on subsequent audits. And that should require only a frac-

tion of the time taken in the original compilation.

Summary

Once this preparatory review is complished, the auditor can then
define his Specific audit objectives and determine the basic approach
he feels would be most appropriate to accomplish those objectives. The
most important decision which he must make at this point is what he must
do once he has arrived on the job. The direction, intensity, and scope
of his initial on-the-job review will all be determined by this advanced

planning and preparation.

The Initial Survey

 

The initial survey, like the advanced planning, is critically impor—
tant in the determination of the direction, the scope, and the extent of
the audit effort. It is imperative in planning for the evaluation of
management control. The purpose of the initial survey is to familiarize
the auditor with the operations and programs of the agency and to identify
the various elements of the management control system. Such a survey should
be brief but comprehensive. Its purpose is only to identify the elements
of control and the nature of operations, not to evaluate them. One step
in the survey is to determine the location of physical assets and accoun-
ting records. Another is to obtain familiarity with the nature of the
operations of the agency. The auditor Should determine as part of this
survey what programs are being administered by the agency, and he should

obtain and review the financial statements and other relevant reports

159
which may be of value to him in gaining familiarity with the organization
and its operations.

The most important part of the survey, however, is the review of
the organizational structure and the planning function. The auditor
should determine who is responsible for what phases of the operations.

He should know to what extent planning has occurred, whether or not objec-
tives have been identified formally in the planning process, and on what
basis budgets are prepared and accounting records are kept. The audits
should also ascertain whether or not performance standards have been estab-
lished and used. He should Obtain copies of all written policy Statements
of executive officials, and he should determine whether or not internal
auditing and review is performed.

This initial inquiry is particularly important on the initial perfor-
mance audit, in that it identifies the elements of control that actually
exist and provides a basis upon which to prepare formal audit programs
to evaluate the control system. All information gained in this survey
which will have value in future audit engagements should be recorded in
the ”permanent file" along with the other vital information. Like
advanced planning, this survey is likely to require much less time on
subsequent audit assignments if proper records are kept on the findings

of the first assignment.

The Audit Program

 

Based upon the advanced planning and the results of the initial
survey Of conditions in the agency, the auditor is prepared to formulate
Specific audit programs to accomplish the objectives of his audit.

Only when such programs have been carefully and competently designed
can the auditor hope to attack his problem in an orderly and professional

manner.

160

The audit program for a performance audit differs from audit programs
of traditional financial audits. First, the audit programs of financial
audits are conditioned by the internal control analysis, whereas the audit
programs of performance audits must be designed with particular emphasis
on the evaluation of controls. Likewise the praticular elements of control
subject to audit review are different. The financial audit is concerned
with financial controls, while the performance audit is concerned with all
control elements which are designed to insure effective, efficient, and
faithful operations. And as outlined in Chapter IV, this broader view
of management control includes financial control, but it goes far beyond it.

Another difference between the audit programs of financial audits
and those required for performance audits is that while financial audits
deal with historical results—-such as financial condition, statements of
expenditures, etc.--performance audits are primarily oriented toward
determining rpy_the results and conditions are as they are, not just ESE.
they are. Performance auditing tests the underlying causes of performance
results. Efficiency and effectiveness of administration and the faithful
execution of program reSponsibilities are the basic criteria. Performance
is analyzed, not just reported. And audit programs must be designed with
that in mind.

Likewise, the control analysis in the financial audit emphasizes
the preservation of the agency's assets by preventing abuse or misuse
of delegated authority or reSponsibility, whereas in the performance audit
the evaluation of control must also determine whether or not there are
additional ways of operating or new Opportunities available for using
the resources of the agency which would increase the agency's contribu-
tion to society. Management control, in this sense, should seek to pro-

mote and improve, not merely to restrain and police. Lost opportunities

161
are equally as serious as wasteful practice.

Audit programs must be tailored for each assignment, for each audit
will be different. The audit program should reflect the particular condi-
tions that exist in each agency, and it must direct primary attention to
those areas having the greatest apparent need for review and analysis.

Written programs should be prepared and used wherever practicable.
Oral instructions or standard check-lists are not adequate for this impor-
tant work. Neither are Standard programs designed to cover all engagements.
And even the written programs which are designed specifically for the
audit being conducted must be used as general guides rather than Specific
and rigid requirements.

Good supervision and proper direction has always been essential to
the audit regardless of the quality of the audit program, and this is
particularly true of the performance audit. This type of audit requires
a high degree of analytic skill and the ability to apply competent judge-
ment throughout the course of the audit. Audit programs must be flexible
enough to permit the application of such skill and judgement, yet be
specific enough to provide effective direction in the application of appro-
priate tests so that informed judgement is possible.

Inadequately planned audits, like inadequately planned operations
of any other kind, will fall far short of their desired objectives. Per-
haps the greatest challenge of the performance auditor is the planning of

his work.

The Evaluation of Management Control

 

Without doubt the single most important phase of performance eval-
uation is the evaluation of the management control system, for it is by

means of the controls that are established that faithful, efficient, and

162
effective performance is secured and insured. Indeed, this step alone
will likely consume a majority of the audit time on any engagement, parti-
cularly on the initial performance audit. Without a full and complete
understanding of the control system and its effectiveness, evaluation of
actual performance is difficult if not impossible. Thus, this portion of
the audit needs to be carefully and thoroughly planned.

The procedures and sequence of steps to be used in evaluating
management control will differ for each assignment. The discussion below
is therefore not intended to provide a first-second-third order of steps
to follow. Neither is it intended to represent by any means an exhaustive
list of the things that can or should be done in such an evaluation.
However, those items noted here are important in every audit of admini-
strative performance, and each should receive the attention it merits

in the particular situation.

The Extent of the Control Evaluation

 

As noted above, the purpose of a management control system is to
insure faithful, effective, and efficient performance of program respon-
sibility on the part of administrators and agency personnel. Faithful
performance refers to whether or not actual performance conforms with
established policies and commitments. Effective performance refers to
whether or not the desired objectives are achieved. Efficient perfor-
mance refers to whether or not resources are used in their least-cost
combinations to accomplish the Objectives, including the elimination
of waste. Thus, audit tests of management control must cover each Of
these areas. The auditor's reSponsibility here is to test and evaluate
each of the elements of control identified in the initial survey, and

to determine what controls are needed which were not found to already

163

exist in the agency.

Planning. The starting point in evaluating the management control
system is with the initial agency planning.1 First the objectives of
the agency must be determined, and the programs by which the objectives
are to be achieved must be identified and defined. Presumably these are
the programs that were presented to the legislature for approval, so
theoretically it is not difficult to determine legislative intent concerning
them. In reality, however, it seldom occurs that way. Planning is often
fuzzy, and programs are at best nebulously defined. Historically, most
programs have been reviewed by the legislature only on an incremental basis.
Seldom, flureflme, is an overall program policy stated by the legislature.
Nevertheless, if objectives have not been defined, and if programs have
not designed to achieve them, management has not performed one of its
most basic functions. Without proper planning and orientation of pro-
grams and activities, management control has no direction or goal, and
it is therefore ineffectual at the program level.

In the absence of defined programs and Objectives, the auditor may
still inquire of agency management: What are you trying to accomplish?
And what are you doing to accomplish it? How do you know if your acti-
vities contribute to your goals?

Answers to questions such as these will at least give the auditor an
idea of the underlying motivations of management, and they will help in

the evaluation of the accomplishments of the organization.

Organization and Poliey. The next step in the review of the manage-

 

ment control system is the evaluation of the plan of organization and the

 

1William Travers Jerome,III, "Management Control--Some Audit Impli-
cations," The Internal Auditor (September, 1957), pp. 41-43.

 

164
assignment of responsibility for each part of the work to be accomplished.

Equally important with delegating Specific responsibility for the
work that is to be done is the reSponsibility to secure qualified and
competent people to perform the tasks assigned. Efficient and effective
operations cannot be expected if those charged with responsibility are
incompetent and unqualified for the technical direction and decisions
that are required of their jobs. Thus, the auditor should review the
methods by which employees are assigned to their jobs within the organi-
zation to determine, for example, the extent to which such assignment
takes note of the particular Skills of the employee. He should also review
the recruitment and training programs, and particularly he should inquire
into the turn-over rate of employees and determine the reasons why respon-
sible and capable persons are leaving the agency, if in fact they are
doing so.

Even further, the auditor should evaluate the policies that give
direction to employee activity. The policies should not only be eval-
uated in terms of their relevance and significance to the conduct of
assigned responsibilities, but also on the basis of whether or not
they are consistent with the agency's Objectives and plans and with legis-
lative will. The auditor must also determine whether such policies are
effectively followed and enforced throughout the organization.

Finally, the organization structure should be evaluated in terms
of its relationship to programs and plans. It is impossible to eval-
uate program performance in terms of administrative reSponsibility unless
the organizational plans and the program plans correspond. Programs are
conducted by people, and objectives are achieved through human effort.

The auditor should test to determine if in fact those who are engaged

in program activity are motivated by the objectives. Such motivation is

165
essential for effective and efficient Operations.

