1. Restructure Arkansas' state budgeting process to require performance-based budgeting in all agencies rather, than the traditional incremental budgeting still in use in most states.

2. Define and implement a system of performance-based pay for all state employees.

3. Incorporate Activities Based Costing (ABC) into the state's accounting system with expenditures tied not only to costs but to measurable, performance outputs.

4, Provide for .a fully independent audit of state government overseen by a bipartisan audit committee comprising a preponderance of members outside of state government's management and legislative sphere. And, in connection with the audit function, implement the recommendations contained in, the management letters issued by the accounting firm of Deloitte & Touche over the course of three successive state government audits--1995; 1996, and 1997.

Table of Contents

Foreword and Summary of Recommendations

Performance-Based Budgeting

Merit Pay for State Employees and Teachers

Activity Based Cost Accounting

Creating an Independent Audit Function

Members of the Murphy Commission's
Oversight Advisory Council
Chairman, Mike Haigh
Madison Murphy
Dorsey Jackson
Ray Gash
Bob Hogan
George Breazeal
Rep. Ted Thomas
Michael Watson
Steve Stephens
Bob Ratchford

Chairman, Murphy Commission

The Murphy Commission's primary focus, when it began its review of state government months ago, centered on discovering ways to save money in state agencies and across the breadth of Arkansas.' state system. As it nears the end of its work, the Commission's stated mission remains the same: "discovering ways to make state government smaller, leaner, more efficient, and more accountable." And now -- even snore so than at the beginning of the effort --members realize this mission is achievable and can be accomplished without jeopardizing he ability of the state to deliver those essential and traditional services the people of Arkansas expect.

"Arkansas -- according to a just released report by the National Association of State Budget Officers (NASBO) --remains one of only twelve states that currently has no performance measures developed for major governmental functions ...it is one of only nine states that does not publish any performance results for its citizens apprising them if their tax dollars are producing the intended results established when those dollars were allocated to a state function."

Still„ in the course of its work; the Commission has realized its one-time effort to identify cost savings in state agencies will never be sufficient to re-center government on its core functions, to incentivize government managers to provide the best services for the lowest costs, and to infuse government with a "customer first" attitude.

Achieving these objectives requires seeking out those best practices in management and finance and implementing them in a manner designed to assure government always performs with the greatest possible efficiency, with an ingrained sense of stewardship over taxpayers funds, and with a here-to-fore unheard of level of accountability and openness. The Murphy Commission sees identifying such practices, recommending them to the slap V, and working to implement them in the years ;ahead as its singular most important goal. To that end, there is good news. Out among the states there is already an accountability, performance, and cost ;containment explosion already well-underway.

Citizens, weary of rising government expenses and constantly higher taxes coupled with declining quality of services, have demanded change. And, as a result, tough, business-minded governors, such as George Allen of Virginia and Zell Miller of Georgia, have responded with conviction to install innovative managerial and financial reforms based on higher performance at less cost. The benefits of such reforms are already apparent in states such as Virginia, Texas, Michigan, Georgia, Florida, Arizona and others. Government expenses are falling, citizens' taxes are decreasing, state economies are booming, public services are improving, and massive inefficient government bureaucracies are giving way to lean customer-oriented operations bent on "bang for buck" delivery of services tied wholly to measurable performance objectives.

By contrast, Arkansas -- according to a just released report by the National Association of State Budget Officers (NASBO) -- remains one of only twelve states that currently has no performance measures developed for major governmental functions. As such, it is one of only nine states that does not publish any performance results for its citizens apprising them if their tax dollars are producing the intended results established when those dollars were allocated to state function.

Arkansas needs to join the performance, cost, and accountability movement occurring now in other states. The following four primary recommendations are among several direction.

2. Define and implement a system of performance-based pay for all state employees.

Governor Huckabee asked the Commission and its Oversight Advisory Council to look into these four reform issues in more detail and then offer some advice and guidance. In responding, the Oversight group's original intent was to define "how" the state should craft these reforms as well as how and when they should be implemented. But in the course of surveying some 27 states it became obvious that it would be inappropriate for a single group of citizens to strictly define how four such important reforms should be done in Arkansas.

The more important role for the Commission was to survey other states and collect information, assess the literature and the policy debate to provide supportive arguments, and to offer a starting point with a "foundation" of information and a clear perspective as to why these reforms should be done. This report then can serve as a "primer" for citizens, candidates, elected officials and others interested in introducing performance management to state Government in Arkansas.

When the Murphy Commission conferred with other states that successfully implemented such changes, it became apparent that adopting them does not happen because a single interest group defines them and says they must be done. Instead, the group saw a consistent pattern wherein a partnership of government and the private sector teamed up to 1) carefully craft the reforms (which differed in each state due to unique needs), 2) thoughtfully assure stakeholder input (but not domination), and 3) put the reforms in place in a workable, uniform, and integrated manner with broad-based public support.

In each state, however, there were elements common to these efforts that contributed to their success:

1. As a matter of political leadership, the Governor, as the state's chief executive officer, became their staunchest advocate. Change is always difficult to affect and therefore significant change needs a champion. In states where the Governor threw the full weight of his office and legislative initiatives behind these reform, they happened. This was especially true where legislative champions also emerged. George Allen of Virginia and George Bush of Texas are examples.

2. The Governor gave substance to the means by which performance measures came into being. This usually took the form of special commissions and offices. Forming such groups had the added advantage of surrounding the Governor with like-minded people and experts and gave "arms and legs" to his initiative. It was these special task forces or commissions that did the work -- keeping the Governor informed and involved -- and handed him a completed package with all details.

3. The working commissions, task forces and special offices in each state showed great sensitivity -- on the one hand -- by assuring input and representation by stakeholder groups such as state employees groups and agency personnel. They valued and respected their views and their points were all weighed and carefully evaluated. But on the other hand, they were not allowed -- because of obvious self interest -- to dominate the process. For the sake of objectivity and balance the groups drew more heavily on private sector expertise, policy groups, and experts from around the nation.

The Murphy Commission believes this report, as a "performance primer", will he useful to the Governor, the Legislature, and others. But getting the job of actual reform done will require an approach similar to that of other states as outlined above. The following recommendations outline the Commission's suggestions on one possible approach to implementation that may have merit and which we encourage the Governor to consider:

In order to facilitate the implementation of performance reforms, the Governor should additionally take the following steps:

The Governor creates a new Commission (i.e. the Arkansas Government Accountability Council or some similar title) and empowers it to work with, guide, and assist him and his staff in achieving these four recommended measures in the most timely manner possible. He further names a chairman from the private sector to head the Accountability Commission and who regularly joins the Governor in reporting its progress to the media and to the public at large. The Commission is peopled with enough members that four smaller groups (each enhanced with advisory members from stakeholder groups) can work on the four main reforms.

Such councils are not new. Florida, for example, has its Florida Commission on Government Accountability and Iowa has formed a 13 member bi-partisan Iowa Council on Human Investment charged with defining and implementing measures that keep that state "performance" and "results" oriented and continually focused on public accountability.

An Arkansas Accountability Council ideally should comprise business leaders, public policy experts, and accounting experts, most all of whom are outside the sphere of government, its agencies, the legislature, and state employee associations. Legislative, executive branch, and state employee membership would be allowed, but limited. It should also require a bi-partisan balance and the Governor should involve work closely with legislative leaders from both sides of the aisle. In its initial stages it should be tasked with assuring the completion of the following steps:

• accumulate the best practices from all states relative to the four accountability reform measures outlined above. (i.e. Texas is among those states now fully implementing performance-based budgeting, throughout its government, Iowa makes effective use of Activity Based Cost accounting and Georgia has one of the leading merit pay systems in the nation as does Colorado.)

• consult with and accumulate the latest literature from accounting firms, public policy groups, and support organizations such as the National Association of State Budget Officers (NASBO) and the Government Finance Officers Association. Invite briefings and testimony from these and many other groups. The Government Finance Officers Association, for example has recommended as part of its best practices package for all states, the formation of a state government audit committee.

• review all initial findings from the discovery phase outlined in the two steps above and make initial determinations about the form and substance of the four reform measures as they could be applied to Arkansas.

• determine a working time schedule and the tactics needed to transition from current practices to the four reform measures. (taking into account costs, phased-in approaches, pilot programs, etc.)

• facilitate ample input from all stakeholder groups.

• implement the new reforms allowing for the inevitable bugs and transitional problems, strive to correct them through evaluation, adjustment, and follow-up.

• remain in place to further evaluate existing programs and accountability measures, new ideas, practices and innovations Arkansas should consider in the years ahead and recommend their implementation.

• representing the Governor, this individual would drive-full-time-the process of implementing the recommendations in the Deloitte & Touche management letters covering the last three audits (see section four of this report)

• while representing the governor in day - to - day follow through on all accountability and performance reforms such as audit recommendations, this person – and leis or her staff - would also resource Arkansas' Accountability Commission providing input and resources - as arms, legs, eyes and ears, for this group.

* In order to be effective in carrying out these two tasks, the Governor's special assistant for accountability would likely need staff assistance, expenses, and other support. An adequate budget would be required. The Commission also recognizes that such a position would require special expertise both managerially and with respect to orchestrating these measures. It would require an ability to work in agencies, get along with people, drive the process, and pull in resources from around the state and nation. Accounting expertise would be needed, but the special assistant would not necessarily need to be an accountant, but more of a driver. Business or policy experience would be a plus -- along with public relations skills and a writing ability.

It is worth noting here, again, that this concept also is not new. Arizona has its Office for Excellence in Government and Florida created its Office of Program Analysis and Government Accountability - both of which support the Governor's accountability and performance initiatives. They also work very closely in tandem with their legislatures.

Miscellaneous recommendations made in connection with this report's findings on performance measures also address

higher education. As stated m the first section of this report (following) it reads:

(More information about this recommendation is provided in the Performance-based budgeting section of this report.)

