Local Governments Characteristics and Quality of

Financial Reporting in Indonesia

Nurmali Agustina

, and Dyah Setyaningrum

Postgraduate Program in Accounting, Faculty of Economics and Business, University of

Indonesia, 16424, Depok, Indonesia

Faculty of Economics and Business, University of Indonesia, 16424, Depok, Indonesia

Abstract. This study aim to propose measurement of local governments financial

reports (LGFR) quality in Indonesia and compare the quality of financial reports

based on the local governments‘ characteristics. Measurement of LGFR quality

is based on qualitative characteristics of government financial statement. Local

governments characteristics consists of size, wealth, age, and number of

legislative. The sample used is 1002 local governments during 2016-2017 using

the content analysis method and the mean difference test. The result show that

the mean value of LGFR quality in Indonesia is 37,78 or only 68,69% from the

full score. We also found that larger size of local governments have better quality

of financial reports compared to smaller size of local governments. On the other

hand, local governments with greater wealth, longer age, and larger member of

legislative have lower quality financial reports compared to local governments

with smaller wealth, shorter age, and smaller member of legislative.

Keywords: Local Government Characteristics, Quality of Financial Reporting

1 Introduction

Local Governments in Indonesia adhere the principle of local autonomy in organizing

its government affairs. It means that every local government has the right, authority,

and obligation to regulate the affairs of all matters relating to the implementation of

government and also the society’s interests [1]. As a form of accountability for what

has been done, the local government must create accountability reports, one of which

is the financial statement. Financial reports one of the essential components of creating

accountability. In preparing the financial reports, the local government refers to the

applicable regulation [2]. In ensuring the reliability and fairness of a government

financial reports , it is necessary for external parties to review and audit the

government's financial reports who is conducted by Supreme Audit Institution (BPK)

[3]. Audit activities both internal and external have function to ensure the reliability of

financial reports and detect whether there is a fraud or non-compliance activity in

accordance of applicable laws and regulations to provide useful information [4], [5].

Based on summary of audit report [6], all local governments have implemented

accrual-based accounting as the implementation of applicable regulation [2] concerning

Government Accounting Standards (SAP). In the last two years (2016-2017), there was

an increasing number of local governments that receive unqualified opinions (WTP)

Agustina, N. and Setyaningrum, D.

Local Governments Characteristics and Quality of Financial Reporting in Indonesia.

DOI: 10.5220/0009854300002900

In Proceedings of the 20th Malaysia Indonesia International Conference on Economics, Management and Accounting (MIICEMA 2019), pages 215-227

ISBN: 978-989-758-582-1; ISSN: 2655-9064

215

which previously 70% becoming 76% in 2017. In addition, there was also an

improvement from disclaimer opinion (TMP) become qualified opinion (WDP) of 7

LGFR and from qualified opinion (WDP) become unqualified opinions (WTP) of 45

LGFR. The increase in opinion indicated that the financial statement complies with

applicable regulations and free from material misstatements.

Policies in the public sector especially government accounting differ from one

country to another. Thus, in determining and measuring the quality of financial reports

must be aligned to the conditions of certain countries. Some studies in the public sector

try to measure the quality of financial reports with restatement [7] and financial

reporting deficiency score [8]. Financial reports contain useful financial information in

the decisions making process [9]. In order to present useful information, financial

reports must meet several qualitative characteristics. The qualitative characteristics of

financial information consisting of relevant and correct presentation, comparable,

verified, timely, and understandable [10]. In the Government Accounting Standards

(SAP) which is a reference for local governments in creating financial reports explained

that the qualitative characteristics of financial reports consist of relevant, reliable,

understandable, and comparable [11]. A study that have tried to measure the qualitative

characteristics of financial reports by using 21 items of qualitative characteristics in

231 annual reports of companies listed on the US, UK and Dutch capital markets in

2005 and 2007 [12]. This measurement measurement of qualitative characteristics is

quite comprehensive using proxy of the qualitative characteristics of financial reports

into 21 items. When comparing between private entities (companies) and public entities

(government), the concept of the qualitative characteristics in the financial reports has

the same basic principles. This measurement [12] also has been used to develop a

questionnaire related to the quality of government financial reports [13]. Research on

the quality of financial reports which focuses on the qualitative characteristics of

financial reports on a national scale is still relatively rare.