The evaluation of the organization, even though it is far more pene-
trating and purposive in the performance audit than in the financial audit,
should not be difficult for the auditor to accomplish. The plan of organ-
ization has long been one of the traditional areas of audit inquiry, and
the expanded scope of the inquiry required here should present no major

new problems to the skilled auditor.

Performance Standards. It is impossible to evaluate performance

 

either of individuals or of programs without performance standards. Thus,
they too become a very important subject of audit review and analysis.

First, the auditor must determine if standards have been set in the
agency. If so, he must evaluate them to determine if they are relevant,
sufficient, and reliable. That is, the auditor must do more than iden—
tify the standards; he must evaluate them. He must next determine the
extent to which they are used by internal management. Unless they are
used, the most carefully prepared standards in the world are ineffective
as control devices. Finally, the auditor must determine how effective
the standards have been when used. Again he is testing the effectiveness
of administrative performance in an important area.

Performance Standards, while designed primarily as control devices
for internal management, can also be used in many cases to evaluate
performance after the fact. In fact, without some type of standard or
performance indicator, it is impossible to render qualitative opinions on
performance. Thus the auditor general must not only determine whether
or not performance standards are effective for internal management, but
also whether or not they are useful for his post—performance review.

Two kinds of performance standards were mentioned in Chapter IV:

166
personal standards and program standards. Personal standards are primarily
used in the employee-employer type of relationship. They are used when
one person reviews the performance of another person under his direction.
Standards of this type are not likely to be of great value to the auditor
who does not witness the actual performance of the employee involved.
However, the auditor is under just as great of an obligation to determine
that such standards exist and are used as he is for program standards.
To effectively review such standards, the auditor should become very
familiar with their nature and purpose.1 Otherwise, he can identify
their presence or absence but cannot evaluate them for relevancy, effec-
tiveness and adequacy.

Program standards, on the other hand, are designed to indicate
program progress toward the achievement of the objective sought. These
too are difficult to define, as discussed in Chapter IV. They can also
take a variety Of forms, but only by using such Standards is it possible
to competently render an opinion on the achievement of program objectives
or the appropriateness of policies and procedures designed to promote
program success. It is important, however, that the auditor evaluate
the standards before he uses them. Only if and when he feels that
they represent reliable indicators of performance should they be used
in the post—audit evaluation by the independent auditor, and only then
with extreme care.

In spite of the obvious need for standards both to management and

to the auditor, very few such standards formally exist in any state today.

 

1Some excellent sources of information in this area are Carl Heyel,
AppraisingfiExecutive Performance (New York: American Management Asso-
ciation, 1958); Virgil K. Rowland, Improving Managerial Performance
(New York: Harper 8 Brothers, 1958); and Virgil K. Rowland, Managerial
Performance Standards (New York: American Management Association, 1960).

 

 

 

 

167

It is true that in the minds of administrators, performance is evaluated
in terms of some standard. But few of these standards have been written
down and formalized as part of the control system. Thus the question
that arises is: How can performance be evaluated when such standards
do not exist? This will be answered in a later section of this paper.

For now, the important fact is that setting and using meaningful
performance standards is a management reSponsibility. It is a vital
part of the management control system, and the auditor is evaluating
another part of administrative performance when he evaluated the quality
of performance standards set and used in an agency. Perhaps no perfor-
mance area is in greater need of the auditor's attention than this. And
no one is better qualified to evaluate the quality of performance indicators

than the auditor whose whole responsibility is to evaluate performance.

Accountingrand Reporting. Accounting is the means by which the events

 

that occur in the organization are recorded, and reporting is the means

by which the results of such events are broughttt>the attention of admini-
strative officials and others such as the legislature. Yet accounting is
more than recording events. That is the function of a historian. Accoun—
ting connotes the idea of responsibility. Accounting is the means by

which the results of decisions made by reSponsible officials (as reflected
in the activities and programs of the organization) are recorded. It is

a process Of identifying cause and effect, input and output, responsibility
and performance. Thus accounting too is a proper subject for performance

audit review.

Here the auditor is concerned with the type of accounting system
used. Does it articulate with the other elements of control and with

the patterns of responsibility? Is it sufficient to provide timely,

168
relevant, and reliable information to those who are responsible for making
decisions and appraising performance? Does it provide a record of the
diSposition and use of agency resources and relate the use of such resources
to the programs and accomplishments of the agency? If the record of actual
performance is incomplete, or if it does not permit relevant comparisons with
plans and standards, evaluation of program performance is extremely diffi-
cult. And if the results of decisions and actions of administrative offi-
cials cannot be identified with those decisions or actions, it is impossible
to determine the effectiveness of them.

Thus in the evaluation of the accounting and reporting system, the
auditor is again rendering an opinion on an important element Of administra—
tive performance, for it is the responsibility of the administrator to
secure proper accounting and render competent and reliable reports to
the legislature and to top Executive officials.

Of all areas in the performance audit review, this one is perhaps
closest to that Of the financial audit review. Yet even here the objec-
tive is different. In the financial audit, the auditor has traditionally
been concerned with the proper recording of transactions according to
prescribed accounting rules. Now he must determine whether or not the
accounting rules themselves are adequate and meaningful. Such an evalu-
ation requires that the auditor determine whether accrual accounting and
cost accounting procedures are being effectively used in those situations
which require them. Program acCounting systems should be fostered among
the agencies, and the auditor Should recommend them and evaluate them
as they are developed and come into use. In many cases, progress in this
area has been impeded by rigid and out-dated laws, and the auditor should
be especially careful to point out to the legislature those areas where

management cannot affect improvements until the legislature amends the law.

 

169

Finally, reports must not only be prepared in accordance with accepted
accounting principles. They must also provide relevant information to
the person receiving them. They of course need not be restricted to finan-
cial areas, but should include performance areas as well. Thus the auditor
must go beyond the manner in which reports are prepared and evaluate them
in terms of their use. No better example of inefficiency exists than
where reports are prepared at substantial cost and effort but are never
used. Accounting and reporting systems in state government have a long
way to go before they will meet their potential objectives. And the
auditor, perhaps more than anyone else in the state, can push this pro-
gress along with careful and competent recommendations and reports on

the accounting systems in the agencies audited.

Internal Audit and Review. The only way that management can insure

 

that its plans have been followed and that the results that have been
achieved are those which were desired is by reviewing what actually hap-
pened and comparing it to what was expected to happen. This is accomp-
lished by personal reviews and by internal post—audit reviews. Personal
reviews were mentioned under personal performance standards. They are
vitally important, and the auditor should determine whether they are
conducted and how effective they seem to be in promoting more effi-
cient and effective performance on the part of those reviewed.1

However, the major internal review of operations and program.per-
formance will probably be made by the internal audit group. To some
extent this type of review occurs in the annual budget preparation, but

the bureau of the budget certainly has no means to affect a performance

 

1See Richard E. Brown, A Review of Employee Evaluation Systems
(Chicago: Public Personnel Association, 1963). This book also con-
tains an excellent five page bibliography on the subject.

 

 

170

audit of every agency or department or institution of the state. This
work is that of the internal auditor. And the work of the internal
auditor is another important area for evaluation by the auditor general.

Internal auditing, like independent auditing in the state, has been
traditionally associated with financial audits in the few departments
and agencies where it has been done. In recent years, however, as noted
in previous chapters, internal auditing has also expanded into performance
areas. In fact, one can seldom find a discussion of internal auditing
in the professional literature today which does not go to great lengths
explaining the merits and means of expanding the scope of the internal
audit review. And in its statement of responsibilities, the Institute
of Internal Auditors includes ”appraising the quality Of performance
in carrying out assigned responsibilities" as one of its duties.1

This development has occurred not only among industrial internal
auditors, but also in government. A recent study in California recommen-
ded a greatly expanded role for the internal auditor.2 So did a 1958
study of internal auditing in the federal government which was made by the
General Accounting Office.3 This expanded concept has been referred to
as operational auditing or management audit. In either case, the auditor

is expected to review the Operations and programs of the organization

 

1Statement of the ReSponsibilities Of the Internal Auditor (New
York: The Institute of Internal Auditors, 1957), p. 2.

 

2California, Office of the Auditor General, Report on a Review of
Internal Auditing Within the Executive Branch of the California State
Government (Sacramento: State of California, 1962).

3U.S. Government Accounting Office, Internal Auditing, August, 1957.
See also Ellsworth H. Morse, Jr., "Some Considerations behind the General
Accounting Office Statement on Internal Auditing,” The Federal Accountant
(December, 1957), pp. 30—49; and William A. Newman, Jr., "Evolutionary
Changes in Auditing in the Federal Government," The Federal Accountant
(December, 1958), pp. 41-55.

 

 

 

 

 

171
as though he were a management official, not just a financial expert.
Such an internal audit function is truly needed in state government,
and it is a management responsibility to see that it is established
and competently performed.

Not every agency will be of sufficient size to warrant its own
internal audit group, and in those cases departmental internal auditors
should be assigned to periodically reveiw the agency's Operations. It
is the responsibility of the auditor general to review the extent and
quality of the internal audit under either situation. He may accept
or reject the work of the internal auditors, but in any event he must
do sufficient work to evaluate their work. His purpose is to appraise,
not to duplicate. And to the extent that he accepts the internal audit
work as competent and adequate, he will be able to reduce the detail

of his own examination.

