2.2 Nairobi City County audit report excerpts, 2013

revenue collection. However, the requirement that incoming county governments establish asset registers overnight was unrealistic, at least in the first year of transition. The main reasons include the following:

• First, the outgoing local entities did not have asset registers and reliable asset records, so they were not able to provide them even if they were willing.

However, they should have handed over all documentation they possessed regarding assets and liabilities. These would not have constituted asset registers but would have been useful for the incoming governments. • Second, developing asset inventories with thousands of verified records from scratch takes a year or two, and it was unrealistic to expect the incoming governments to do them weeks or months after induction. However, the warnings in audit reports were right and timely. Box 2.2 shows excepts from the audit report of Nairobi City County (interpreting TA Law 2012). • Third, the OAG interpreted the existence and operation of and communication by the TA to mean that the TA would inventory assets and would transfer assets and liabilities only after audits. Interviews suggest that county administrations believed that they were not authorized to take over assets and liabilities and inventory them after induction.

BOX 2.2

Nairobi City County audit report excerpts, 2013

Failure to take over by the county government The County Government of Nairobi had not officially taken over the assets and liabilities of the former City Council of Nairobi (CCN). Overall, the audit found that Nairobi City County had 16 departments which were uncoordinated and operated as independent units. No [processes for] handing over notes were prepared and business continued as usual, and as a result it has not been possible to conclusively confirm the accuracy of the assets and liabilities taken over from the former CCN. A senior management committee to take over the role of the council during transition was not established as directed by the then Ministry of Local Government vide Circular no. MLG/1333/TY/52 of 18 February 2013.

Cash and bank balances The defunct CCN historically operated 40 bank accounts out of which sixteen (16) bank accounts were dormant, while 12 accounts had credit balances totaling KES. 35,459,356.20. However, the County did not produce for audit all the cashbooks and bank reconciliation statements to confirm the accuracy of the cash and cash equivalents. Failure to close bank accounts The Ministry of Local Government had issued instructions via Circular no. MLG/1333/TY/52 of 18th February 2013 requiring all defunct local authorities accounts to be closed and the existing funds transferred to the General Rate Fund Account and as soon as practicable, a Single Account to be opened at the Central Bank of Kenya. However, the accounts were not closed as required and business continued as usual and instead four (4) new accounts were opened.

Failure by CCN bankers to confirm cash and bank balances It was not possible to confirm whether the forty (40) bank accounts disclosed by the former CCN were the only accounts operated before the transition period as the CCN bankers, mainly, Equity Bank, Cooperative Bank of Kenya, Kenya Commercial Bank, and the National Bank of Kenya, did not respond to our requests for disclosure of all accounts previously held and also requiring them to confirm the balances in each account. The number of bank accounts varied

continued

Box 2.2, continued

from different lists presented for audit with some lists showing 40 [or] 41 and others 42.

Underbanking of revenue collected Revenue records made available for audit revealed that during the period 1 January 2013 to 30 June 2013, a total of KES. 5,511,732,231 was collected from the various sources of revenue but only KES. 5,258,849,088 was banked resulting to under-banking of KES. 252,883,143.

The audit also revealed that out of the total underbanked revenue, KES. 29,021,813.00 was subsequently

Source: OAG 2013. Note: The audit uses the symbol KES. for the Kenya shilling. issued as IOU’s to various officers while the balance of KES. 223,861,330.00 represented checks cashed in by County staff for various miscellaneous activities such as purchase of goods and services and other numerous consumable items.

It was also noted that during the period under review Cess Income totaling KES. 60,725,305.00 was collected in various divisions but only KES. 57,889,995.00 was receipted at the cash office and banked resulting in a difference of KES. 2,835,310.00 not accounted for and banked.

These apparent legal, regulatory, and/or communication challenges hindered policy dialogue that would have clarified mandates and responsibilities and led to adoption of clear operation procedures for county governments on asset and liability takeover. Furthermore, the slow progress on asset verification was very apparent, since the TA did not complete, even in one single county, the verification and audit of assets inherited from defunct entities by the election day of March 27, 2013. Evidence of this severe delay was apparent already in 2013 but had not led to national policy dialogue or corrective measures that year or later until 2016, when the TA was closed.

By the same token, the counties failed in proper takeover and management of the bank accounts, cash, and inherited financial assets and liabilities that did not require an extensive workload to take over as compared with the requirements of fixed-asset registers. OAG had raised issues on bank and financial statements and repeatedly listed specific shortcomings in each county’s audits. But these audit statements have not induced corrective measures in counties, nor have they opened a national policy dialogue to seek nationwide and strategic corrective options and stipulate immediate corrective measures months after induction of county governments.

The takeover of inherited assets was obviously problematic, but it is hard to justify the county administrations’ inaction on starting simple but proper recording of the fixed assets acquired after March 27, 2013. The lack of handover of such assets did not constrain records, because those were new assets, although with many installed additions to old inherited assets (for example, new school rooms or a new ward of a health center). It is more worrisome that the financial transfers (equitable shares) from the national government had increased substantially at the course of devolution and the counties surveyed rightly invested about 30 percent or more of the local revenues and each acquired assets in billions of Kenya shillings in the years after devolution. (Nairobi City County [NCC] invested over K Sh 9 billion into fixed assets between 2013 and 2018.)