This act mandates government agencies engage in comprehensive strategic planning and submit those strategic plans for both public and legislative review. It also requires defining results in terms of measurable outputs rather than process inputs and reporting progress toward those results regularly. Agencies must also report the interim or ongoing cost of all activity and report final results when they are achieved (or when they fail). Federal law also spells out the details of how and when agencies; do these things including time schedules and reportable benchmarks. Such a law in Arkansas would surely serve to spear the use of performance and accountability measures as a matter of routine in state government.

The Arkansas Accountability Council, as described above, should be charged with crafting such a law and the Governor, in turn, should make it a part of his agenda and take the leadership in advocating its passage.

The Commission commends these recommendations and the following supportive briefing notes that accompany them to the Governor, his staff, key state agency heads, and other governmental personnel, all legislators, and other constitutional officers. In the years ahead, the Commission intends to aggressively work for the incorporation of these timely reforms into state operating policy and will endeavor to build a ground swell of public support to help make them a reality.

A word on how best to use this report...

Each section on the four proposed reforms begins with a brief summary of that reform, how it works and why it is important. For readers seeking a quick read, skip to the beginning of each section and read the first few paragraphs. For readers wanting more detail and examples, read the full narratives of each section and the appendices. They are full of details, facts and figures.

Good reading.

PERFORMANCE-BASED BUDGETING

The premise of performance budgeting is simple. It would require state government to define what constitutes good performance for all of its functions and then allocate budget dollars to those functions on the basis of how effectively the intended performance outputs are being achieved. As is the case with a number of stags, Arkansas still uses an incremental approach to budgeting rather than a performance-based approach.

The state's current budgeting process generally allocates funds to agencies and their program and operating budgets based primarily on their requests made prior to each legislative session. These requests, more often than not, are based on an almost routine expectation of some kind of increase. And while there is considerable executive and legislative review of proposed budgets, the agencies are not required to submit any form of strategic plan for review, any detailed assessment of measurable program outputs versus costs, or any quantifiable performance output measures for proposed new programs.

Arkansas bases its budgeting much more on input -- how much money, hose many people, what new equipment is needed -- and not nearly enough on output. Output is defined as measurable and quantifiable results that should be stated acrd cost projected at the time of budget allocations ...and assessed for progress regularly.

In contrast, 14 states are incorporating performance-based budgeting into their operations and at least 20 others are seriously considering it. Moreover, Virginia -- according to The National Association of State Budget Officers (NASBO) -- periodically zeros out its state budget forcing agencies to fully evaluate and re justify their programs. The Murphy Commission budgeting recommendation in Arkansas also reflects a need to periodically zero out programs. The best way to accomplish this is to establish a statutorily prescribed number of years after which each agency would automatically zero base its budgets. The budgeting schedule could be arranged so only a select number of agencies would zero out in a given year -- thereby avoiding a zero-budget for all of state government in a given cycle.

The federal government is implementing performance measurement and budgeting through the Government Performance and Results Act of 1993 (GPRA), Sen. John Glen and Representative John Conyers, sponsors.

GPRA requires federal agencies to develop, no later than the end on' fiscal year 1997, 5-year strategic plans that include the agency's mission statement, identify the agency's goals, and describe: how tire agency intends to achieve those goals through its activities and through its human, capital, information, and other resources. Under GPRA, agency strategic plans are the starting point for agencies to set goals for programs and measure the performance of the programs in achieving those goals.

In addition, GPRA requires agencies to submit, beginning in fiscal year 1999, annual program performance plans to the

Office of Management and Budget (OMB) and program performance reports to the President and Congress. Program performance plans are to describe how agencies are to meet their program goals through daily operations and establish target levels of performance for program activities. In these plans, agencies arc to define target levels in objective, measurable terms so that actual achievement can be compared against the targets. Agencies' individual performance plans are to provide information to OMB for m overall federal government performance plan that OMB is to develop and submit annually to Congress with the president's budget. In their program performance reports, agencies are to show (1) program achievements compared to the targets specified in the performance plans: and (2) when a target has not been met, an explanation of why the target was not met and what actions would be needed :o achieve the unmet goals.

GPRA also allows agencies to propose in their annual performance plans that OMB waive certain administrative requirements. These administrative waivers would provide federal managers with more flexibility to structure agency systems to better support program goals. Under GPRA, the administrative requirements eligible for waiver would be nonstatutory and involve only budgeting and spending within agencies. In return, agencies would be held accountable for "achieving higher performance."

And lastly, CPRA requires a 20-year test of performance budgeting in not less than five agencies, at least three of which have had experience developing performance plans. Under the test, performance budgets are to provide Congress with information on the direct relationship between proposed program spending and expected program results and the anticipated effects of varying spending levels on results.

In fiscal year 1994, OMB selected 53 agencies or programs to pilot strategic planning, performance planning, performance measurement, and performance reporting and will select additional pilot agencies in fiscal years 1995 and 1996. OMB also will be selecting agencies from among the initial 53 to pilot managerial flexibility and test performance budgeting in fiscal years 1995 and 1998, respectively. Although GPRA does not call for government-wide implementation of strategic planning and performance planning until fiscal years 1998 and 1999, respectively, OMB and the administration's National Performance Review have strongly endorsed these reforms and have encouraged all agencies to develop their strategic and performance plans as soon as possible.

Florida, Minnesota, North Carolina, Oregon, 'Texas, and Virginia
The Success of Their Performance Measures Attracted Federal Attention

When GPRA was first proposed, a Federal objective was to first identify some of the experiences state governments had in implementing management reforms that were reported as successful and thus could guide federal agencies in implementing GPRA. States that had sought to increase their focus on program results through strategic planning, performance measurement and reporting, and performance budgeting were identified. The winners in this federal search were Florida, Minnesota, North Carolina, Oregon, Texas, and Virginia because they were implementing some or all of these reforms.

When the U.S. General Accounting Office (GAO) issued a report on findings in these six states -- Managing for Results, 1994 (GAO/GGD-95-22) -- it said their unique brand of results-oriented management reforms could indeed help a federal agency focus more on program outputs than resource inputs which could in turn lead to improved program effectiveness. It went on to say that collectively the experiences determined "that strategic planning and performance measurement could be an important means for stakeholders to obtain agreement on common goals and measure progress toward achieving those goals" It added that each state "used strategic planning to improve working relationships within and across agencies and across levels of government aimed at achieving outcomes." The report concluded by saying, "The state's experiences suggest that, if successful, GPRA could serve as a powerful tool for developing and communicating agreement across the federal system on program's goals and for measuring progress in achieving those goals."

According to the GAO report there was one downside: Some state officials said that despite progress in getting agencies' staff to develop and use results-oriented measures to manage and gauge progress, legislators made limited use of agencies' performance information during the budget process, in part because consensus between the executive and

Strategic Planning

- What are the mission, goals, objectives of programs

Outcome Measurement

- What arc programs producing?

Benchmarks

- What standards should programs meet?

Provide agencies flexibility in using resources within programs

Hold them accountable for performance

Encourage management innovation and focus on performance

Requires systematic review of agency organization and purpose

Helps identify performing and non-performing parts of government

Encourages long-term planning

Makes everyone consider purposes of government, not just day – to - day business

34 states have legislation calling for the use of performance-based budgeting

14 other states Lave initiatives not involving legislation

Only Arkansas and New York have not acted

North Carolina

Complete performance-budget submitted in 1997

Florida

Phasing in PBB through fiscal year 2002

Texas

Now using performance measures for all state agencies

Budgets have to be restructured

Agency structure may have to change

Legislator's expectations of agencies may have to change

legislator's have to learn a new way of thinking about budgets

The focus is on activities and outcomes - what purpose is achieved-rather than line item expenditures

An activity like health may be the responsibility of several agencies

Budgets must focus on activities, not agencies

In the long run, performance budgeting could mean restructuring agencies to put responsibility for a given activity in one agency

Focus budgeting on goals or activities, not on specific expenditures

Allow agencies greater flexibility in shifting money to meet program goals

Accountability for program outcomes, not specific expenditures

Governor submitted both performance based and traditional budgets for 1997-1999 biennium

North Carolina has focused on structure, with performance standards added.

Sets 10 abroad areas of government activity, independent of agency structure:

Health, Human Services, Corrections, Public Safety, Environment, Economic and Community Development, Education, Cultural Resources, Transportation, and General Government.

"The Health Program Area protects North Carolinians against illness and injury in the day-to-day environment in which they live and work, and provides treatment and access when health problems occur"

The budget breaks down Program Area's activities into

- Goals, Programs, Subprograms

And for each subprogram it sets

- Objectives

- Outcome measures

- Performance measures.

Budget shows proposed funding for each goal, program and subprogram

For state health programs, for example,

- 3 goals

- 7 programs

- 13 subprograms

*The budget also shows how the funding is divided among 8 different agencies that are responsible for parts of the goals of the overall Health Program Area:

- Agriculture, Commerce, Environment and Natural Resources, Human Resources, Insurance, Labor, University Hospitals, and Administration

Phasing in performance budgeting over 7 years (5 or so agencies a year)

Agencies group their activities into programs and recommend performance measures and standards

Agencies designate programs

Provide measurement standards and reports

Agencies create large programs -- grouping several former budget entities into one program

Agencies gain budget flexibility

Revenue Department for example, has two programs

General tax administration

Property tax administration

Increased management flexibility

Focuses attention on agency purposes

Identifies weaknesses in information

Produces a sense of teamwork among agency staff

Size of Programs

Budget flexibility (unlimited transfer authority within programs but not between programs)

May lack specific purpose

Hard to set performance standards

Agency lack of historic data to provide baseline standards

Lack of expertise in measurement

Benchmarks are assigned to broad areas of state government

All agencies have created strategic plans

Goals, (objectives, strategies and measures

Strategies" are the budget unit

"Key" outcome measures go into the budget bill

Legislative Budget Board evaluates and reports on nature of measures and performance reports

State Auditor evaluates performance reports

Agencies have developed around 11,000 measures of performance

Difficult for agencies to shift from activity measures to performance measures

Lack of historic data to provide a basis of competition

Lack of expertise in measurement

Must involve Legislature and Executive Agencies both

Florida - legislative program audit agency

Texas - Legislative Budget Board and State Auditor

Minnesota - Legislative Auditor

A health program goal in North Carolina is to reduce infant mortality. If infant mortality is o educed, how do you whether that the program's activities deserve credit, or whet her external factors caused the change?