Each local government has different characteristics. Several studies in Indonesia

that discuss the characteristics of local governments are usually associated with the

level of disclosure in government financial reports [9], [14], [15], [16], [17], [18]. The

results indicate that several characteristics of local governments such as size, age,

wealth, and also the number of local government legislatures are related to the level of

disclosure in government financial reports. The higher level of disclosure shows that

local governments are more transparent, and the quality of financial reports will also

improve. There is still limited research focusing on the effect of local government

characteristics toward the quality of financial reports. A study that examined the effect

of government characteristics on the quality of government financial reports found that

several characteristics such as government size, intergovernmental revenue, and also

governmental spending affect the quality of financial reports as measured by the values

relevance in the financial statement [19]. Otherwise stated, local government

characteristics has aneffect to the quality of local government financial statement.

The purpose of this study is to compare the quality of local government financial

reports between small and large groups based on the characteristics of the local

government itself. The local government characteristics used in this study are size,

wealth, administrative age, and also the number of legislatures

. Therefore, the research

questions in this study are:

RQ1: How does the comparison of the quality of financial reports between small

size and large size governments?

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RQ2: How does the comparison of the quality of financial reports between small

wealth and large wealth governments?

RQ3: How does the comparison of the quality of financial reports between shorter

administrative period and longer administrative period governments?

RQ4: How does the comparison of the quality of financial reports between small

number of legislatures and large number of legislatures governments?

This study has two main contributions. The first contribution is to propose

measurements related to the quality local government financial reports. The second

contribution is to test the differences in the quality of local government financial reports

based on the characteristics of local governments.This study uses content analysis

methods to assess the quality of local government financial reports, and the mean

difference test to figure out whether there are differences in the quality of financial

reports in local governments based on the characteristics of local governments in 1002

local governments. The results show that the average quality of the financial reports of

local governments is 37,78 or only 68,69% of the full score. According to the research

results, the mean difference test on the characteristics of local government shows that

the quality of financial reports of large-size local governments is better than the quality

of small-size local government financial reports. On the other hand, governments with

greater wealth, longer administrative age, and a greater number of legislatures have

lower quality compared to local governments with smaller wealth, shorter

administrative age, and smaller number of legislatures. The implication based on the

results found in this study is that local governments with greater wealth, longer

administrative age, and a greater number of legislatures should further improve the

quality of financial statement.

2 Literature Review

2.1 Agency Theory

The agency relationship is a contractual relationship whereby one or more acts as the

principal appoints another person to act as an agent to carry out the task as a form of

delegation of authority [20]. Agency problems arise when there is a delegation of

authority from principals to agents [21]. Agency problems can be caused by factors of

incentive and avoidance of pressure [22]. Agents as parties who are authorized by the

principal to carry out the task, they have information and full power in making a

decision. From this situation, it can be seen that the problem that arises is the existence

of asymmetric information, which is when one party has more information than the

other party [14].

The parties involved in the agency problem in the public and private sectors are

different. In the private sector, agency problems occur between those who have capital

or shareholders and those who carry out the day-to-day operations of the company or

managers. In the public sector, especially government, agency problems that arise

involve the publics as principals and also the government as an agent [15]. This

statement is also supported a statement that agency problems in local government occur

Local Governments Characteristics and Quality of Financial Reporting in Indonesia

217

between elected local officials and the community [14]. In Indonesia, the community

can directly elect its local head (government) through local head elections which are

held in every 5 years. This local head election creates agency relations when the

community as a voter delegates authority to the elected local head [23]. that Agency

problems can also occur when the government implements policies that only benefit

one particular party at the expense of the interests and welfare of the community [23].

In other words, agency problems arise when the government has more information than

the public in the administration of government or public services, and also has the

authority to make local decisions and policies that may benefit one party. In these

conditions, it appears that the agency problem that arises is asymmetric information

between the government and the community.

In term of explaining accountability, agency theory is the main theory that is often

used to explain conditions that occur and formulate hypotheses [24]. Accountability in

the context of the public sector is defined as the obligation of the party that is authorized

(the government) to provide accountability, present, report, and disclose what has been

done while running the government to the party that gives authority (the public) [25].

Financial statement are one of the ways to reduce the informationasymmetry. The

government is required to make financial reports as a form of government

accountability to the community for what they do in carrying out government functions

in a period.