Method of Testing Management Controls

 

The purpose of the test of management control is to determine its
effectiveness in promoting faithful, efficient, and effective perfor-
mance. The proof of such control can only be tested by comparing accom-
plishment with plans, results with standards, practice with policy. As
Ernest Miller has said:

To audit is to investigate in order to obtain informa-
tion on practices and results accomplished, with careful atten-
tion to the reliability and validity of the information Obtained.
The Objective is to arrive at a dispassionate and verifiable
basis for comparing what is being done and how well it is
being done with the plans, policies and standards of the organ-
ization, and to understand the reasons for positive and nega-
tive variances from these plans, policies and standards.

The starting point in evaluating such a system is to find out how

 

1Ernest C. Miller, "The Case for a Management Audit Group," The

Internal Auditor (Fall, 1961), p. 9.

 

172
the agency itself performs this evaluation. This can be done by selec—
ting a few items as Special case studies and by tracing them completely
through the organization from start to finish. In a hospital, for
example, it may be helpful to begin with the admittance procedure for a
given patient and trace the patient's case through diagnosis, treat-
ment, and ultimate release. The purpose of this inquiry would not be
to evaluate the medical judgement or treatment, but the operating con-
trols. Who is responsible? What procedures are followed? Is there
unnecessary duplication of work or records? Is adequate information
available at all points? These and many other similar questions can be
asked.

Another example might be to test the use of foods and drugs. This
can be done by again tracing a few examples through from start to finish--
beginning with the determination of the need to place an order, then
following through the placement of the order, the receipt of goods,
paymeng.storage, distribution, preparation, and ultimate waste or gar-
bage diSposal. In this case the auditor is made aware of numerous Oper-
ating policies and procedures, and these he can test against the stated
Objectives of the hospital. In each case he should inquire about the
assignment of reSponsibility for each phase of the process, determine
whether or not standards exist to evaluate the performance Of those
assigned, and find out what measures are taken to bring discrepancies
to the attention of top management officials and what action is taken
when irregularities are found.

At every turn, the auditor must be aware of possible inefficiencies.
For example, are inventories excessive? Are reports used? IS waste
controlled? Is there evidence of carelessness? Are there unnecessary

duplications or work or records? Are purchasing procedures such that

173
goods are acquired at a minimum of cost? Are employees properly trained
for the jobs they are required to do? Is equipment used and serviced
properly? Are proper time and work records maintained for payroll pur-
poses? In this connection, another test might be to trace what happens
to an employee from the time he makes application for employment until
his termination with the agency. This would include hiring, training,
assigning, promoting, paying, demoting, firing, and retiring employees.
And it would include security clearance and other such items if appro-
priate.

The auditor will always be faced with areas where he is incompetent
to judge the effectiveness of a policy or procedure. For example, he
cannot judge whether or not the method used to assign state police officers
to their reSpective duties is the most effective way to secure public
safety. However, the auditor can take the matter up with responsible
administrators and make a reasonable judgement of the control system
by asking the following types of questions and then testing the answers.
How do you deploy your peOple? Do you have a plan? Why do you deploy
your peOple as you do? What alternatives have you considered? What are
the criteria you use to determine if this policy or procedure is effec-
tive? What measures do you take to assure that people are working at
what they say they are? These questions are necessarily broad. Depen-
ding upon the answers received, the auditor can become more Specific
and detailed in his questioning until he fully understands what is done.
Only then can he determine whether or not the procedures seem adequate.

The auditor must always be careful in judging the technical ability
of an administrator. Sudianabflity should be evaluated only by the evi-
dence found in the operations, not on the basis of personal impression.

Technical or professional ability is inherent in the satisfactory

174
performance of the management function as required in the particular
organization. As Charles Inman points out, ". . . by the examination
of controls we should be able to satisfy ourselves as to the reasonable-
ness of technical and professional abilities in the performance of a
function, . . . we should not attempt directly to evaluate the exact
degree of technical ability in an operation.”1

Finally, throughout all of this analysis, one theme must prevail.

The cause is more important than the effect. The auditor has not per-
formed his reSponsibility if he has only pointed out poor results or
symptoms of weak control. These are the evidences of weaknesses in
controls or in planning, but until the auditor has determined the cause
of causes of each of the irregularities or inefficiencies, he has not
completed his evaluation of the control system.

In some cases, due to lack of records or other objective information,
it may be impossible for the auditor to fully explore the causes of the
discrepancies noted. Certainly the existence of good accounting and repor-
ting procedures facilitatesthe conduct of the audit. However, such records
are not a condition precedent to carrying out performance audit work in
an agency. The accounting and reporting function is a management responsi-
bility which is subject to audit review itself. And the auditor should
make every effort to ascertain and evaluate the other elements of control
regardless of the adequacy of written records. In fact, the inadequacy
of accounting records in vital performance areas Should be an added reason
for further investigation into those areas, not an excuse for stopping at
that point.

The approach described here is broad and general, and for each audit

 

1Charles N. Inman, "Managerial Auditing of Operations," The Internal
Auditor (June, 1958), p. 49.

 

175
engagement the auditor will have to break down his examination into manage-
able portions and Specify in his audit programs the methodology to be used

in each instance.

Implications of the Manegement Control Evaluation

 

If planning has occurred and if control is effective, performance
will agree with the plan. Thus the test of management control is the
most important step in evaluating administrative performance. The find—
ings of the audit of the control system will reveal areas of operations
and decisions where controls are non—existent or weak, and these areas
are, of course, subject to suspicion and should be further examined.
Based upon the findings of the control evaluation, the auditor can prepare
competent and effective audit programs to proceed with his audit into
these exceptidnal areas. This is the policy of audit by exception.

In those areas where plans and program objectives are clearly out-
lined and where controls are effective so that performance correSponds
with the plans and objectives, the auditor need make no further inquiry.
This assumes, of course, that he has evaluated the plans, standards, pro-
grams, etc., to determine that they are reasonable, consistent, and appro-
priate for the objectives sought.

In actual practice, the auditor today is likely to find that this
system of management control breaks down very fast. Thus, more often
than not, the auditor will find that adequate controls do not exist and
that planning has not occurred in the manner described.

The question that must be asked at this point is: What happens
when the management control system is found to be lacking in many of
its essential or vital elements? Does this mean the end Of performance

audits until and unless such planning, prOgramming, etc., occurs? The

176

answer must be an emphatic "NO!" Performance auditing is certainly facili-
tated by these things, but it is by no means entirely dependent upon them.
Executives still appear before the legislature to request funds to carry
out activities or programs, budgets are prepared on the basis of some
plan or objective, accounting systems are designed to report some ele-
ments of performance, and organizational structure, however inadequate
or inappropriate, does exist. The purpose of the evaluation of manage-
ment control is not only to determine where it is weak or strong and to
make recommendations for its improvement, but also to enable the auditor
to plan the conduct of the balance of the audit. Indeed, the very fact
that such controls do not exist in an ideal condition underscores the
fact that performance cannot be evaluated on a broad, over-all basis.
Rather it must be attacked in pieces and chunks on a smaller basis at
first. Later, perhaps, it can be expanded as the bits and pieces fall
together and are included within a more comprehensive system of manage-
ment planning and control.

In conclusion, then, a penetrating analysis of management control
is essential; first, to determine where such controls are weak and to
make recommendations for their improvement; and second, to determine
those areas which require Special attention from the auditor. Some
alternative ways of approaching the audit assignment when the manage-
ment control system is not up to standard are presented below. However,
the most important recommendations which the auditor can make to pro-
mote efficiency and effectiveness in state Operations are those designed

to strengthen and improve the control system.

Financial ASpects of the Performance Audit

 

Both in this chapter and in those which preceded it, several

177
differences and similarities between financial and performance audits
have been mentioned. It is appropriate at this point, however, that
the exact relationship between these approaches be emphasized again.

First, under the general name of financial audit, several things
have been done by state auditors which seem at first glance to be quite
Similar to what has here been described as the management control evalu-
ation. For example, in a letter to one of the delegates of the Michigan
Constitutional Convention, one member of the staff of the Michigan Auditor
General stated the following:

The scope of our audits is much broader than would ordin-

arily be expected. In addition to merely verifying mathematical

accuracy, test checking transactions, and counting cash our

audits include (a) review of systems and procedures for pro—

priety and adequacy, (b) review of practices for compliance

with legal provisions, established procedures and proper govern-

mental accounting standards, (c) review of the adequacy and

effectiveness of internal controls, (d) verification of proper
recording and handling of funds and property and (e) verifica-

tion of legality and propriety of disbursements.

There is no question but what this type of audit includes many aSpects
of management performance and responsibility. Neither is there any ques-
tion on the fact that performance audits must include these financial
aspects of administration. Performance in financial areas is certainly
an important part of total performance, and most of the audit procedures
that have been used in financial audits are applicable and important in
the conduct of a performance audit. Nothing in this discussion is inten-
ded to imply that the financial audit is not important. Indeed, the con-

trary is true. The financial audit takes on increased significance when

financial statistics can be related to program output and the achievement

 

1William J. Wood, letter addressed to Eugene G. Wanger, delegate
to the Michigan Constitutional Convention, on the subject of the duties
of the Auditor General, dated November 15, 1961.