Structure of a performance based budget is at odds with traditional budgeting

- Not a line-item format

- Can be at odds with budget committee/ subcommittee structure

Program budgets may appear in difference agency budgets

Focus is on the long term, not the next year or biennium

No one has figured out how to tie budget allocations to measures and performance

Incentives (similar in Florida and Texas):

Additional flexibility in budget management

Flexibility in salary and position management

Retention of unencumbered balances at end of fiscal year

additional funding

Sanctions

Quarterly reports to governor and legislature

Quarterly appearances of staff to report

Restructuring or elimination of a program

Reductions in staff or budget

Reduction of managerial salaries

Can improve agency management

Systematic review of agency organization and purpose

Helps identify performing and non - performing parts of government

Encourages long-term planning

Makes everyone consider purposes of government

It will neat tell legislators whether to increase or cut funding for a poorly performing (or an highly satisfactory) agency

It will not tell you what to do about a poorly performing but essential agency

It will not tell you how to allocate money between roads and schools

New kinds of information, possibly better information

Facilitates debate and discussion in the budget process

Encourages long-term perspective

Focus on agency accountability for outcomes

A powerful tool to improve government management ' • Helps meet legislators' and voters' needs for

Accountability

Orientation to service

Quality measurement

Focuses attention on outcomes

legislative branches had not been reached on what would be measured and how the measures would be used.

Exhibit I offers a summary over view of the six states studied and their programs.

"Government must be accountable for results." This statement, voiced repeatedly by politicians and citizens, by the media, and by other watchdogs of government is deceptive in its simplicity. It raises, but does not resolve, several fundamental questions: What are the desired "results" of government? How do we know whether government has achieved some intended result? What does it really mean to be accountable?

Until recently, government accountability was largely a matter of accounting. When public funds were appropriated, the key accountability questions focused on how the money was spent ante on what. Were funds spent on particular programs as intended? What portion of the money was spent on personnel, equipment, buildings, overhead, etc.? Were proper rules and procedures followed for spending public moneys, awarding contracts, and tracking expenditures? Fiscal audit and budget reports, which answer these types of questions, have been used for years to demonstrate accountability and responsibility in government, but seldom very effectively or in a manner where citizens has easy access to understandable information about the use of their tax dollars and the results they generate.

Since the beginning of this decade, however, the concept of governmental accountability has taken on a new meaning. In this view, government demonstrates accountability when it shows its citizens: (1) what they are getting from the use of public funds in terms of products and services, (2) how these expenditures benefit their lives or the lives of those they care about, and (3) how efficiently and effectively the funds are used. This type of accountability holds government responsible not only for its actions, but also for the results of its actions.

In order to demonstrate accountability in this way, state and local governments and federal agencies have begun developing new measurement and reporting systems. These are generally called "performance measurement systems" or sometimes "performance accountability systems."

Research into performance measurement has been an ongoing process by state and local governments as well as organizations such as the Urban Institute. In the mid-1980s, the Governmental Accounting Standards Board (GASB) began a research project into performance measurement that resulted in a series of reports published under the title Service Efforts and Accomplishments Reporting: Its Time has Come (1989-1993). The GASB reports explore the state of the literature and the state of practice for twelve of the most costly state and local services.

From its research, GASB concludes that performance measurement and reporting is rapidly developing and is of value to elected officials, citizens, and management. GASB recognized, however, that there is a need for further work on developing valid and generally accepted indicators, gathering data, and developing methods to verify and present the information. While GAS13 is not expected to issue standards requiring the inclusion of performance measurement in the comprehensive annual financial report in the near future, its research and interest in the topic has provided yet another spur for experimentation by state and local governments.

Echoing GASB's push for performance measurement is the 1990's explosion of management reform initiatives that rely on performance measurement data. Management reforms such as activity-based management, total quality management, re-engineering, rightsizing, reinventing government, visioning, and strategic planning movements need access to valid performance data in order to improve the provision of government programs and services. In fact, many reformers now say these processes are essentially meaningless unless tied to performance and output measurement. They are right.

On another front, a survey conducted by GFOA in May 1994 found that of the 508 state, provincial, anti local government responses to the question of where performance measurement data are reported, 69 percent report performance measures in the budget document, 57 percent report them in an internal management report, 39 percent report them in other public reports to elected officials or citizens, and 23 percent report them in annual financial reports. The movement has grown considerably over the last four years. Presented in the Appendix to the section is a state by state outline, developed by NASBO, showing which states have instituted performance measures in their programs and which states have implemented performance - based budgeting.

These exhibits are the source for the data showing Arkansas among those states that do not use performance-based budgeting and one of only twelve states not making use of performance measures in agencies. It is worth noting here that until the last legislative session in 1997, Arkansas did have one major functional area - higher education - under a performance-based allocation system. Rather than address some obvious flaws in that system however, it was, instead, deliberately eliminated in- the last legislative session by a powerful state senator with an ax to grind over college funding. Arkansas' higher education performance model had been singled out by other states as one of the best in the nation - written up in national publications.

The Commission feels so strongly about this recommendation that it will remain a primary focus throughout the life of the Commission and a matter of continued advocacy until Arkansas' higher education productivity systems are fully restored and functioning. The Murphy Commission, at the request of Arkansas' State Higher Education Board Chairman Curt Bradbury prepared a confidential briefing for the Governor's consideration at the time of the legislative initiative to do away with Arkansas' productivity system. For the reader seeking more background, it is available on request.

Performance measurement is a process for determining how a program is accomplishing its mission through the delivery of products, services, or processes. Performance measurement systems attempt to measure performance through ongoing data collection efforts, as opposed to program evaluations, operational audits, and other special studies that generally are more extensive and less frequently performed. In other words, performance measurement is a periodic rather than episodic form of evaluation. The process of measuring and reporting performance is similar to financial reporting systems, which routinely collect financial data and report financial performance. Performance measurement reporting adds another dimension of accountability to taxpayers.

Performance measurement encompasses indicators that measure performance along several dimensions. Although there are many different terms and combinations of indicators, most attempt to measure performance along one of three dimensions; quantity, effectiveness, of efficiency. Ideally, a set of performance measures answers four key questions: How many? How efficiently? Of what quality? To what effect?

There are several different terms used to describe performance measures. One of the most frequently used set of terms divides performance measures into four basic types:

Input
Output
Effectiveness/outcome
Efficiency.

Input Measures: Input indicators measure the volume of resources, both monetary and non-monetary, that are used in delivering a program or service. Total expenditures arising from the provision of a program or service is a frequently used monetary input measure. When using cost data, it is important to define the specific items of cost included and the year in which the costs occur so that fair and accurate comparisons can be made between different time periods or programs. It may be necessary to use constant dollars in order to remove the distortion of inflation.

Items of overhead, such as payroll, computer services, administrative support, and building use, may be included with the input measure if a jurisdiction allocates these costs to programs. Jurisdictions also differ as to their definition and treatment of capital costs. Certain equipment costs should be amortized over their useful lives and allocated over the appropriated periods rather than in the year the actual expenditure is made. On the other hand, it is not necessary to include in the input indicator a cost item that is not relevant to the problem being addressed. For example, when examining the performance of a work crew that does not have control over its administrative costs, these costs should not be included in the input measure.

Not all inputs are measured in dollars. The most frequently measured non-monetary resource is labor, expressed as full-time equivalents or labor hours. Another non-monetary input indicator used is equipment hours. Care should be taken in comparing non-monetary inputs among governments, as some jurisdictions contract out services that others do not.

Output Measures: Output indicators report the quantity or volume of products and services provided by the program. Output indicators are commonly referred to as workload indicators. Some jurisdictions obtain much detail about workload, counting not only the number of outputs of product or service by the program but also the amount of workload coming into the program (e.g., applications for assistance) and the amount currently being processed and thus not yet completed as a unit of output. Some also use indicators that measure of demand for the good or service compared to the amount of service currently being provided.

Units of output are not always easy to define. A valid unit of output should be...

mutually exclusive,
definable and countable,
uniform over time,
directly related to the mission of the program.
characterized by dimensions of quality that can be defined, and
readily available for measurement.

Effectiveness indicators, also known as outcome indicators, measure the results, accomplishments, or quality of the item or service provided. Some systems distinguish between effectiveness indicators and outcome indicators, defining effectiveness indicators as measures of the quality of the program outputs-responsiveness, timeliness, compliance, accuracy, and customer satisfaction-- and defining outcome indicators as measuring the degree of program mission accomplishment.

Recognizing that the final outcomes of many government programs are not fully under the control of program officials, some government have developed two sets of outcome measures: intermediate outcomes and end of long-term outcomes. The book Reinventing Government (Osborne and Gaebler) describes them, respectively, as program outcomes and policy outcomes, with the authors opining that program officials must examine both, although they should not be held solely accountable for achievement of the latter. An example of the two forms of outcome indicators follows.

Some governments describe the two levels of effectiveness indicators as performance benchmarks and strategic benchmarks. In this case, performance benchmarks refer to productivity and service standards of performance of individual government programs. By contrast, strategic benchmarks refer to community and social goals, such as reducing teenage pregnancy rates or reducing crime, on which a variety of organizations and factors have an impact.