A small portion of the capital budgets would have been sufficient for the counties to hire a firm and develop a simple, pragmatic initial asset inventory or register. That would have been evidence of due diligence, although some would

consider it a redundant action in parallel with the TA-planned asset inventorying and audits. Some experts had the view that the real reason behind avoiding formal takeover of assets was that counties did not want to take over stockpiles of inherited liabilities.

The World Bank supported Kenya’s devolution process through, inter alia, the Kenya Devolution Support Program, a US$200 million Program for Results project, aimed at enhancing capacities and systems of county governments. Under this project, counties are taking steps to establish basic asset registers. However, there is generally no strong national policy dialogue and/or specific guidance to encourage counties to keep proper financial and asset records (in the form of quite simple registers or Excel tables), at least of the assets acquired from the current revenues after March 27, 2013. Overall, counties have achieved little progress toward establishing initial asset registers for both the inherited and the newly acquired assets in nine years of devolution.

Installation of the integrated financial management system (IFMIS) to counties may have created another source of confusion. Gradually, the mainstream approach of counties became to wait for installation of an AM module in the IFMIS and use this need as a justification for lack of actions toward inventory and registration of county assets. This seems to be a misunderstanding or misinterpretation of key aspects of both the IFMIS and AM. First, AM is not a mere accounting issue (as discussed in previous sections). Second, without verified field data, a reliable asset register cannot be established in a computer module due to lack of information. Third, such a module would remain a software application and while it would be a good start with possibilities would not yet constitute or turn automatically into an asset register.

Possession with partial takeover of inherited assets and liabilities

County governments jump-started operations right after induction and managed to ensure uninterrupted provision of basic local services (a key objective in TDG Act 2012) regardless of the noted issues on financial and bank accounts, assets, and liabilities. This is a major achievement of the Kenya devolution that cannot be underestimated. The incoming administrations assigned officers to manage key services and functions and operate services, plants, buildings, systems, and equipment. Thus, they had captured the flow of operation while overlooking the “stocks” of information and assets and stocktaking issues. In this sense, the devolution and transition to new county governments was smooth and pragmatic. One example is that county governments appointed or assigned officers to manage the key services and fulfill key functions (less so though in financial and asset management), and the ministries provided seconded staff to fill gaps in human capacities, so the new county governments possessed assets and were fully functional from the beginning.

The county governments informally but effectively took over assets that were the material basis of local services and functions, such as offices, health centers, education buildings, markets, and roads. They even immediately started urgent repair and expansion of assets in areas of critical shortages: for example, building additions to health care and school facilities. With few exceptions, counties expanded development expenditures substantially as increased budgets permitted. The share of development expenditures between 2013 and 2018 increased from 10–15 percent to 20–30 percent or above in many counties, for example,

Kakamega and Makueni in our survey (see part II). In this sense, the devolution resulted in visible improvement of some assets and services and bettered the appearance of urban areas.

The counties’ core fixed assets that serve key functions are under counties’ possession and reasonable management, are operational, and fulfill required functions (schools, health facilities, offices, markets, stadiums, and water and sanitation facilities). However, the lack of a reliable inventory and register of land and buildings, especially those not attached to key services, is a major impediment to good AM. Thus, one can conclude that the partial takeover of assets was a pragmatic but unsatisfactory approach that may have resulted in substantial material loss of public wealth via encroachments or other forms of lost value.

Counties inherited a substantial volume of current assets and liabilities, K Sh 110.8 billion and K Sh 53.8 billion, respectively (figure 2.3 and figure 2.4). The numbers may suggest that the counties can easily pay off inherited liabilities from the inherited current assets, but this quick judgment is incorrect and needs closer scrutiny. NCC has inherited about two-thirds of the total local government sector in both current assets and current liabilities. These numbers are estimates as of March 2013, but the present value of current assets has since presumably changed substantially, because old and unverified claims and collectibles have little value (and the inherited claims are now nine years older). The stock of current assets also increased in the meantime, with uncollected new current assets due to a low level of collection efficiency. For example, the collection efficiency of property tax (property rate) is below 50 percent (see cases in part II), so collectibles are growing in nominal values.

In contrast, the present value of inherited current liabilities (claims against counties) has increased substantially since 2013, because of accumulating interests and penalties, even though some counties have made strong efforts to pay new liabilities. Estimates suggest that the volume of inherited current liabilities has doubled between 2013 and 2018 despite substantial repayments. The challenge is that the counties have limited capacities, expertise, and procedures to set policies and collect the inherited current assets, so the majority of the property rates have been uncollected for maybe over a decade. Thus, these face-value figures need careful interpretation and treatment, because a quick and simple conclusion that the counties can repay all inherited liabilities from the stock of inherited assets is unrealistic and misleading.

Counties made some efforts to work out inherited financial liabilities. For instance, the NCC government appeared to be ahead of other counties on these. Counties took over all the staff from the defunct local entities, and as a result, they faced severe redundancies and overstaffing in many areas. They started restructuring and streamlining the workforce, which often required substantial funds for severance payments. But counties were also more mindful of working out of inherited overdue staff emoluments, which they verified and largely paid in the first year of devolution. NCC also attempted to negotiate statutory deductions and aimed to annul penalties in exchange for paying inherited overdue deductions net of penalties. Most of these negotiations have failed, however, due to the reluctance of various fund administrators. Counties mostly continued servicing the inherited bank debt, except NCC has disputed some large inherited debts and has not started debt service to date.