178
of objectives. Thus, while the above audit procedures are essential
to the conduct of some aspects of a performance audit, such an audit
must involve much more, as outlined in this chapter.

For example, testing management compliance with legislative intent
has always been recognized as an essential area of audit review. Yet,
for the most part, such tests have been confined to issues such as whether
or not state laws have been violated, whether statutory requirements have
been met, and whether or not items for which money was appropriated were
in fact purchased. The test of compliance with legislative intent has
seldom if ever been designed to determine whether or not programs have
been administered efficiently, effectively, and in the manner intended
by the legislature and promised by the executive. Thus, the performance
audit does not do away with the former practice; it adds to it and builds
upon it so that the totality of compliance is tested.

The same is true in this matter of control evaluation. Internal
control has always been a vital area of audit under financial audit
procedures. Matters such as the division of responsibility, the proper
authorization of warrants and requisitions, the pre-numbering of checks,
invoices, and receipts, and a host of other items have long been examined
in the internal control evaluation. The performance audit does not remove
the need for this evaluation; rather, it adds to it by going far beyond
this test to determine if in fact objectives have been set, programs have
been planned, performance standards have been established and used, and
responsibility and accountability secured-—not only for the use of funds
but also for the use of other resources and the control and exectuion of
all program activities.

Thus it is true that State auditors have done some performance auditing

in the past. But the type of performance auditing envisioned by the framers

179
of the Michigan Constitution and that deveIOped in this study goes
far beyond these traditional areas. This fact has been noted and
explained throughout this study. In fact, the provision of the Michigan
Constitution which requires performance audits also requires financial
audits, as noted in Chapter 11. And as noted in Chapter III, this type
of audit is vitally important to the legislature as well as to admini-
strative officials. But by itself, without being related to performance
in terms of program achievement and objectives, the financial audit is

inadequate to meet the needs of modern state government.

The Analysis Of Exceptional Areas

 

The fourth phase of the performance audit is the analysis of those
areas which lack effective control or which are found to require addi-
tional attention beyond that which is possible through the control eval-
uation. There are numerous possibilities both in terms of type and scope
of such Special investigations, and particularly in early performance
audits where many of the control elements are found to be lacking, this
type of investigation may be necessary in almost every phase of the opera-
tions of an agency.

The planning for this type of investigation must be based upon the
findings in the management control review. It should also recognize
the patterns of responsibility that do exist in the organization, for
even if planning has not occurred in such a way that standards and other
essential control features are available, certain individuals still bear
the responsibility for the Operations of the organizations.

In the absence of standards or other effective criteria with which
to evaluate performance, three alternative approaches are available to

the auditor. These are (l) a comparative analysis, (2) the use of

180

borrowed statistics, and (3) the test Of reasonableness. It will be
helpful in the discussion of these concepts to remember again that the
basic criteria for evaluating performance are efficiency, effectiveness,
and the faithful discharge Of program responsibility. The approaches
discussed below, however, can only test efficiency and effectiveness.
Faithful performance depends upon the existence of instructions, prom-
ises, agreements, or established policies which, if non-existent, cannot
be hypothetically formulated or tested by the auditor.

Finally, any one or all of the methods outlined in this chapter
may be used on a given audit engagement. The important thing is for the
auditor to do all that he reasonable can to obtain sufficient and compe-

tent evidence upon which to base his judgement and render his opinion.

Comparative Analysis

 

The first method of evaluating performance in the absence of Speci-
fic standards is by comparison of similar situations. This can occur
in two ways. First, current performance can be compared to past perfor—
mance. Second, performance of one agency or institution can be compared
to that of another.

Comparison of successive periods has the advantage of being able to
reveal trends in performance. For example, if the cost per prisoner fed
in a penal institution rises from year to year, attention is drawn to the
fact that either prices have risen, inefficiencies in food preparation
have increased, prisoners are being fed larger quantities, or a better
quality of food is being used. The auditor can evaluate the Situation
further and determine precisely why the cost per inmate has in fact risen.
In this case, the criteria by which actual performance is evaluated is not

a pre-determined plan or a formal set of performance standards, but Simply

181
that which was done in prior years. Such standards are not capable of
permitting judgement as to whether or not the rise in price per inmate
fed is good or bad. Neither can this method enable the auditor to
determine whether or not costs are too high. But it does identify the
causes so that administrators and legislators can make a judgement on
performance as it occurred.

This type of comparison presents no problem in terms of the simi-
larity of the units being compared. With few exceptions, the admini—
strators, the programs, the organization structure, the size of the Opera-
tions, or the personnel involved will all be very nearly the same for
both periods of time. Likewise the geographical location and the public
being served will be unchanged.

The biggest disadvantage of this type of comparison, however, also
is a product of this same similarity in the units compared. While trends
are possible to note and examine, meaningful comparisons of alternative
methods or procedures cannot be accomplished. This is the great advan-
tage of comparisons between two different but similar organizations, for
nearly always such an analysis will provide an opportunity to evaluate
different approaches to program administration. And having determined
the results of different approaches to administration, the auditor can
make helpful recommendations for improving efficiency and effectiveness
in the Operations of both organizations.

It was noted in a previous chapter, for example, that the auditor
cannot determine what it should cost to Operate an English Department at
a state college. Neither can he judge whether or not the actual costs
of operating such a department are excessive in the absence of some
standard. He can, however, determine why it costs more to operate such

a department at one college than at another college. And by pointing

182
out the "why” to the difference, he focuses attention on the variables
which are relevant for the value judgements of administrators and legis-
lators.

Again this is a problem of determining the cause of differences,
not just determining what the differences are. As noted earlier, this
is the essence of the performance examination. And all audit recommen-
dations, to be truly effective, must get at the cause of the problem,
not just the symptoms or the results.

There are some inherent dangers in comparing two separate organ-
izations, however. One danger is that of failing to note factors which
justify differences between the two. For example, the comparison of two
hOSpitals is difficult since no two hospitals treat precisely the same
type of patient, hire the same type of doctors, use the same type of
equipment, or have the same proximity to supplies of food and other
essentials. Thus any comparison must take these items into account.

Two hospitals would, however, have many of the same types of problems
regardless of their differences, and the similarity of the problems

can at leaSt lead the auditor to examine how each administrator handles
these common problems and to describe what the consequences of such
decisions and actions are. And in this way, alternative possibilities

for improving the efficiency and effectiveness of operations are brought
to 'the attention of the auditor for his analysis, and his recommendations
can then reflect his judgement based upon the evidence of the utility

of each of the alternatives used.

The Borrowed Standard

 

Several groups throughout the country have recommended that studies

be made on a broad scale to provide uniform and comparable standards

183

for evaluating performance in various institutions and organizations.
Some of these were mentioned in Chapter IV. However, here again there
are some dangers.

First, national averages and broad-based statistics never relate
to Specific situations. Thus, while such statistics give some indication
in general terms of the performance of the agency, they cannot be used
for precise measurement or evaluation. Second, very few such national
averages or uniform statistics actually exist. And in those cases where
they do, such as hOSpitals, prisons, libraries, etc., they either relate
to such a small portion of the areas subject to audit, or the statistics
are so limited in their ability to indicate performance beyond very restric-
ted areas, that they serve little use to the auditor.1

A corrolary of this problem also has important implications for the
auditor. In testing the standards used by an agency or institution,
it is important that the auditor determine whether or not such standards
have been Specifically developed to fit the programs and the needs of the
agency or whether they have been "borrowed" from some other source.
Unless they are tailor made for the specific agency, they are likely
to be somewhat inappropriate. Consequently, they are probably ignored
by most agency personnel.

Still, borrowed standards are Often better than no standard at all,
and as further studies are made both to broaden the types of statistics

available and to enlarge the areas covered, this type of criterion may

 

1For example, see The Feasibility of Inter-City Comparisons, A
report of the Comparative Measurements Study, John L. Fava, Project
Director (New York: Citizens Budget Commission, Inc., November, 1963).
This is an excellent study of this problem at the municipal level. Also
see Henrik L. Blum and Alvin R. Leonard, Public Administration--A Public
Health Viewpoint (New York: The MacMillan Company, 1963), pp. 289-290,
for a discussion of this problem in public health.

 

 

 

184

become an even greater aid to the auditor, particularly in the evaluation
of the adequacy and appropriateness of standards established by the agency.

The important point for the auditor to remember when using borrowed
standards is that he must be equally as critical of them and evaluate
their appropriateness just as completely, and perhaps more so, than
he would the performance standards established by the agency. Only when
and if they are found to be relevant and appropriate should they be

used by the auditor.

The Test of Reasonableness

 

Even when standards are non-existent, when comparisons are impossible,
or when borrowed statistics are unavailable, it is still possible for the
auditor to test performance on the basis of reasonableness. From his ex-
perience in auditing the many areas of the state, the auditor gains
considerable familiarity with state operations and its many problems.
Thus the auditor brings a broad perSpective and wide experience to his
job. Because of this, he can often Spot irregularities and weaknesses
that would escape a reviewer without such a background.