Efficiency indicators quantify the relationship between input and output. They can be expressed as productivity ratios (i.e., output divided by input), or as unit-cost ratios (i.e., input divided by output). Efficiency indicators measure how much output or outcome can be produced or provided by a given resource level or how much input it takes to produce a given level of output or outcome. As indicated earlier, input can be stated in monetary or non-monetary terms, such as labor hours.

Some jurisdictions use productivity measures that combine dimensions of efficiency and effectiveness into one measure, such as unit costs per effective meter repair. For example, the unit costs of a piece of equipment's repairs are included in the numerator, while only the number of successful repairs are included in the denominator. Another type of efficiency measure often used is the degree of resource utilization (i.e., the amount of equipment or personnel downtime).

Two other terms often expressed in relationship to performance measurement are benchmarks and service efforts and accomplishments.

"Benchmarks" often is used synonymously with performance measures, but for many it connotes additional meaning that goes beyond performance measurement. The term benchmarking first emerged in the private sector, which uses it to refer to the process of seeking best practices and attempting to emulate them. Benchmarking in this sense is practiced by governments, but the term also is used by the public seeker when referencing comparisons of performance to a goal, past performance, or another program's measurement data.

"Service efforts and accomplishments" is a term that was coined by GASB in its research into the status of performance measurement practice and research. GASB recommends use of the "classic" performance measurement indicators-inputs, outputs, outcome, and efficiency-but labels inputs as service efforts, outputs and outcomes as service accomplishments, and efficiency measures as indicators that relate service efforts to service accomplishments.

GASB also uses the term "explanatory information" to refer to descriptive text that accompanies presentations of performance measurement data. Relevant information to include would be factors or events influencing program operations that affect its performance. GASB and others group this information into types: 1) demographic data or events that are outside the control of program personnel and 2) elements that the agency does control, such as staffing patterns. When comparing and reporting performance among jurisdictions, explanations or service profiles that describe differing populations, geographic size, and terrain are particularly needed.

There are four major sources of data for use in measuring performance. These sources are described below:

1. Managers can first turn to existing program records for performance measurement data, such as workload counts, complaint records, and response times for various services. Another program record is time logs, which are either regularly maintained timesheets detailed by activity or special studies undertaken periodically. Time logs frequently are used in computing labor-related efficiency measures or compared with engineered work standards. Standards are seldom available, however, for activities other than vehicle maintenance and construction. Time logs of equipment utilization also can be maintained, as well as those for labor.

2. Another source of performance measurement data is trained-observer ratings. Trained-observer ratings are best used for assessing physical characteristics, such as the condition of facilities and infrastructure. "Their collection usually involves extra costs and special equipment, such ad air and water quality monitors and street surface "roughometers".

3. Client surveys help measure perceptions regarding the adequacy of services, any deficiencies, and the extent of usage of the service. Surveys of the general population and businesses in the community also obtain feedback about specific services and factual data, such as the extent to which government facilities and programs are used by the public. The accuracy of surveys depends on the degree of sampling error, quality of the questionnaire design, knowledge of the survey respondent, and mode of interviewing (e.g., by mail, telephone, or other means). While in-person or telephone interviews usually yield the best information, the costs of using this mode can be prohibitively high.

4. Accounting reports provide the revenue and expenditure data that usually accompany reports of program activity and results (e.g., reporting the total and net costs of operating the program). Sufficiently detailed accounting systems also can report the per-unit costs - something government accounting fails to do in many cases. Accounting reports also provide the revenue and expenditure data that usually accompany reports of program activity and results (e.g., reporting the total and net costs of operating the program). Sufficiently detailed accounting systems also can report the per-unit costs of providing a good or service, among other useful measures of program efficiency.

Responsibility for reporting performance data can rest with a variety of officials and departments. In some jurisdictions, the data are reported by program officials. In the City of Portland, Oregon, the data are reported by the auditor's office as well as being reported in the budget. In the State of Florida, the information is reported by the Florida Commission on Government Accountability to the People, a committee created by the governor. Yet another variation is found in the State of Minnesota, where agency officials report performance measures in annual reports, which are reviewed and evaluated as a whole by the legislative auditor's office in a separate report.

When designing a reporting system, a government must consider the audience for the report, level of detail, and frequency of reporting. The Innovation Group proposes a three-tier model of performance measurement reporting. The most outcome-oriented and least detailed information is provided in a report to the public. The second tier of reporting, provided to upper management, compares goals and objectives to effectiveness measures and uses both its stated objectives and actual results achieved in assessing a department's budget request and its overall efficiency in managing resources. The third tier of reporting- to operations and program management personnel-provides the most detailed information about a program, such as monthly workload targets, assessment of personnel and equipment utilization, and assessments of projected and actual service demands. Access to all three levels of reports should - by law - be available to all citizens.

A good performance measurement system possesses several important characteristics. Performance measures should be based on program goals and objectives that tie to a statement of program mission or purpose. They should measure program results or accomplishments and provide for comparisons over time. In measuring both efficiency and effectiveness, performance measures should be reliable, verifiable, and understandable. They should be reported internally and publicly. They require monitoring and should be used in decision-making processes. Finally, performance measures should be limited in numbers and complexity so that they provide an efficient and meaningful way to assess the effectiveness and efficiency of key programs.

One of the most critical elements of the performance measurement system is the measures themselves. Measures are developed by program officials and employees, promoting employee buy-in to the performance measurement system, and are reviewed annually to evaluate their relevance and usefulness and to guard against the unintended creation of perverse incentives, such as accepting only clients most likely to succeed. The measures are developed by considering what information would be most useful and relevant for measuring program performance, not by looking only at the program data already being collected. Exhibit 1 presents a checklist for selecting and evaluating performance measures.

It is important to have the right mix and number of measures. A government may choose to report publicly only effectiveness measures; however, output, process, and efficiency measures are useful for internal review and administration of programs. Too many measures may be more than citizens, legislators, and others can absorb, and they are expensive and time-consuming to collect and track. On the other hand, having too few measures can lead to the neglect of certain program area responsibilities and can create perverse incentives.

In addition to performance measures being developed for an overall program area of function, they also should be disaggregated, that is, separately measured by significant client population, neighborhood, or other appropriate category of workload. Program effectiveness can vary dramatically with the client or neighborhood being served, and disaggregation can help to identify needy or underserved groups and areas.

A growing number of states and communities have integrated outcome and performance measurement with the budgeting process. The idea of incorporating more performance data into the budget process is sometimes referred to as performance-based budgeting. Performance budgeting is the allocation of resources to achieve specific objectives based on program goals and measured results. Its basic principle is to focus on accountability for service quality, quantity, efficiency, and effectiveness-not just on meeting the requirements of budget laws and not overspending the budget.

A budget functions as an instrument for financial and policy control, as a guide for operations management, and as a vehicle for policy planning and implementation. Before performance measurement can be integrated into budgeting, agreement must be reached on program goals and priorities. Decisions must be made on which measures adequately reflect whether progress is being made toward achievement of the goals. Finally, the data must be organized and collected.

Performance measures can contribute to the formulation and justification of budget requests. They can serve to illustrate the benefits that can be achieved with an additional level of resources made available to a program. Similarly, in cases of shrinking resources, performance measures can help governments make the case for budget reductions targeted in particular programs or functional areas rather than effecting reductions with across-the-board cuts.

Very few governments, however, know the exact amount of services and outcome that will be provided at a given level of allocated resources. While not a state government, perhaps the City of Sunnyvale, California, comes closest to this ideal: The city council approves goals for city programs, and the level of resources necessary to meet the goals is implicit. This system is possible because Sunnyvale operates on a full cost - accounting basis; thus, officials know how much it costs to provide each unit of output and level of service. (See the next session of this report which outlines Activity Based Cost Accounting, ABC Performance, budgeting and ABC enhance one another and together form the basis for transforming government into a model of lean and efficient operation).

Another advantage of using performance measures in budgeting is the avoidance of micro-management. Budgetary control is moved from a focus on inputs towards agreement on performance and outputs desired. This change lets management exercise more creativity in performing their jobs and is designed to reduce or eliminate the micro-management of inputs (i.e. resources) by elected officials, keeping them focused instead on getting the best results for the public's money. The budget serves as a performance contract between an agency and elected officials. In contrast to traditional budgeting, the focus is on the unit cost of achieving a particular outcome rather than on the unit cost of providing a service.

[Editors Note: During the course of the Commission's work, agency leaders and their deputies frequently complained of excessive legislative micro-management in the affairs and programs of the agencies. Concern over budgetary reprisals by certain legislators who are confronted on this issue deters many agency personnel from challenging the practice. As a result the "separation of powers" line between the executive and legislative branches of Arkansas' state government continues to blur. When coupled with the statutorily and constitutionally weakened office of the Governor in Arkansas, it blurs even more. Legislators, in some cases, may tend to have more influence over executive offices than the Governor.

The end product of legislator intrusion in Arkansas' executive branch is seen not only in excessive micro-management, but in the abuse found in agencies such as the Department of Human Service where self-serving deals and contract abuse have made too many headlines in recent months. As noted above, the move to performance measures in budgeting clarifies proper roles and can end too much legislative influence over programs and thwart abuse and misapplication of taxpayer funds]

Many state and local governments have begun measuring the results of their programs and services, but some have also begun measuring and reporting on overall conditions in their states and communities as well. Oregon pioneered this approach when it published Oregon Benchmarks in 1991. This report recommended 158 measures (later adopted by the state legislature and increased to 272 measures) to be used as "benchmarks: to gauge progress toward a strategic vision of what the state should look like in the year 2010.

The vision itself was developed through a strategic planning process that used public forums to elicit the views of the state's citizens. Oregonians, for example, want their children's educational competencies to "meet high minimum standards and rank in the top national and international tiers"; they want a developed environment that is "convenient, affordable, accessible, and environmentally sensitive." Example of benchmarks for these areas include: the state's ranking on national assessments of student math skills, the miles of rivers and steams that meet state and federal water quality standards, and the percentage of workers whose one-way commute between home and work is less than 30 minutes.