2.2 Qualitative Characteristic of Financial Reporting

Financial reports consist of information about what has been done as a form of

accountability to certain parties for the delegation of authority. The higher quality of

financial reports, the more useful the information contained in the financial reports of

its users [26]. Base on applicable regulation in Indonesia, the qualitative characteristics

of financial reports are relevant, reliable, comparable, and understandable [11].

2.2.1 Relevant

Relevant characteristics are related to the use and materiality described by the ability

to make decisions by users of financial reports [26]. A government financial report is

believed to be relevant when the report contains information that can influence in the

decisions making by helping them evaluate past or present events, and predict the

future, and confirm or correct their evaluation results in the past. All information must

be presented in a complete and timely manner so that it can be useful for decision

makers [11].

2.2.2 Reliable

For a financial report to be useful, it must contain reliable information. Reliable

information means that the information is free of material biases and errors [26]. A

government financial report is said to be reliable when the report contains information

that is free from misleading notions and errors material, honestly presents every fact,

and can be verified [11].

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2.2.3 Comparable

The third qualitative characteristic is that it can be compared. This characteristics allow

users of financial reports to compare financial reports [26]. A government financial

reports is said to be comparable when the information contained in the financial reports

will be more useful if it can be compared with the financial reports of the previous

period or the financial reports of other reporting entities in general [11].

2.2.4 Understandable

This characteristics can be fulfilled through effective communication between financial

reports makers and users of financial reports [26]. The better the understanding of users

of financial reports, the higher the quality of financial reports [27]. A government

financial reports is said to be understood when information presented in financial

reports can be understood by users and expressed in terms and terms that are adjusted

to the limits of understanding of users [11].

2.3 Local Government Characteristics

2.3.1 Size of Local Government

The size of an organization reflects how large an organization is [14]. Size is usually

reflected by the total assets owned or managed by an organization [17] The greater the

assets that are managed, the harder for them to get to be managed by the organization.

The demand for transparency on budget management and government affairs would be

greater in local governments that have a larger size compared to smaller size local

governments [14]. Local governments with greater total assets will tend to increase the

level of disclosure and ultimately improve the quality of financial reports [9].

2.3.2 Wealth of Local Government

An organization's wealth reflects the organization's ability to finance its own

operational matters. In measuring the level of wealth local governments usually use the

amount of original local government revenue (PAD). This is because PAD is a

collection of local taxes and levies obtained from the people of an area [14]. The greater

amount of PAD shows the greater community contribution; thus, community demands

for government disclosure and transparency are also greater [28], [17].

2.3.3 Administrative Age

The administrative age of the local government shows how long a local government

has been formed from the beginning based on the law on local formation. An area with

a longer administrative age tends to be more experienced in making financial statement

because local government implemented recommendation form BPK [14], [17], [18].

The longer the administrative age of the local government, the better the quality of its

financial reports [29]. Another study found that when an organization has a longer

Local Governments Characteristics and Quality of Financial Reporting in Indonesia

219

administrative age, the possibility of discretion gets smaller and ultimately degrades the

quality of financial reports [30].

2.3.4 Number of Legislatives

In Indonesia, Local Representative Council (DPRD) acts as a legislative body. As

community representatives, the DPRD’s tasks are to conduct monitoring and

controlling of the running government to match the aspirations of the community.

Legislative members will make sure the budget is allocating properly and ensure the

realization of transparency and accountability through oversight of the implementation

and financial and performance reporting [28], [14]. The number of legislatures in a

region is determined based on the number of population in an area, the city and district

governments have a minimum number of 20 and a maximum of 50 legislatures [31].

The greater number of legislatures will increase the number of disclosures in an area,

so that in the end it will improve the quality of financial reports [15], [28], [14].

However, another study state that the increasing number of legislatures does not

correlate with the function and the oversight role by the legislature to be optimum [32].

Therefore, it can reduce the quality of financial reports of local governments.

3 Methodology

3.1 Data and Sample

The population in this study were all local governments in Indonesia in 2016-2017.

This research excludes provincial government, because it has different characteristics.

In determining the sample, this study uses a non-probability-purposive sampling

technique, by determining several criteria to obtain a research sample. The criteria used

are the city/district government, that publish financial statement for 2016-2017, and

published number of legislative members. Based on these criteria, the sample of this

study are 1002 local government financial statements ( table 1).