Furthermore, there are what may be termed "general standards of
society” which have application to good management in any field, public
or private. For example, work that is being carried out in a loose,
unsatisfactory, and inefficient manner can often be cited even in the
absence of specific standards. Obsolete inventory, excessive supplies,
personnel who are continually absent from work, abuse in the use of state
resources such as automobiles and expense accounts, or negligence in
processing documents or in handling state funds, are all examples of
items which can Often be evaluated through the test of reasonableness.

Thus there are numerous examples of inefficient practices and

185

ineffective administration which the auditor can test simply because of
his familiarity with state operations and his competence as a control
expert. Most state auditors already evaluate some aspects of state adminis-
tration on this basis. And as the auditor general and his staff gain fami-
liarity and experience with performance auditing, their ability to test
performance on the basis of reasonableness will greatly improve.

Finally, this test is always an appropriate tool for quick reviews
of operating areas not subjected to detailed analysis. And even when
a detailed analysis has occurred, the auditor should still examine his
conclusions for reasonableness. This will insure that he has not become
so engrossed in his statistics that he has overlooked important items

or placed too much weight on items of a minor nature.

Audit Reports and Recommendations

 

The final phase of the performance audit is rendering a written
report of the audit to the legislature outlining the scope of the audit,
the nature of the tests conducted, the findings in terms of cause and
effect, and recommendations for improvements which the auditor feels
are needed. Such reports Should also be made available to the Governor
and/or other responsible administrative officials.

Most states require the filing of a summary audit report on an
annual or biennial basis, but the auditor should also report findings
of the specific audits as the audit is completed, or as matters warrant
legislative attention.

Prior to the submission of the report to the legislature, the auditor
should review the report in its entirety with the responsible administra—
tive official of the agency audited. If proper repore exists between

the auditor and the agency administrator, such a review will prove to be

186
beneficial for both sides. The administrator will have a final oppor-
tunity to review audit recommendations and to discuss them with the auditor,
thus insuring that he fully understands the basis for the report and the
recommendations. On most recommendations, he will likely take immediate
action to affect the necessary changes, and the auditor can report this
action accordingly. On issues where he feels he has a legitimate reason
for differing with the auditor's opinion, the administrator can at least
express his feelings on the matter to the auditor and prepare his defense
before the legislature and the Governor.

The advantage of this review to the auditor is that it helps him
"clean up” his report. And this every auditor needs on virtually every
audit. This is an Opportunity to discuss proposed recommendations and
to again review their soundness and importance. It is also the place
to pick up additional loose ends and to discard frivolous and immaterial
items. Certainly the auditor leaves himself open to severe criticism
and takes an unnecessary risk when he fails to undertake this final
review, regardless of the quality of his audit performance. Further—
more, his recommendations.are much more likely to be followed if they
are presented in a spirit of fairness and mutual cooperation and interest.

Each item included in audit reports must be significant and must be
fully supported by facts obtained during the course of the audit. Findings
must be based on reliable evidence, and they should be stated in a concise
and objective manner. Particularly in the early stages of performance
auditing, the manner in which the auditor approaches his engagement will
be closely observed, and it is important that he proceed in a careful,
constructive way. He must never give the impression that he intends to
use his authority as a club to impose or force something on the adminis—

trator. Rather his Spirit must be one of helpfulness. And in this regard

187

it is important that the auditor give proper recognition to favorable
findings as well as to those areas found to be weak or in need of further
attention. His Obligation is to report administrative performance whether
it be good, bad, or otherwise. And he must do so constructively and con-
vincingly.

The recommendations should probably be divided into three groups for
maximum effectiveness. First, those recommendations which were made
and immediately implemented by the agency administrators should be noted.
Second, those recommendations which require specific legislative action
should be listed. These include items requiring changes in public
laws or a clarification of legislative policy. Items such as a transfer
of funds, changes in statutory authority, or the revision of laws affecting
the use of public assets are examples of this type of recommendation.

The third group of recommendations includes those which come under
management or executive reSponsibility but which were not implemented
as of the date of the report. These items are thus brought to the atten-
tion of the legislature which may use whatever means it finds desirable
to review them and enforce them according to its will. Among these
recommendations may be some which will require substantial time to
affect, such as recommendations involving programming or the establish—
ment of performance standards. Others might include the establishment
of program accounting or the formation of an internal audit group.
Most of the recommendations in this group, however, will Simply be
those on which the auditor and the administrator have differences of
Opinions or where the administrator, although agreeing to the desira-
bility of the change, has not had time to affect it in the manner

recommended.

188

Particular attention should be given to those recommendations which
have been made in previous audit reports and which the auditor now finds
necessary to repeat again. If the legislature properly supports the
auditor and follows through on the basis of his audit report to review
and enforce the changes recommended, there should be no occassion for
repeating recommendations unless the corrected practice or policy has
again been allowed to fall short. And if this is the case, the auditor
should note it. Furthermore, prior recommendations in which the legis-
lature did not concur and which it did not therefore enforce may be
brought to its attention again, properly noted as such, but only if
there is some reason to believe that the legislature will decide differ-
ently this time or if the auditor feels that circumstances have changed
which now make the recommendation more appropriate.

Finally, the audit report should provide information on anything
affecting the agency which the auditor feels should be formally made
known to the legislature. Some items do not require corrective action
on the part of agency administrators but still need to be made known
to the legislature. Such items are basically those which the legis-
lature may find useful in conducting its investigation and inquiry into
budget requests or proposed programs. These items are reported for the
general education and enlightenment of the legislature to enable it to
make a more informed judgement and render a more meaningful statement of
policy.

In all of his report, the auditor must be careful not to disclose
publically any information of a classified nature. And matters involving
crimes, fraud, or other illegal acts should be made known immediately

to proper legal and state authorities for prompt prosecution.

189

Implications for Staffing

 

It is important that the performance auditor be equally as well
qualified to judge the performance of administrators as those whose
judgement he may have reason to question. To insure that this degree
of competence exists, several things are necessary.

First, the auditor general must secure for his staff persons with
the necessary skill and ability to enable them to qualify, or to become
qualified, for the job to be done. To the extent possible, they should
be familiar with accounting systems, organization principles, and
government operations.

Some persons have suggested that the auditor general should hire
engineers, political scientists, and statisticians. There is no question
but what much of the performance audit could be conducted by persons with
these backgrounds, but the purpose for hiring them and assigning them
to audits must not be to question the professional and expert judgement
of management in these areas, but rather to render technical assistance
to the audit. In this respect, it seems doubtful that such persons
could add significantly to the skills that can be acquired by the use
of top—level accountants whose training or experience includes these
other areas. Accountants trained and experienced in management services
and administrative science seem particularly well qualified to assume
this reSponsibility.

Probably the single biggest handicap that state auditors face in
the development of a competent and professional staff is the inability
to hire good personnel. Most states are under some type of civil
service classification which prevents the auditor general from hiring
competent, experienced auditors at either an attractive position or a

competetive salary. And starting salaries for college graduates are

190
usually so low that the auditor is unable to get the top students. Thus
he has to be content with the average or below average student, and in
some cases even to hire persons without a college degree. Among most
state auditors with whom contact was made in this study, this problem
was listed as the single biggest handicap to the development of a highly
professional and competent audit staff.

Undoubtedly the most favorable situation revealed in this study is
the one in California, where the auditor general has the power to set
the salaries of his own employees, who by law are not under civil service
classification. Thus the auditor general has been able to surround him-
self with a highly competent staff. Over half of the auditors on his
staff are Certified Public Accountants, and others have completed the
CPA examination and merely await the completion of the experience
requirement. The supervisors and audit managers have all had broad
experience\mid1national CPA firms. Certainly this situation is an
envious one compared to what most states have to contend with.

Michigan is one of the few states which has a fairly good situation
in spite of the civil service classification of its employees. Recent
adjustments in salary rates have made them more competetive, and also
permission has been granted to the auditor general to hire experienced
auditors at the upper levels of the classified ratings. Providing the
Civil Service Commission continues to keep pace with the changing envi-
ronment outside of state government, this situation may prove to be of
no great disadvantage. But if it works out that way, it will truly
be the exception rather than the rule.

Illinois has avoided this problem by contracting over ninety—eight
percent of the state's post audit work out to CPA firms, and other states

are being forced to follow this example in order to obtain competent

191
audit reports. Among the states which have recently moved more in that
direction are New Mexico and Iowa, and many other states have shown con—
siderable interest in the idea.

There is no reason, however, why the legislatures of these states
could not provide by law, as was done in California, for the hiring and
training of a competent audit staff responsible to the auditor general,
and then the states would be able to benefit from the accumulated know-
ledge and experience of the audit staff as well as have in its possession
the audit working papers for each assignment. Such a procedure seems
preferable, particularly if these states intend to expand the scope of
their audits to include an examination of administrative performance.