Oregon Benchmarks presented the 1990 baseline levels for these and other benchmarks and projected the desired levels of achievement for the years 1992,1995, 2000, and 2010. By comparing these projections to the actual levels of accomplishment reported in subsequent years, the state's leaders and citizens can judge whether Oregon is on its way to achieving its vision of a preferred future.

Catawba County, North Carolina, began experimenting with performance budgeting in 1992. Six departments received a lump-sum appropriation based on revenue projections and - from that total ---negotiated outcomes that they would be responsible for achieving .They could move moneys and positions as they saw fit within their lump-sum allocation and did not have to justify receipt of this total. The first year's results were seen during the budget process for the following year. Departments budgeting under the old system required average increases in their total budget of over 8 percent, whereas departments budgeting under the new system required average increases of less that 2 percent.

Although performance-based budgeting provides much better information about the actual outcomes of government than traditional program budgeting, the act of choosing which outcomes to support with public dollars is still left almost entirely to the political process. The Alliance for Redesigning Government in its publication Deciding for Investment proposes a new process to aid decision-makers in estimating the costs and consequences of each choice. Called "investment decision-making," this process combines and builds on the other processes already discussed, program outcome measurement, jurisdictional benchmarking, and performance-based budgeting. What it adds to this mix is a means for estimating the return on investment for public spending.

Investment decision-making presupposes that a state or community has established benchmarks through a public process, for example, to reduce the percentage of families living in poverty from the current level of 10.1 percent to a 2.0 percent in the year 2010. Government leaders might consider funding two policy initiatives related to this benchmark. One would have a goal of moving 50,000 poor families out of poverty by 2010 through a combination of job training programs, incentives to employers, and individual development accounts. The other would prevent the ongoing formation of impoverished families by using a combination of health, education, and mentoring programs to reduce the number of teen births from 3,300 per year now to 600 per year in 2010.

Under the investment decision-making process, experts would estimate the cumulative monetary value (over a period of say, ten years) of achieving each type of outcome: moving one family out of poverty, preventing one teen birth. It is recommended that this value be calculated at three levels:

for the individual (increase in earnings, avoidance of child care costs, etc.);

for government (increase in taxes paid, decrease in welfare expenditures, etc.); and

for society as a whole (increased domestic spending, reduced crime, etc.).

Through a performance-based budgeting process, public decision-makers can also get estimates on the average unit cost to the government for each of these outcomes, that is, what it costs on average to move one poor family out of poverty or to prevent one teen birth. By comparing the cumulative value of the outcome to the cost, they can determine the return on investment to the individual, government, and society. They key question is whether the value of the outcome over time substantially outweighs the present-day costs of the program or service. If one of the two strategies, say, reducing teen births, offers a much greater return on investment, elected officials may decide to shift priorities and spend more in that area.

The investment decision - making process also allows officials to judge whether particular programs are good investments by requiring program operators to report unit costs per outcome. For example, a job placement service that has a low cost per client served may have a high unit cost per outcome because very few of its clients find jobs that will move them out of poverty. An expensive apprenticeship program, on the other hand, may be a better investment if it is highly successful in placing its graduates in good jobs. In order, to meet a goal of moving 50,000 families out of poverty by 2010, officials may decide to invest more funds in the apprenticeship program or, alternatively, find a new job placement agency with a lower cost per outcome.

[Editors Note: In Arkansas, the use of Investment Decision Making is needed, but will likely not come unless performance-based budgeting linked with accurate cost accounting (see section on ABC accounting) is put in place. An example of its possible application, however, is seen in the state’s Department of Health. Dr. Sandra Nichols, head of that department, shared her frustration with Commission members that she could not accurately determine the "unit cost" of administering immunizations across the state. Through Investment Decision Making linked to performance budgeting and cost accounting, Dr. Nichols would eventually be able to contrast - as a hypothetical example - the cost and benefits of delivering this needed service through the present system, as an outsourced service, or by means of vouchers for shots. She could then make a "bang for buck" decision that might show a way to improve results for less cost.]

The most significant impact of performance measurement may be to improve and strengthen internal managerial processes. Performance data are pivotal to the success of several managerial initiatives, such as customer-focused management, market-driven management, strategic planning, and total quality management. Performance measurement is a communications tool that links program staff together. This is increasingly valuable as governments move from organizing work around hierarchical authority systems to multi-center, horizontal teams.

Another valuable function of performance measures is to help governments improve program operations. Regular and timely collection and monitoring of performance data can alert managers to problems and encourage analysis of why problems have occurred. In some cases, the data may indicate a need for in-depth program evaluation. Moreover, establishing a performance measurement system prior to undertaking a program evaluation can improve the quality and efficiency of the evaluation can improve the quality and efficiency of the evaluation by preparing managers to take an analytical approach to service delivery and by providing a time series of data, which makes the findings more conclusive.

Performance measures are valuable tools for managing programs that have been contracted to the private sector. Outcome-related performance requirements should be written into contracts whenever feasible.

Performance measures also are useful for motivating employees and in evaluating the performance of supervisory and managerial employees. Care must be taken, however, not to hold managers accountable for events outside of their control. It is fair to hold managers accountable for client benefits/impacts and work process outputs but not for outcomes.

In addition, performance measurement reporting provides accountability to elected officials and to the public. Moreover, performance measures can be excellent public relations tools for government to communicate the results that governments are achieving with tax dollars.

In summary, performance measurement provides information useful in serving ii variety of planning, budgeting, and management functions in government. It is most useful as both a reporting system and a tool for serving a variety of management processes.

For the last several years, pay-for-performance systems have become widespread in the Unites States. The vast majority of private sector firms operate under a system in which compensation and advancement is tied directly to an individual's personal and professional ability to effectively accomplish the job to which he or she is assigned. The Federal government has also implemented performance-based pay for members of its Senior Executive Service. And at the state level the concept of paying employees based on performance is gaining momentum. Georgia, Colorado, Michigan, California, and Idaho are among the leaders with programs such as Colorado Peak Performance and Georgia Gains setting the pace for other states.

When Governor Pete Wilson implemented California's performance pay system for management level employees, he succinctly summed up the major compensation issue for most states, including Arkansas:

Rather than use pay as a reward system, our state has typically raised pay uniformly under the old civil service model acrd regardless of performance. This is no way to guarantee that government will become efficient and responsive - all important objective at a time when our resources are finite and shrinking and citizens are demanding governments do more with fewer tax dollars. Pay systems which link employee performance to organizational performance will contribute to leaner and more efficient government-giving our citizens what they demand. It's what I call a win-win-win. Employees improve, government performance improves in terms of program cost to benefit, and taxpayer approval improves. What are we waiting for?"

Governor Wilson is right. The basic premise underlying performance-based pay seems so natural, so rooted in common sense, that it is difficult for most Americans (including many Arkansans) to understand why government employees are resistant to the idea.

Simply expressed, pay-for-performance means employees advance in their organization and gain in pay according to how well they do their jobs according to defined performance outputs that can be measured. Moreover, they fully understand how their jobs relate to achieving the greater vision expressed in their organization's mission statement; how they are tied to that mission, and how it--in turn--relates to broader performance measures that define organizational success. Performance pay encourages in all employees a constant devotion to improvement and quality in both job performance and skills enhancement. The focus on mission coupled with performance rewards ...also builds in an understanding that service--even public service-ultimately serves the needs of people.

Additionally, performance-based pay creates an environment in which all employees know what's expected, both individually and organizationally, and how they will be evaluated and compensated for their service. When viewed in this context it seems almost illogical that anyone would argue against or resist the idea. And indeed, it is contested very little in most of the industries and businesses of America where merit or performance pay is so commonly accepted that to reward employees on any other basis would be the exception rather than the rule.

Has compensation tied to performance worked? If the private sector offers any indication, the answer is yes. Certainly there is a consensus among private sector managers and workers alike that American business leads the world in production, innovation, and business practice--and the incentives it offers employees is undoubtedly a factor. The proliferation of performance pay in the business sector has been a key element in the success of American business and it follows that it could significantly improve government's performance as well. But when policy analysts and senior government officials began trying to import the idea to government it inevitably encounters resistance.

1. The Civil Service model is the way we've always done it: Over the years, tire long-standing civil service approach, common to all levels of government, has become some so entrenched that replacing it with something new and different is bound to be resisted. Change is the most difficult goal to achieve in any organization and people naturally resist it. In the culture of "civil service", the system - even though it can be complex - has becomes familiar, comfortable, and - as one official expressed it - "the way we have always done it around here." That it fails to inspire excellence - even in the face of such typical government reforms as Total Quality Management (TQM) and other quality control reforms - is indication enough, however, that a new system is in order - one based on real incentives to do better.

2. The nature of government-absent profit motives, customer orientation, and accountability - is that it has little incentive to change or improve performance. Managers and employees alike can grow comfortable in the automatically guaranteed process of fitting in slots or grades and moving up the ladder based on length of service and seniority. Moreover, the argument is sometimes advanced that since government is not a profit-making endeavor, there is no need for performance pay - and certainly the monetary rewards such as profit sharing are not available.

Still, in the face of these arguments, the facts suggest otherwise. First, numerous surveys and anecdotal evidence both say citizens want to be treated like customers by an efficient, friendly and competent provider of government services -service they pay for, voluntarily, with their taxes. There is a clear expectation of a return of quality and efficiency for their public-service investment. And when they don't receive it, public sentiment can turn ugly and government can pay a price in a loss of respect and confidence. In this sense, government has every incentive to economize and deliver good service ...and state employees have good reason to be customer oriented.

Moreover, it is a fallacy - as well as a disservice - to suggest government employees cannot be the beneficiaries of exceptional monetary rewards for their service - rewards that parallel and sometimes exceed market-based private sector pay. The price for achieving this higher pay however may be more than unions, employee associations, and many current state employees are willing to pay however. Still, where governments, absent performance and quality controls, have grown bureaucratically and have too many employees - especially employees who are ill-equipped or untrained to do the job - their exists an opportunity for much better compensation. It's as simple as 1-2-3.