In comparing the quality of local government financial statements, this study uses

two groups for each characteristic. The first group is the smallest group in each

characteristic after being sorted. The second group is the largest group in each

characteristic after being sorted. The selection of this group uses percentile distribution,

by dividing the sample into 100 groups. Group selection in this method is done to avoid

grouping values in a particular group, so that two extreme groups are taken.

This study uses secondary data in the form of analysis of qualitative characteristics,

total assets, and the Owned SourcedRevenue (PAD) derived from the audited financial

statements, the administrative age of the local government obtained from the Ministry

of Internal Affairs, and the number of local legislative members obtained from the

Puskapol Universitas Indonesia.

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Table 1. Research Sample.

Sample Selection Criteria

Population 2016-2017 1096

Province Governments (68)

City Administrative (DKI Jakarta) (12)

Missing Financial Reports (10)

Missing number of Legislative (4)

Total Sample 1002

3.2 Variable Measurement

3.2.1 Quality of Local Governments Financial Reports

A study tested 21 combined items as a measure of the quality of financial statement

[12]. The research indicates that the measuring instrument is valid and reliable to be

used in assessing the quality of financial reports. This study measures the quality of

LCFR using that measurement adjusted to the qualitative characteristics of government

financial reports based on applicable regulation in Indonesia [11] by giving scores for

items used and supported by textual analysis to strengthen the consideration of the

quality of financial reports to be more accurate and reliable. Textual analysis helps in

assessing specific information that can be used as an assessment at a specific index.

After making adjustments to applicable regulation in Indonesia [11], the items used to

measure the quality of financial reports are 11 items. Each item will be given 1-5, where

1 is the lowest and 5 is the highest.

3.2.2 Size

This study uses total assets to measure the size of a local government based on the

measurement methods used in the some research [14], [17], [19].

3.2.3 Wealth

Wealth is a measure of the independence of a local government proxied by Owned

Source Revenue (PAD). PAD is a collection of local taxes and levies from the

community, which also shows the level of community participation in government [14],

[17], [28].

3.2.4 Administrative Age

Administrative age shows how long an organization has been running its activities since

it was formed. Thus, the administrative age is measured from the year of local

government formed based on the laws of local formation [[14], [17], [18].

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3.2.5 The Legislature

The legislative council or better known as Representative Council (DRPD) is the

people's representative to ensure that the aspirations of the people are conveyed and the

government is well organized. The legislative characteristics in this study measured by

the number of members of the city and district DPRD [14], [15], [28].

3.3 Method

This study uses content analysis methods to assess the quality of financial reports and

the mean difference test to answer the research questions. Before conducting a mean

difference test, local governments will be divided into large groups and also small

groups. First, local governments will be sorted from small groups to large groups based

on the characteristics of size, wealth, age and also the number of legislature. After being

sorted, the local government will be grouped by percentile, meaning the data is divided

into 100 groups. In order to do the mean difference test, it requires two groups, the first

group with a limit value <P10 represents the small group, and the second group with a

limit value> P90 represents the large group. The mean difference test or t-test is a

comparative test or different test to find out whether there are significant mean

differences between two different independent groups [33]. Before conducting the

mean difference test the researcher also conducted the homogeneity test required as a

basic assumption of the independent t test.

4 Results and Discussion

4.1 Descriptive Statistics

This study uses a sample of 1002 local government financial reports during 2016-2017.

Table 2 shows the descriptive statistical results of all variables in the sample.

Tabel 2. Descriptive statistics.

Variable N Mean Std. Dev Min Max

FRQ 1002 37,78 5,90 20 52

Size 1002

Rp. 3

trillion

Rp. 3.7

trillion

Rp. 369

billion

Rp.41

trillion

Wealth 1002

Rp. 228

billion

Rp. 414

billion

Rp. 3.9

billion

Rp. 4.9

trillion

Age 1002 38,72 24,17 2 67

Legislative 1002 34,14 10,03 20 50

Table 2 shows that the average value for the quality of local government financial

reports is 37.78 or around 68.69% of the total score. With a scale of level 1-5, these

results indicate that the quality of the financial reports of local governments in

Indonesia is at level 2 or 3. The minimum value for the quality of financial reports of

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20 is given to the local governments of Magelang and Central Lombok. The maximum

value for the quality of the financial statements of 52 is given to the local government

of Merangin district in Jambi Province. The lowest total amounts of assets are owned

by PulauTaliabu district in North Maluku Province. The lowest amount of original local

government revenue (PAD) is owned by Maybrat district in the Province of West

Papua. The local government with the highest total assets and total owned source

revenue (PAD) is Surabaya City. Another interesting result we can see from the

administrative age of local governments. In recent years, there have been a number of

new regions which have been divided into several existing regions. This can be seen

from the significant difference from the minimum number of administrative age of local

government that is 2 and the maximum number of administrative age of local

government that is 67. For the legislative size of local government has been determined

in accordance with applicable regulation [31], with a minimum number of 20 and the

number of 50 at maximum.