The second need in the development of a competent audit staff is
a good training program. The auditors need not become experts in all
fields, but they should have a thorough understanding of the procedures
of planning, programming, budgeting, organization, accounting, reporting,
and internal auditing. They should also understand the system of legis-
lative control and the legislative process of which they are a part.
Furthermore, inexperienced auditors need training in audit procedures,
instruction in how to assemble and evaluate information and how to
conduct tests of the efficiency and effectiveness of operations.

Much of this training can come on the job. But a good portion of
it is better provided in formal training sessions, where concepts and
policies can be discussed and developed, and where traditional pro-
cedures and old habits can be challenged in open and free debate.

Training alone, however, does not qualify the auditor for his job.
He must bring to his work such characteristics as imagination, initiative,

creativity, diligence, and self confidence. Likewise, a certain degree

192
of skepticism and curiosity is important. If these basic building blocks
are inherent in the person conducting the audit, he will find performance
auditing an exciting challenge. If he expects to depend upon a list of
procedures or a set of rules to guide his every act and provide answers
to his many questions, he will never succeed in this difficult assignment.

Perhaps more than anything else, the characteristic which is needed
by the performance auditor is the ability to correlate complex informa-
tion, critically analyze it, and effectively communicate to others the
results of his analysis. And while this may in part be a native ability,
it is primarily an ability that is based upon experience and training.

An important element of this ability is the skill to determine the impor-
tant things and not to worry little things to death. There is no better
example of this problem than the auditor who meticulously audits petty
cash while overlooking irregularities and lack of control in contracting
procedures which involve thousands of times the amount of state funds or
resources. Items such as this are certainly proper subjects for audit
training sessions.

Statistical sampling is another area that can be studied in staff
training sessions. This fact is explained by the Federal Government
Accountants Association as follows:

There is a strong feeling among some auditors that the
effective use of statistical sampling methods requires a long
period of training involving highly technical mathematics.

Actual experience indicates, that at least during the initial

learning phase, this is not so. In many ways, it is similar

to the problem of driving a car. One does not have to be an

automotive engineer to learn the mechanics of driving a car;

so it is with the auditor who does not have to be a mathema—

tical statistician in order to apply the mechanics of statis-
tical sampling effectively.l

 

1Audit Sampling in Action, Research Bulletin Number 1, (Washington,
D.C.: Federal Government Accountants Association, 1961), p. 4.

 

193

Other areas such as computer programming, administrative and organ-
ization theory, and management science also need to be studied. Adequate
familiarity with the problems and theories in these areas may require
that members of the audit staff attend classes at a local college, or
it may be necessary for the auditor general to hold week-long seminars
in which these subjects may be properly treated. This he must decide.

The auditor should never attempt to become competent in all areas.
If expert technical advice and assistance is needed, arrangements should
be made to obtain them. In fact, one mark of a mature auditor is that
he recognizes his weaknesses and inadequacies and is quick to acquire
assistance if and when it is needed, recognizing that persistence in
going into areas that are beyond his competence will cost him his audience
elsewhere and will defeat his purpose. He should, however, at least be
able to identify the problem areas and to determine the type of Special

assistance needed.

The Need for Independence

 

Throughout this study, the concept of independence has been stressed.
One of the primary purposes of having the auditor general responsible
to the legislature is to make him independent of the executive branch
whose work he must audit and evaluate.

Not only is it important that the auditor general be independent
of the executive branch in the matter of his responsibility, but also
it is very important that he be independent from other outside influences,
including the legislature, to pursue the objectives of his audit in a
professional manner. As Sharaf explains, "If he has anything less than

full freedom of investigation, the privilege to examine what and where

194
his professional judgement directs him, he lacks complete independence."1
Independence in this sense means the avoidance of all situations which
might tend to impair his objectivity or permit personal bias to influence
his professional judgement.

Furthermore, it is important that the auditor maintain his indepen—
dence not only in fact but in appearance. All of the auditor's work is
conducted in a political area where the slightest appearance or indica-
tion of deviation from this standard is likely to explode into an open
political issue. The auditor, regardless of party affiliation, must
Show absolute fairness, and he must maintain the highest standards of
personal integrity to insure that facts of performance are judged
impartially and objectively.

The auditor cannot, of course, attain absolute independence. As
one writer Observed, "No human being can free himself from all outside
influences . . . No one except a hermit can avoid the influences of his
family, friends, what he reads and hears, and the attitudes and standards
of his community."2 To contend that the auditor general should have no
relations with members of the executive branch or that he should disavow
any affiliation or activity with his political party for fear that the
public might suspect a conflict of interest would lead to an absurd
situation. The auditor would, in effect, be working in a vacuum. He
would lose the benefit of free and frank discussions with Officials of
the state by which he is able to obtain a better understanding of the

organization and activities of the state. He cannot issolate himself

 

1Hussein A. Sharaf and R. K. Mautz, "An Operational Concept of
Independence," The Journal of Accountancy (April, 1960), p. 51.

2John L. Carey and William 0. Doherty, "The Concept of Independence--
Review and Restatement," The Journal of Accountancy (January, 1966), p. 42.

 

 

195
from the world he is responsible to audit.

What he can do is avoid becoming involved in the decisions that are
made by other state officials, and he can critically evaluate and judge
impartially the merits and weaknesses of each. Such conduct will bring
to him and to his office the prestige and respect which is needed if the
performance audit is to truly become an effective control element in

state government.

Other Audit Poliey Implications and Considerations

 

There are several other items which have important implications for

audit policy and which deserve mention in this chapter.

Hindsight

First is the problem of hindsight. Since the auditor general will
always be auditing performance some time after it occurs, he will always
have the advantage of hindsight. This raises the possibility that deci-
sions which seemed perfectly valid and reasonable when made will look
foolish and unwise in light of information subsequently learned. As
Mautz and Sharaf explain, ”Judgements which appeared completely valid
at the time they were made sometimes appear far less sound and reasonable
when viewed, not so much 'in the light of the morning,‘ as with the
benefit of knowledge of changed conditions and additional data."1

The administrator will always have to swallow the fact that the
auditor is going to have this advantage of subsequent information. He

cannot avoid it. But the auditor too Should realize in his evaluation

and recognize in his report that the quality of a decision is unaffected

 

1R. K. Mautz and Hussein A. Sharaf, The Philosephy of Auditing
(Madison, Wisconsin: American Accounting Association, 1961), p. 32.

 

196

by subsequent information which was not available to the administrator

at the time the decision was made. In light of the subsequent information,
the auditor should feel free to make recommendations designed to avoid
similar mistaken judgement in the future, but chances are that the admin-
istrator will have already recognized the problems and made the necessary
adjustments. If this is the case, the auditor should recognize that fact
in his report. Fairness, Objectivity, and the ethics of his profession
require that the auditor avoid evaluating performance of any kind simply

on the basis of hindsight.

A Reasonable Attack

 

Another important policy consideration is the need to limit the
scope of the audit examination to manageable proportions. The area
of management responsibility is extremely broad and complex, and the
auditor cannot hope to render an opinion on the overall operations of
the agency. And even if he did so, it would likely be meaningless.

Performance can only be measured effectively by breaking down the
areas of responsibility into their component elements and by attacking
them individually. Some areas may produce positive results, others
negative. And the report on performance evaluation will be far more
meaningful if the findings in each of these areas are noted rather than
attempting to report on the totality of performance.

This point has particular implications for initial performance
audits. As outlined in this chapter, the most important aspect of per-
formance evaluation is the appraisal of the management control system.
Yet to evaluate every element of that system and then to investigate
every area of weakness would likely consume so much time that only a

few audits could possibly be performed in a year's time. Thus, a more

197
sensible approach would be to restrict the audit to those areas which seem
to have the greatest possibility of making a Significant contribution to
efficiency and effectiveness of operations. Experience on a limited scale
such as this is essential as the first step in refining the methods of
audit examination in an area where extensive precedent is currently lacking.
The area of interest must always remain broad and comprehensive, but the

attack should be made in manageable portions.

Easy Areas

 

When the auditor begins to select the special areas for Specific
audit attention, he must be careful not to select only those areas which
seem easy to accomplish. Certainly there is merit in starting with areas
which present the fewest obstacles. The danger, however, is that the
areas conducive to easy auditing may not be the areas most in need of
auditing. And the audit effort should be concentrated in the areas of
greatest need. Even a rough analysis of areas of substantial importance
may be more meaningful than a detailed study of other items. An example
might be the value of an analysis of construction costs as compared to a
detailed study of the use of custodial supplies and services, although

the latter would probably be far easier to accomplish.

Frequency of Audits

 

Not only is the amount of time to be devoted to each audit important,
but also the frequency of the audit. And there is a wide variety of
policies and practices among the states on this matter. Some states try
to audit all agencies every four years, and others do it every two years.
Still others try to conduct some audits annually while allowing longer

periods of time to elapse between other audits. Each state will have to

198

make this decision for itself, but a few considerations are important
to note.

First, audits should be conducted as often as they are needed by
the legislature for proper legislative review and analysis. Second, if
agencies are left too long between audits, the danger of minor irregu-
larities becoming major problems is increased. Third, audits by the
auditor general are probably needed more often where no effective internal
audit is performed. And finally, since the auditor has limited resources
and manpower with which to conduct his audits, he must find some reason-

able compromise between the intensity of his audit and its frequency.