1. Eliminate excess jobs and learn to do more with fewer people -- people who are well-trained and willing to work hard in a highly competitive system for rewards and exceptional compensation.

2. Introduce performance measures and competition into every facet of government operations. The effect will transform government as these two factors further lean out operations while improving overall performance.

3. Apply the dramatic cost savings that will inevitably come as a result of items 1 and 2 above toward paying remaining state employees at or above comparative market base..

While the thought of a reduced government workforce is unthinkable in certain quarters (see "Unions" below), there are benefits to those state employees who can function in a lean and competitive environment - namely higher pay, constantly improving skills, and greater opportunity for advancement.

Murphy Commission conversations with state employees, over the course of the Commission's work in the agencies and at state employee association meetings, found a number of them saying they would favor the trade - off- fewer employees, but higher pay. Some also said they could work faster and more efficiently, but the cultural protocol of state bureaucracy forces them to "pace themselves." And many acknowledged that it is not considered politically correct to talk of such concepts openly and if they were to do so they would find themselves ostracized, possibly denied advancement, and even threatened with the loss of their jobs.

Cultural taboos aside - think how remarkable it would be if performance pay were to lead to much higher compensation in a lean and efficient system of state government. The much resented practice of creaming wherein the private sector, offering higher pay raids the public sector to lure away its best employees after they have been trained at taxpayer expense, would end. 1n fact, it might reverse.

It is not difficult to imagine a public sector where public service might be more than a noble endeavor - it might hold the promise of some of the best jobs in our society. The scenario of the public sector raiding the private sector to lure away the best performers may yet happen - and why not given the importance of government and its mission. Governance brings order and rules to a civil society, protects rights, and provides for our common welfare. It ought to be done exceptionally well. The best employees coupled with a performance oriented approach can assure that it is.

If there is a single overriding factor in the deterrence of performance-based pay and the transformational effects it can have on inefficient government, it is the entrenched resistance of labor unions and employee associations. In a few states such as Texas and Florida recent attempts to convert to Performance-based compensation systems were thwarted by strong employee union opposition.

When Georgia proposed its move to performance pay the unions publicly fought the proposal. While states across the nation were seeking to emulate Georgia (,inquiries came from Pennsylvania to Rhode Island and many other states say Georgia officials) Stewart Acuff, president of the Atlanta Labor Council said, "Doing away with the civil service model is going to allow human beings who are in management and supervisory roles to indulge their biases, whatever those biases are." Even the national office of the AFL-CIO weighed in saying, "It's going to be a reversion to the old spoils system, something they are very capable of in Georgia."

Writing later about the Georgia performance pay revolution, Governing Magazine, published by the Council of State Governments (COSG) said this in response to broad union opposition. "But to those scores of state and local managers with hat-fulls of stories about the job candidate that got away, the burns they couldn't fire, the horrors of bumping, or the pure pain and frustration of having to deal with central personnel bureaucracies lent on blunting the most common-sense job action with paper piles of permissions, Georgia's move to performance-based pay represents freedom to build a high performance and responsive workforce."

WHO NEEDS CIVIL SERVICE? is the title of the COSG article on Georgia's new pay system. It ran in the August 1997 issue of their publication, "Governing." The following comments were drawn and condensed from that article:

Under the terms of Georgia's new performance pay law the civil service rights of anyone coming to work for the state after July 1, 1996 no longer apply. Some 54,000 existing employees are still covered by the old Georgia "merit" system - a civil service model. But all those folks who have signed on with Georgia state government since that date can be promoted, demoted or transferred instantly. Their raises are offered on the basis of performance only. And they can be handed an envelope on any given afternoon instructing them to clean out their desks and clear out of the office on the spot, with no right of appeal. New hires are offered the same basic benefits package as all other state workers, but otherwise their terms of employment are radically different. Nobody hired by Georgia these all "at will" employees.

Georgia's Democratic governor, Zell Miller sold his pay for performance system as a key piece of his continuing drive to make government more responsive to citizens. Miller was inspired, in part, by the popular book Death of Common Sense, whose author, Philip K. Howard, was invited to Atlanta to address the state's top management staff. Of particular interest at that meeting was the "rules and regulations-based" nature of government and how it gets in the way of performance.

Miller's Commissioner of Natural Resources, Lonice G. Barret, for one, believes it's the perfect formula: A combination of personnel flexibility coupled with "a little bit of insecurity" for employees will add up to crackerjack government. "People should keep their jobs because they do their jobs, and not because of some artificial policies or laws," he says.

Of the two basic fears raised against the new personnel order in Georgia - that it will lead to patronage hiring, on the one hand, and unshackle lousy managers, on the other - the patronage argument is the one that supporters tend to dismiss most readily.

Joe Tanner, Executive Director of the Governor's Commission on Privatization of Government Services responded. "The biggest concern raised about this was that you're going to politicize the system, that you're going to be able to hire and fire anyone you please without good reason or good cause, and that over a period of time the professionalism in state government will evaporate. We countered that by pointing out the major embarrassments that we had in some state agencies where you had all the abuses - including political hirings, political firings, political contributions being solicited by supervisors from subordinates - and it was all occurring under the old civil service Merit System."

Even more to the point, says the Georgia System's new commissioner, W. Daniel Ebersole, "there are a host of external factors that now mitigate the broad return of patronage." He goes on to cite the media, federal and state regulations, and a number of precedent setting court cases. "If we don't treat people fairly, then the; have ample recourse to respond through the legal system, and it's been my unfortunate experience that in most cases they're not real reluctant to use it." Between the court remedies and the ever watchful eyes of the media, abuse is kept to a minimum he says.

As the Murphy Commission surveyed states and collected data on performance pay systems two states seemed to be among the most innovative. They are Georgia and Colorado. The pay systems for these states are well documented in extensive manuals too lengthy to reproduce here, but available for review in Murphy Commission office. or on state internet sites. However, in the appendices that follow--readers interested in more details will find partial versions of these innovative plans for their review and study. Commission offices also have on hand a number of other state performance pay plans.

In the foreword of this report, the Commission recommends that the Governor form a special performance pay taskforce (in the context of an Accountability Commission)--modeled after the Colorado design team that planned that state's performance pay system.

more important) why shouldn't those we entrust with this critical mission be required to perform, have their performance evaluated, and be held accountable. The education establishment will characteristically resist such bold change offering endless reasons why it should not be adopted. In fact, it can and should be the practice in our schools for many reasons. The Commission's education task force will address this issue more fully in a future report.

In Arkansas, each agency uses its own accounting system - all different - in addition to the state's centralized accounting system to which they are all linked. Having agencies utilize two systems is certainly redundant and costly. But in addition to that there is no accounting uniformity between agencies. What constitutes "administrative support" in one agency, is defined differently in another...if defined at all. This absence of uniformity in accounting makes it impossible to know how agencies account for their dollars as allocated to traditional accounting categories because they are all counting by a different set of rules. It has been the cause of both confusion and concern for Murphy Commission members and other citizens who simply want to know where the money goes and if it gets results.

Activities-based cost (or ABC) accounting allocates dollars as they're spent in tile agencies--in a consistent and uniform manner - to defined service activities and administrative and support functions. When tied to outputs under a system of performance budgeting, ABC becomes a vital tool of managerial information and needed public reports to citizens. At the push of a button, citizens and government leaders alike could see--under an ABC system--not simply how much money is being spent in an agency and its departments, but where it is being spent in each agency relative to the vital major services they provide, relative to their costs of operating, and relative to what we have all agreed they should be accomplishing for the good of the state.

Iowa has moved recently to an ABC system, and Virginia's Commonwealth Competition Council has developed a software tool for their agencies that, once installed on accounting computers as a special module--will not only properly allocate costs to activities in agencies, but suggests whether or not an activity is a good candidate for competitive outsourcing. On the education front, the accounting firm of Coopers and Lybrand worked with a smaller company, Fox River Learning, to develop an extraordinary ABC accounting system for public education that tells parents to the penny where their education dollars go and makes this process uniform from school to school. The company will soon add a module to its costing program that also ties costs to academic performance allowing the public to accurately assess the cost of academic success or failure.

The Walton family Foundation sponsored a pilot program for the Fox River system recently without much cooperation from Arkansas schools. The Murphy Commission believes it deserves another look, and will bring both of these programs (Fox River and the Virginia software) back to Arkansas for demonstrations and more evaluation with an eye to pilot programs. More about Fox River's Incite software will also be addressed in forthcoming report of the Murphy Commission's education workgroup.

It should be noted here, that the Murphy Commission also supports the Deloitte & Touche and DF&A recommendation, issued in recent audit letters, that Arkansas purchase and install a new centralized computer accounting system. As documented in three successive management letters it is needed to bring the state in compliance with GAPP. The cost is more than justified by the efficiency and management benefits that will accrue as a result of this action. But the Commission qualifies its recommendation with two points. 1) Any new accounting system must provide for ABC. And 2) it must managerially and financially accommodate performance-based budgeting.

The following more detailed discussion on ABC was drawn from a paper developed by Mark D. Abrahams and Mary Reavly. It appeared in its original form in Government Finance Review. Mr. Abrahams graciously allowed the Commission to use this work which is presented here, as originally written, with only a slight modification in the order of topics. Mr. Abraham is president of The Abraham Group in Framingham Massachusetts, assisted the state of Iowa in its transition to ABC and authored their state's policy manual and handbook on that subject. He lectures on ABC frequently and is a member of the Government Finance Officers Association (GFOA).

Mary Reavly heads the performance management and budgeting project for Iowa's Council on Human Investment.