Evaluating Auditor Performance

 

A final consideration for audit policy and practice is the need for
the auditor general and other top officials on his staff to review the
performance of the audit staff after each assignment. The importance of
this evaluation is expressed by Roberts who said, "To one whose duty
involves appraisal and criticism of another's performance, self—appraisal
may be even more useful to keep his perSpective in proper focus."1

To accomplish this review, it is necessary that performance require-
ments be clearly designated and that the objectives of the job be clearly
defined. Performance standards should be used to provide an Objective
basis for measuring accomplishment and to promote a better understanding
among members of the staff of what is expected of them. Campfield
discusses this subject as follows:

A performance requirement is the understanding which

exists between a staff member and a supervisor defining the
necessary performance on a Specific assignment considered

 

1Ralph S. Roberts, "Internal Audit--Praise and Criticism," The

Federal Accountant (June, 1960), p. 14.

 

199
acceptable by the supervisor. Since the practice of auditing
involves a large measure of judgement, performance

requirements for auditors must necessarily be stated in suf-

ficiently broad language to avoid constant alteration and

change. . . . The requirements should include, in addition

to the minimum printed criteria established . . ., written

and oral instructions of supervisory audit personnel.1

Certainly performance evaluation is as important in the area of the
auditor's responsibility as it is for any other state official. And
since he is the one primarily responsible for performance evaluation

throughout the state, it is not unreasonable to expect that the auditor

general himself should set the example in this regard.

Progress among the States

 

Progress among the states is extremely difficult to assess, but
some indications of progress are evident and some states have conducted
audits that come near to being the type of audit described herein.

Michigan has been working for over a year on the problem of develop-
ing performance auditing procedures, and a few audits have already been
conducted in which the audit supervisors were specifically instructed to
look for "performance areas." The most comprehensive such audit conducted
to date was one involving the Ionia State Hospital, where the auditors
looked into the quality of the supervision, personnel relations, communi-
cation, and other operating areas of the hospital.2 Also the treatment
program was analyzed, and recommendations were made to improve controls
throughout the hospital. More recently, the auditors have been analyzing

Space utilization and other performance criteria at some state colleges

 

1William L. Campfield, "A Blueprint for Appraising and Guiding
Audit Staff," The AccountingrReview (October, 1957), p. 626.

 

2Michigan, Office of the Auditor General, Audit Report of the
Ionia State Hospital, Performance and Financial Audit, as of June 30, 1965.

 

 

200
and universities.

Basically, the Michigan approach has been one of letting individual
audit supervisors determine for themselves which aSpects of performance
they wished to evaluate. Each audit supervisOr is encouraged to use his
own initiative in determining the area of evaluation, the extent of the
evaluation, and the manner in which evidence is collected and performance
is described. Recently, procedures have been initiated which call for
closer supervision by top officials of the department in setting up the
examination and evaluation procedures in the "performance areas.”
However, no standard or formalized approach to the conduct of the audit

has yet been developed by the department.

California does not claim to adhere to a policy of performance eval-

 

uation in its audits, but the auditor general has followed a policy of
conducting very penetrating examinations of the control systems in

the departments and agencies of the state. Several such audit reports
were examined in connection with this study, and from them it appears
that the state does more evaluation of performance than it claims to be
doing. Certainly the audit staff in the state of California is as well
qualified to examine and evaluate the performance on a broad scale

as is any audit staff in the nation.

Also, as noted in an earlier chapter, California is one state which
currently has an active internal audit program in addition to the legis-
lative auditor general. And much of the performance evaluation is seen
by the auditor general to be the responsibility of this internal audit
group, whose work is evaluated and supplemented by the auditor general
in the course of his own examination.

Hawaii seems to have one of the most promising audit systems and

201
policies among the states. In a report of the programs and goals of the

Office of the Auditor issued in 1965,1

the Auditor clearly outlines an
audit policy which includes an examination and evaluation of the manage-
ment control system, including planning, programming, budgeting, and
other such areas. And in a letter accompanying the report of the first
"management audit" conducted in the state, the Auditor noted that it was
"the first of a continuing series of management audits which will be con-
ducted by this Office." He added, "In this examination, we have attempted
to evaluate management's effectiveness in program planning and execution
in light of the goals, policies, and resource commitments for the .
"2

program.

In the report itself, the following significant comment is made:

The questions we have raised in our examination are

characteristic of those which management is expected to

ask of itself, in order that it may continuously subject

itself to searching self-Scrutiny to ensure that it is

effectively serving an essential mission.3

The report itself seems to be everything it is represented to be,
and it constitutes one of the finest examples of this type of audit
examined in this study. Certainly Hawaii gives every indication of
being one of the leaders among the states in the development and use
of performance audit policies and procedures.

New York, although it does not have a legislative auditor general,

has made considerable progress in developing a more comprehensive audit

 

1Hawaii, Office of the Auditor, Report to the Legislature of the
State of Hawaii, Long and Short Range Programs of the Office of the
Auditor, December, 1965.

 

2Hawaii, Office of the Auditor, Report to the Governor and the
Legislature of the State of Hawaii on the Examination of the Office
of the Revisor of Statutes, Audit Report No. 66-1, January, 1966, p. i
of transmittal letter.

3Ibid., p. 2.

 

 

202

program. As a branch of the Comptrollers office, the post audit function

in the state is looked upon as a top-level internal audit program, and

the expanded audit program is referred to as an ”operational audit."l

New York has by far the most comprehensive and advanced audit manual

of any state contacted in this study, and in that audit manual the audit

policy is clearly outlined to include operational and performance areas.

For example, on the matter of relating the audit to the basic programs

or missions of the agency or department, the following instructions are

given:

To effectively serve the needs of modern Government,
audit must look beyond the accounting records and into the
basic programs or missions of the activity audited. Upon
reaching the audit site, the auditor might well ask himself:
”What are the basic programs of this organization, and what
factors have a significant bearing on the effective and econo-
mical performance of these programs?” Upon approaching a Speci-
fic activity or element of the organization, the auditor might
first ask: ”What is the objective of this activity and what
would I expect to find if the activity were to be effectively
(or ineffectively) performed?" . . .The audit program would
then be tailored to prove the adequacy or inadequacy of pro-
gram accomplishment.

Later in the same section of the audit manual, this significant

comment is made:

Costs result from decisions--management decisions--based
upon alternate courses of action. . . . It may therefore be
stated that costs and financial reports reflecting these costs
represent quantified results of management decisions and con-
trols. A meaningful audit, therefore, requires that the audi-
tor examine into the management decisions and controls which
underlie the incurrence of the costs.3

Three comprehensive Operational audit reports were examined in the

 

York

1Arthur Levitt, "Operational Auditing in New York State,” The New
Certified Public Accountant (May,l964), pp. 337—341.

 

2New York, Department of Audit and Control, Division of Audits

and Accounts, Field Audit Manual, Vol. I, Sec. 1-2, p. l.

 

3Ibid., p. 2.

203
process of this study. In each case, the audit clearly went beyond the
traditional scope of financial audits and included an examination of
a number of areas of management control and performance. These audits
represent an excellent example of performance auditing done internally
within the executive branch. An no one contacted in this study demon-
Strated a better graSp of the problems and concepts of this difficult
area than did those in charge of the New York audit program.

Numerous other states have indicated an interest in expanding their
audit efforts into performance areas, but none contacted in this study
claimed to have done so thus far. And no audit reports examined in any
other state revealed any evidence of such audit effort having been made.

Progress to date, therefore, is extremely limited but encouraging.
As more states become familiar with the work of the states noted here,
and as more of the newly appointed legislative auditors are able to
build a competent and sufficient staff to conduct such audits, no doubt
these concepts and policies will become better accepted and more widely
used by other states. And those states which have to date experienced
limited but significant progress in this area will undoubtedly move
at a much faster pace now that some of the initial formative problems
have been resolved and experience has been gained in the actual conduct

of the audit in this critical area.

Summary and Conclusion

 

This chapter has been a discussion of the basic approach to the
conduct of the performance post audit. The various phases of the audit
were noted and discussed, and the need for effective audit planning was
noted. Several implications for audit policy were noted throughout the

chapter, and the qualifications and independence of the audit staff

204
were analyzed. Finally, progress to date among the states has been noted.
There is no magic formula or simple approach to performance auditing.
Every audit will be different, and the key to success in this type of
auditing lies as much in the ability and skill of the auditor assigned to
the job as in any set of rules or audit guidelines.

Although the material developed in this chapter has been developed
on a theoretical basis, the ideas and concepts have been discussed with
numerous officials throughout the country. Based upon their opinions
and upon the information presented in earlier chapters, the approach
described here seems to be the most reasonable approach to the audit.

The test of this system will come in its use. Only after these
concepts have been put to the test of actual practice will it be pos-
sible to evaluate them specifically. And only then will the problems
be clearly identified which need further attention and development.

As more and more states become familiar with these concepts and adopt
these practices, additional examination and analysis of this approach
will be needed. Until then, this suggested approach and any alterna-

tives to it remain empirically unproven and untested.

CHAPTER VI
CONCLUSIONS AND RECOMMENDATIONS

Burkhead reports that Sir Henry Higgs, a noted British financial
authority, once accompanied a friend on a trip to Egypt for the purpose
of trying to improve the fiscal administration in that country. When he
arrived, he found that a sample audit system was being used. And upon
examination he discovered that "items numbered 1, 5, 9, 13, etc., were
regularly checked, so regularly, in fact, that this had become known
throughout the service; obviously, no defalcations were ever discovered."
This situation prompted the remark from Higgs, "There you had the Audit
Office, with its officials going round like squirrels in a wheel, producing
nothing of value, but rather creating a false sense of security in the
minds of those who were relying upon it. ."1

Traditional state audits have likewise created a false sense of
security in the minds of both the citizens of the state and the officials
of the government. Limited as they are to an examination of the financial
controls and accounting records, these audits are not capable of rendering
a report on the manner in which officials of the state discharge their
responsibilities to administer the programs of the state. This fact has

been demonstrated in this study, and a bold new approach to state auditing

has been outlined--one designed to evaluate administrative performance in

 

1Burkhead, op. cit., p. 370.

205

206

all areas from the initial planning to the final review.

Contributions of the Study

 

The contributions of this study are many, and a few of the major
ones will be summarized here.

First, the intent of the Michigan Constitutional Convention, which
adopted the provision requiring performance post audits to be conducted
in the state by the Auditor General, has been clearly determined and
described. This contribution is significant not only because it clarifies
the responsibility of the Auditor General, but also because it outlines
to the legislature, the Governor, and all other state officials the impli-
cations of the performance audit with reSpect to their own reSponsibility.
The performance post audit was related to the structure of state govern-
ment which is characterized by the separation and balance of power con-
cepts, and it was found to be a natural outgrowth of the resulting patterns
of responsibility and of the growth trends and changing complexities of
state operations.

Another contribution of this study is the development of the role
of the auditor general as an element of the legislative control system.
The legislative control system itself was described, and its function
and purpose were noted. From this system, the auditor derives the purpose
for his audit, and it was found that the performance post audit is not
only in harmony with such a control system; it is essential to it. Steps
were also outlined by which the legislature can make the audit meaningful
and effective in the state. Both legislative and executive performance
is improved when such an audit is effectively conducted, and thus the public
is better served.

One of the most significant contributions of this study is the

207
development in Chapter IV of the areas of executive reSponsibility pro—
perly subject to performance post audit review and evalutaion. The
elements of planning and control were described,and their importance
to the auditor were noted. Effective planning and programming are essen-
tial if true performance is to be measured in terms of the services
rendered by state agencies to the citizens of the state. Performance
standards are needed to indicate and measure progress. Organizational
planning must be consistent with programs planned, and the accounting and
budgeting systems must conform not only to organizational patterns of respon-
sibility but also to program planning. And finally, effective internal
audit and review is required if management is to complete its responsibility
to faithfully administer the programs of the state in an effective and
efficient manner.

Finally, an approach to the audit was developed. Five steps were
outlined, which included advanced planning, initial survey, evaluation
of the management control system, analysis of exceptional areas, and the
audit report and recommendations. The most significant part of this audit
is the evaluation of the management control system, for it is here that
efficient and effective operations are insured and faithful compliance
with legislative intent is secured. The audit approach described in
this study is designed to serve in any situation in the state and will
provide for the effective achievement of every objective of the perfor-
mance post audit.

In addition, the bibliography to this study is itself a contribution-—
one that has value for both the researcher and for state audit officials.
Although not intended as a comprehensive listing either of all materials
available or of those reviewed in connection with this study, this bibli-

ography does represent an extensive listing of relevant materials in the

208
published literature, of research studies and significant reports pre-
pared by public organizations or private research groups, and of other
unpublished but generally available materials which have proven helpful

in the course of this study.

Challenges for the Future

 

This study is an attempt to provide a theoretical analysis and
penetrating discussion of the relevant variables and fundamental con-
siderations of performance post auditing, but it by no means is a final
answer to the need for information and analysis of this important area.
In fact, one of the contributions of this study is the identification
of the major areas that badly need additional attention both from the
researcher and from the auditor. And it is appropriate that some of
these areas be noted again at this point.

One area needing attention is that of legislative intent. Much
work needs to be done to modernize the means of formulating, enuncia-
ting, and determining legislative intent and policy. The Council of
State Governments regularly devotes some attention to this problem in
its annual conferences on state legislative services,1 but this is not
nearly enough. Each state legislature must recognize that it is incon-
sistent to call for executive officials or agency administrators to
account for their lack of deve10pment of programs, objectives, standards,

and other control elements if the legislature itself does not take steps

 

1For example, see National Legislative Conference, The Committee on
Rules, "Some Recommendations for Modernizing Legislative Rules," A Pro-
posal of the Committee on Rules at the Fourteenth Annual Meeting of the
National Legislative Conference, recorded in its Summary of Proceedimgs
(Chicago: The Council of State Government, September 7, 1961); and "The
Determination and Implementation of Legislative Intent," in Summaryrof
Proceedings, Part II, Legislative Service Workshop SesSions (Chicago:
The Council of State Government, September 20, 1962).

 

 

 

209
to put its own house in order. And there is no more appropriate place
to start than in the matter of legislative policy expression. Unless
such steps are taken, the auditor will continue to have difficulty
determining faithful administrative performance.

Each of the areas of the management control system could well
constitute a dissertation in itself. The selection of objectives for
state programs is one area which must receive additional attention if
planning is to be rationally accomplished. Programming methods are far
from adequate, and organizational planning along program lines must be
studied. Another area that has been almost totally ignored by accoun-
tants and financial authorities in their zeal to demand program budgets
is the development of program accounting systems. With the exception
of the State of New York, no evidence was found in this study of any
state having done very much in this important area. This subject is
a very timely and apprOpriate topic for dissertation study as well as
for attention by the professional accounting groups and state fiscal
authorities.

Another area needing attention is the problem of obtaining qualified
auditors both for internal audit staffs as well as for the staff of the
auditor general. One of the biggest factors contributing to the lack of
development of internal audit staffs in the states is the inability to
acquire competent auditors to do the work. And as noted earlier, the
same is true of the staff of the auditor general in most states. And
while some states have turned to the use of professional CPA firms for
their post audit work, this cannot be done for internal audits. Probably
this inability of the state to obtain competent internal or independent
auditors is but one part of a much larger problem of effectively staffing

state organizations, but certainly it needs attention.

210

Finally, each phase of the audit as outlined in Chapter V needs addi-
tional study. And these are areas in which the experiences of state audi-
tors will become increasingly important. The approach described needs to
be tested, expanded, and modified as new light is shed on the problems. It
is also important that other individuals critically examine and challenge
the theory here-in developed to insure that important considerations have
not been overlooked in the research and development of this study. Such a
challenge would be welcomed, because it is only in the competetion of ideas
that one's attention is drawn to the many alternatives and numerous complex-

ities of a problem as comprehensive as that of the performance post audit.

Conclusions

 

The hypothesis of this study has been confirmed. Performance audits
are not only meaningfully possible; they are essential to the continued
vitality of state government as known in the United States today. Such
audits are a natural and logical responsibility of the legislative auditor
general, and they are essential to effective legislative control of admin-
istrative performance. Such audits are certainly facilitated by the exis-
tence of an effectively operating management control system, but such a
system is not a condition precedent to the audit.

Both the administrator and the legislator stand to benefit from the
development and increased use of performance post audits. More effective
and more efficient administration of state programs is the product that
can be expected when such audits are conducted in a spirit of mutual
interest and understanding. Finally, the quality of the services ren-
dered by the state to its citizens will be greatly improved, and in the

final analysis, this is the end objective of all state activity.

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223

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226

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228
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231

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APPENDIX A

Article IV, Section 53 of the 1963 Michigan Constitution

The legislature by a majority vote of the members elected to and
serving in each house shall appoint an auditor general who shall be a
certified public accountant licensed to practice in this State, to
serve for a term of eight years. He Shall be ineligible for appoint-
ment or election to any other public office in this state from which
compensation is derived while serving as auditor general and for two
years following the termination of his service. He may be removed
for cause at any time by a two-thirds vote of the members elected
to and serving in each house. The auditor general shall conduct
post audits of financial transactions and accounts of the state and
of all branches, departments, offices, boards, commissions, agencies,
authorities and institutions of the state established by this con-
stitution or by law, and performance post audits thereof.

The auditor general upon direction by the legislature may employ
independent accounting firms or legal counsel and may make investiga-
tions pertinent to the conduct of audits. He shall report annually to
the legislature and to the governor and at such other times as he deems
necessary or as required by the legislature. He shall be assigned no
duties other than those Specified in this section.

Nothing in this section shall be construed in any way to infringe
the reSponsibility and constitutional authority of the governing boards
of the institutions of higher education to be solely responsible for
the control and direction of all expenditures from the institution's
funds.

The auditor general, his deputy and one other member of his staff

shall be exempt from classified civil service. All other members of his
staff shall have classified civil service status.

232

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