Costing services is one of the biggest challenges facing governments today. How can efficiency or competitiveness be measured without knowing service costs? This briefing section provides an introduction to activity-based costing (ABC) a methodology that assigns costs to activities based on the activities' consumption of resources-and offers examples and guidance for implementing ABC in a governmental environment. It discusses two straightforward and manageable approaches to ABC: a "keep-it-simple methodology" (KIS) for governments that desire a simple approach to ABC, and a full-cost methodology. The intent is to illustrate the power of ABC for decision making and management and to demystify and simplify ABC. These concepts and steps are applicable to all governments.

The two fundamental components of ABC are costs and activities.

Costs. Costs are based on resources or inputs. These costs correspond to various governmental charts of accounts generally consisting of salaries, materials, equipment, facilities, and overhead.

Activity. Activities are the steps, or sequences of events that convert inputs to outputs; they exist within programs. An activity focuses on what an agency does as measured by the number of units or outputs produced. A program is a series of activities that produce a product, service or other output to achieve a desired result.

ABC is a tool used to identify the costs of providing government services (see Exhibit 1). Activity-based management (ABM) focuses on the management of an activity to continuously improve the efficiency of the activity (providing the outputs at a lower cost), the quality of the activity (the right response to community and customer needs), and the effectiveness of the activity (providing services that contribute positively to a result or outcome). allocation, activity flow, and performance measurement analyses.

With activity-based data, governments are empowered to redesign processes or to apply process-improvement techniques to reduce cost, improve customer value, enhance accuracy, reduce response time, or otherwise improve efficiency and effectiveness. ABC is the tool used to identify and compute costs for activities and activity outputs. ABM uses the information in a management environment with other tools such as service redesign and process improvement. It is through ABM that ABC can fit and support performance management and service redesign efforts.

Performance management - the system of managing service effectiveness, quality, and efficiency based on measurable results- is the foundation for managing for results. Activity inputs and outputs provide efficiency information on the timelines, accuracy, and customer value. These measures help to determine the extent to which the program purpose is achieved and the program results (outcome) attained. The program, in turn, is aligned to one of the state's policy objectives or that of an elected official. Alignment and cost are the key to achieving the governor's (or any elected official's) leadership agenda in a cost-effective manner.

Activities are evaluated on their efficiency and on the extent to which they align with program and government wide goals. Ideally, an activity has high alignment and low cost. Conversely, an activity with high cost and low alignment is not necessarily providing value and is not efficient. An activity can fall into one of four quadrants:

high cost, low alignment
high cost, high alignment
low cost, low alignment
low cost, high alignment

This analysis is important to reduce. activity costs and enhance the alignment to results. A high-cost, low -alignment activity can be eliminated as it does not provide value and is inefficient. A high cost, high-alignment activity is a candidate for service redesign in order to reduce cost. A low-cost, low-alignment activity is a candidate for elimination unless it can be realigned to statewide policy objectives. A low-cost, high-alignment activity is the ideal.

Activity-based data provide more informative reports than the traditional line-item or organizational framework they were intended to address. ABC, however, cuts through or supplements the traditional costing reports to present the same information by activity to see how resources are spent. The real value in ABC and ABM is to view government services from the perspective of what people and equipment do to satisfy customers. For governmental managers, the focus on activities rather than line-items or organizations is seen as necessary for government personnel to better manage, understand, and improve an activity, and for associating results with costs.

An excellent illustration of an effective ABC system is The Iowa Department of Transportation Paint Crews. ABC was developed for Iowa's transportation department to. provide total activity costs and unit costs to the paint crews three activities: 1) center line, 2) edge line, 3) curb, island, and miscellaneous. This information was then used in a process analysis to determine ways to improve the efficiency and effectiveness of the paint crews. Several improvements were identified including:

performing work for other governments: down time was turned into productive hours resulting in approximately $200,000 of revenue; and

unifying the speed of the trucks, which resulted in a higher overall truck speed and fewer hours worked:

In order to implement an activity-based-costing project there are four basic steps. (see Exhibit P.17). First, resources and costs must be organized in terms of work unit costs, costs incurred on behalf of the work unit, or government wide and department wide indirect costs. Second, costs need to be categorized as either direct to an activity or indirect. For costs which cannot be directly assigned to activities, an indirect cost methodology needs to be selected: either the K1S or full-cost methodology. Third, direct and indirect costs need be assigned or allocated to specific activities. Lastly, unit costs need to be calculated by dividing the activity costs by the activity outputs.

The first step is to identify resources and costs. The Iowa ABC system uses three categories of resources: work unit costs, costs on behalf of work units, and governmentwide and departmentwide costs.

Work unit costs are actual costs charged to the work unit, paid by the work unit. These costs will need to be assigned to activities. Salaries and materials for the paint crews are examples of work unit costs.

Costs on behalf of work unit are actual costs incurred on behalf of the work unit, paid elsewhere by another work unit, department data processing costs incurred by the IDOT data processing unit on behalf of the paint crews. These costs are similar in nature to work unit costs except these are paid elsewhere. These costs will also need to be assigned to activities.

Government-wide and department-wide costs are actual costs incurred on behalf of the work unit that are central to the government or the department. Examples of these costs are fringe benefits, insurance, department directors, and administration costs that need to be assigned or allocated to the paint crews.

Direct Cost Assignments. In activity-based costing, the more costs that can be assigned directly to an activity, the easier the costing becomes. Activity-direct costs may be identified within work unit costs or costs on behalf of the work unit, but paid elsewhere. These are costs charged to the work unit and paid by the work unit or costs charged to a different work unit on behalf of the work unit. Any direct activity cost within the work unit or within another work unit is identified and assigned directly to the activity.

Indirect Cost Assignments. There are many costs that cannot be directly assigned to an activity. These costs need to be reviewed and allocated to the activity. The basis for allocation depends upon the nature of the costs, as illustrated below.

For example, if an agency utilizes 100 telephones, 20 of which belong to a particular activity, then one-fifth (20/100) of the phone bill can be assigned to that activity.

Direct and indirect cost assignment to activities is based on the selected methodology. The IDOT paint crews determined the total costs for each of the six regions for center line, edge line, and curb and island activities. For one region, Central Iowa Transportation Center (CITC), total, and activity costs were:

STEP 4: Defining Unit Costs Once costs are assigned to activities, unit costs are determined by dividing the activity cost by the number of outputs. For example, the IDOT paint crews divided activity costs by the number of outputs to derive the unit costs as follows.

This article suggest two basic ABC methodologies: the keep-it-simple (KIS) method and a full-costing method. The following chart summarizes the authors' recommended options for various objectives.

Keep-it-simple Methodology. The KIS methodology addresses the objectives of comparable and budget estimate costing, but is not the suggested methodology where rate setting, managed competition, outsourcing, or privatization are desired. The KIS approach reasonably assigns costs to activities without speeding a significant amount of time costing them out. It is a methodology in keeping with the American Institute of Certified Public Accountants' spirit of: It is much better to be approximately right than precisely wrong. In many cases, detailed data will be available. The KIS methodology should not be used where detailed data are available.

Costs are allocated based on total direct salaries using the KIS methodology. The following example of a department having a program budget of $9,068,750 is used to illustrate the process. The budget consists of the following:

Of the $9,068,750 of total program costs, $5,275,000 is for direct activity salaries, $2,475,000 for other direct activity costs, and $1,318,750 for administrative costs. The objective is to allocate or assign the administrative costs to the four activities, A1, A2, BI, and B2.

The basic formula for assigning departmentwide costs to activities is based on direct salary costs: the costs to be assigned are divided by total direct salaries. To assign the administration costs of $1,318,750 in the program budget illustrated above to the activities, the following formula is used.

Costs to be Assigned $1,318,750

Total Direct Salaries $5,2 15,000 * 25 %

Administrative costs of $1,318,750 are then assigned to the four activities by multiplying the activities by multiplying the Activity Direct Salaries by 25% as follows (totals may not agree due to rounding)

The $1,318,750 of administration costs are assigned to the four activities and are then added to the direct salaries by activity along with other direct costs to derive the total costs by activity:

The advantage of this methodology is its simplicity. straightforward manner.

It is an acceptable methodology for assigning costs in a simple,

Full Costing Methodology. The full-cost methodology addresses the objective:, of total costs and avoidable costs. It is the suggested methodology for agencies that are performing rate setting, managed competition, outsourcing, or privatization projects. This methodology assigns or allocates each cost element based on a particular rationale. the following discussion will illustrate how this full-costing approach was implemented in the ABC costing for Iowa's DOT paint crews.

When the Iowa Department of Transportation (IDOT) implemented ABC for the paint crews, the objective was to compute the full costs of the paint crews. The methodology described in the following section will provide a detailed step-by-step example of ABC implementation in a government environment. Although this is a state government example, the concepts and methodologies are applicable to all governments.

The paint crews, a work unit within the maintenance division of IDOT, are responsible for paint striping activities on roads. As the paint crews were selected for an ABC analysis to determine how competitive the crews were in providing services, they underwent a managed competition analysis requiring a detailed costing of their three activities. Activity-based costs for the fiscal year ending June 30, 1996.

The three activities-1) center line and no passing markings, 2) edge line markings, and 3) curb, island, and miscellaneous markings-are performed within six regions. The central region, identified as CITC, serves as one example of the ABC full-costing methodology. The following example illustrates the cost allocation process through the various cost categories-personnel, material, facility, vehicle and equipment, and overhead. Totals may not agree due to rounding.

CITC incurred $653,777 of total costs for the three activities as follows: 

CITC Direct Labor. The paint crew employees have a formal system in place to record their time in relation to the activities performed during the day. A total of $211,143 of direct labor was identified for CITC.

Borrowed direct labor related to painting costs is the amount of labor that CITC used from other IDOT cost centers. Borrowed labor costs were $17,345. This amount, however, included vehicle operating costs of $1,154 which are accounted for in another category, making the net borrowed direct labor salary amount $16,191.

Work for others, the amount of time of paint crew employees that was assigned to other activities and, accordingly, did not contribute to painting activities, was determined to be $5,463.30.This amount was reduced by $145.97 relating to overhead contained in the gross figure. Thus, $5,317.36 was the net amount of work for others. A summary of the CITC direct labor costs follows.

The allocation of direct salaries was made based on hours by paint activity. From this, a percentage of hours by paint activity was compiled as follows.

The percentage of hours was then multiplied by the payroll costs to derive the direct labor costs for the three activities as follows:

  CITC Material Costs. Material costs were broken down by type of material and by the six regional cost centers. Material types include the cost of beads, other materials, white paint, and yellow paint. The cost of each type of material was allocated to the activities based on the amount of material usage for each activity. IDOT also tracked the gallons of yellow and white paint and the consumption for reflective beads by the three activities. The percentage of consumption was then multiplied by the costs to determine the material costs per activity. The consumption of the various materials and material costs for the paint crews totaled $313,580, allocated as shown here.

The cost category called "Other" amounted to $5,054 and was allocated based on this methodology as follows

CITC Facility Costs. Facility costs included facilities and utilities. In all but one location the paint crew employees share the building with other IDOT employees. The percentage of each building occupied by the paint crews was determined in order to allocate facility costs to paint crews. The buildings were depreciated on a straight-line basis over 20 years. The facility costs were allocated based on the amount of hours charged for each activity; the percentage of hours was then multiplied by the facility costs to derive the labor costs for the three activities as follows.

CITC Equipment and Vehicle Costs. Equipment and vehicle costs included data on all vehicles used by each paint crew region including the vehicle number, original cost, repair and maintenance operating costs, salvage value, and purchase date. Vehicles wee categorized into two classes: light and heavy equipment. Light equipment had an estimated useful life of four years. Heavy equipment had an estimated useful life of 10 years. the vehicles were depreciated using straight-line depreciation depending on their class and net of salvage value.

The equipment and vehicle costs charged to CITC were $71,034. These cost:, were allocated to the three activities based on heavy equipment hours, factored as the relationship of two vehicle hours for three labor hours. A summary of the allocation methodology follows.

The percent of calculated vehicle hours was then multiplied by the total equipment costs to derive the amount of equipment and vehicle costs allocated to each activity.

CITC Overhead Costs. CITC overhead costs consist of administrative services, operations and finance, special purpose, and maintenance division costs. First, a percentage to allocate overhead costs to the paint crews was calculated as follows.

The percentage to allocate to the paint crews then was multiplied by the administrative services, operations and finance, and special purpose costs. The maintenance division costs were allocated based on the percentage of adjusted CITC costs to the maintenance division total expenditures as follows:

summary of the allocation follows.

The IDOT and state overhead costs of $35,843 were allocated to the three activities based on the CITC equipment and vehicles cost allocation percentages discussed earlier. A summary of this allocation follows.

Finally, CITC other overhead costs and small total costs were allocated based on the percentage of gallons of paint used.

Activity and Unit Costs Summary. A summary of the three activity costs by cost category follows.

Once costs are assigned to activities, unit costs are determined by dividing the activity costs by the number of outputs. The IDOT paint crews divided their activity costs by the number of outputs to derive the unit costs as follows.

SUMMARY Activity-based costing has proven to be a powerful management tool in the state of Iowa's performance management system by providing important cost information. Iowa managers have advocated a thoughtful approach to costing government services by encouraging a "keep-it-simple" methodology to achieve specific complexities of the full-costing methodology. These methodologies have allowed program personnel to work with fiscal personnel to provide a blend of cost and program data for balancing efficiency and effectiveness in the delivery of public services.

Since 1995 the accounting firm of Deloitte & Touche has conducted three audits ) in state agencies and issued three management letters relative to those audits. Copies of these letters are available in the Murphy Commission or Arkansas Policy Foundation offices for anyone seeking to review them.

Over the course of the three audits, these three letters presented recommendations on reportable conditions in 27 state agencies or functional areas ...and recommendations concerning improvement or corrections to accounting, administrative, and operational matters in 20 agencies or functional areas.

The implementation of many of these recommendations could save the state millions of dollars and improve operations. For example, one series of recommendations which focused on the state's risk management procedures could save the state $2-$15 million (see Deloitte management letters) And yet after three years of audits, around half of the audit recommendations still remain unresolved as expressed in the most recent audit report. In fact, Commission analysis shows that as many as 75 of a total of 144 recommendations remain may be still at issue as we move into the third year of the audit. The wording of many of these recommendations, over three years, has remained exactly the same. Business and corporate America would find the slowness of the response frightening.

The Commission is suggesting to the Governor that a special bipartisan public oversight group be empowered to oversee greater responsiveness to the current audit recommendations. The Murphy Commission will also suggest that this group could and should evolve into a citizen-based commission (see introduction to this report and recommendations concerning an Arkansas Government Accountability Commission) tasked with arranging and overseeing an independent state audit and continually reviewing state government for opportunities to competitively outsource state services. The Virginia Commonwealth Competition Council, established under Governor George Allen's administration, will be among the programs advocated as a model.

In recommending that the state conduct its own outside independent audit, the Murphy Commission also recommends the establishment of an independent audit committee with reporting responsibility to a bipartisan citizen oversight group, The Arkansas Government Accountability Commission (AGAC).

Deloitte & Touche recommends that the audit committee should be comprised of five non-government citizens having no contracts with the state, but possessing business and financial experience plus one person from the executive branch and one from the legislative branch. The five citizen members and the executive branch member should be appointed by the Governor and the 'legislative branch member by the Speaker of the House.

The duties of the audit committee should be developed by the AGAC and should include:

1. Selection of an independent CPA firm to conduct the audit of the State's Consolidated Financial Report

2. Meeting with the CPA firm at least twice annually (more if needed), once to review the audit scope and once to review a draft of the report of the CPA firm.

3. Meeting at least quarterly with the CIA (Chief Internal Auditor) to review and approve the audit plan and reports.

The Audit Committee will also report directly to the Governor quarterly and will prepare a report annually for the Legislature. The executive branch would provide staff support, through the AGAC, to assist the Audit Committee.

Moving from the current status regarding auditing is essential. While the current audit firm selection process is conducted in accordance with the applicable state bidding/selection process, a change to put the external audit selection and reporting function under the audit committee as proposed would be a significant procedural improvement. Financial reporting responsibilities and internal audit functions are dynamic in today's society, and this suggests that the objectives and purposes of the state's internal auditing functions must be fully reviewed to determine whether they are serving the state and its citizens as well as they did when first established.

Key questions should drive the evaluation. Are the efforts of the skilled auditors within Legislative Audit and the various agency audit functions actually focused toward the risks that are present in today's society and government functions? Why should the state provide the audit function for each city and county that chooses not to have an external audit function? Should this responsibility - and benefit -be at the local level? Should the audit functions be focused on compliance with laws, regulations and state directives rather than on the balance of the petty cash fund in Anycity, Arkansas? What is the relative risk that the petty cash fund outage at Anycity is of greater concern than the compliance with laws, regulations and other pertinent requirements? Is timely reporting by these internal audit functions more important than the continuation of business as usual? These questions and many other issues remain, for the moment, open to more scrutiny.

Risk assessment, overseen by an independent citizen committee - not the legislature, not the executive branch - is the key to proper utilization of the valuable resources we have in the legislative and other audit functions. Their proper direction should be the duty of the committee as it works independent of the branches, but closely with them in the interest of all citizens and the state.

A consideration in this regard would be to bring all auditors currently employed by the various agencies and commissions under the authority of a single state auditor, with the consolidation of the audit functions under the authority of the Committee. Any savings from such a consolidation could be dramatic and used, in part, to fund the independent audit initiative. With the audit function under the care and direction of the Committee and the Chief Internal Auditor (CIA), no one within state government - not the legislature and not the agencies and not the commissions- will control the direction and outcomes of the audit function. Given the skills of some of the state's current in-house auditors, this move could be made quickly with little concern for the competency of the CIA.

The recommendation for an independent audit, is reinforced by the fact that the Government Finance Officers Association (GFOA) just included such an action as best practice for all states. Below is a summary of GFOA's best practices statement.

The auditor of a state or local government's financial statements must be independent, both in fact and in appearance. A properly constituted audit committee helps to enhance the financial statement auditor's real and perceived independence by providing a direct link between the auditor and the governing board.

One important advantage of an audit committee is that it helps to facilitate communication between management, the auditors, and the governing board. An audit committee also limits the reliance governing bodies must place on the technical expertise of the independent auditor. An audit committee is useful, too, in helping to focus and document the government's process for managing the financial statement audit.

In recent years, the importance of audit committees has come to be recognized increasingly in both the public and private sectors. This importance is reflected in the requirement set by generally accepted auditing standards that auditors determine that the audit committee (or its equivalent) is informed of various matters of importance related to the financial statement audit.

The audit committee should play an advisory role to the governing body. Management and the governing board remain ultimately responsible for the fair presentation of the financial statements and for obtaining and monitoring the financial statement audit.

The Government Finance Officers Association (GFOA) makes the following recommendations regarding the establishment of audit committees by state and local governments:

1. Every government should establish an audit committee or its equivalent. Reliable audits arc essential to the credibility of financial reporting by state and local governments. The audit committee is a practical tool that a government can use to enhance the independence of the external auditor, and hence the reliability of the financial statement audit.

2. The audit committee should be formally established by charter, enabling resolution, or other appropriate legal means.

3. The members of the audit committee collectively should possess the expertise and experience in accounting, auditing, and financial reporting needed to understand and resolve issues raised by the independent audit of the financial statements.

4.A majority of the members of the audit committee should be selected from outside of management. At the same time, the audit committee should include at least one representative each from the executive and legislative branches of the government.

5. At a minimum, the head of the internal audit function should possess a college degree and appropriate relevant experience. It also is highly desirable that the head of the internal audit function hold some appropriate form of professional certification (e.g., certified internal auditor, certified public accountant, certified information systems auditor).