4.2 Mean Difference Testing Result

Mean difference test or T-Test is used to determine whether there are significant

differences between two specific independent groups. The mean difference test result

using percentiles can be seen in Table 3.

Table 3. Mean Difference Testing Result – Percentile.

Small Large Diff T Prob

Size 37.11881 38.77228 -1.65347 -1.9701 0.0251 **

Wealth 38.62376 36.48515 2.13861 2.7838 0.0029***

Age 38.37624 34.34653 4.02970 5.4986 0.0000***

Legislative 38.65347 34.20792 4.44555 5.7047 0.0000***

Overall, the results show that there are significant differences between the quality

of financial reports of one group and the other. To answer the first research question,

we compare the size for small and large local government. For Size characteristics, the

results show a difference value of -1.65347. This negative result means that when

compared between small groups and large groups, the local government with a larger

number of assets has a higher quality of financial reports compared to the local

government with a smaller number of assets. This result is significant at the 5%

significance level. When local governments have a greater number of assets, they have

more resources to carry out several activities such as training in phases of human

resources, developing information systems, and even conducting some research that

can improve the quality of financial reports that they produced. These results support

the research which found that government size is positively related to disclosures in

financial reports [14]. The higher level of disclosure in the local governments financial

statement, the higher expectation on the better quality of its financial reports.

The second research question is comparison of wealth. Table 3 showsthat the

difference value of wealth is 2,13861 which means that when compared between small

Local Governments Characteristics and Quality of Financial Reporting in Indonesia

223

and large groups, local governments that have a greater amount of owned source

revenue have lower financial report quality compared to local governments that have a

smaller original owned source revenue. This result is significance at the 1% level. This

result contradicts the research which found that the greater amount of original local

government revenue, it indicates greater community participation, so the demands for

transparency and accountability are also greater [14]. However, these results indicate

that the greater amount of original local government revenue, the quality of its financial

reports is getting lower which means it also indicates low transparency and low

accountability. This can also be caused by the lack of attention and public demand for

a better quality of financial reports.

The answer of the third research questionregarding age characteristicshow that the

value of the difference between small groups and large groups is 4,02970 which means

that local governments with a longer administrative age have lower quality financial

reports compared to local governments with shorter administrative ages. This result is

significance at the 1% level. These results contradicts with some researches [14], [18],

[29]. However, these results support the findings in the other research who argue that

the longer life of an organization, the possibility of discretion in financial statements is

also smaller [30]. This is caused by local governments with shorter administrative ages

tend to make reports based on reports that have been made by governments with a

longer administrative age by making improvements so they can produce higher quality

of financial reports.

The last research question is the characteristic number of legislatures. The result

shows a difference value of 4,44555, which means that local governments with more

members of legislative have lower quality financial reports compared to local

governments that have fewer legislative numbers. This result is significance at the 1%

level. These results contradict the findings of some researches [[14], [15], [28]. This

could be caused by increasing number of legislatures making the function and role of

supervision carried out by the legislative council less optimal, resulting in a lower

quality of financial statements.

4.3 Additional Analysis

We conduct additional mean difference test using median. The result can be seen in

table 4. The result in table 4 in line with main analysis in table 3 except for the size.

Overall, we can see that by having the small size, wealth, age and legislative member,

local government can be focus to increase the quality of their financial statements.

Table 4. Mean Difference Testing Result – Median.

Small Large Diff T Prob

Size 38.26148 37.28543 0.97605 2.6237 0.0044***

Wealth 38.79441 36.7525 2.04192 5.5538 0.0000***

Age 39.27745 36.26946 3.00798 8.3332 0.0000***

Legislative 38.57884 36.97806 1.61078 4.3559 0.0000***

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5 Conclusion

The purpose of this study is to propose measurement of the quality of government

financial reports and compare the quality of financial reports based on the local

governments’ characteristics. The quality of financial reports measure using 11 items

of local governments qualitative characteristics. In general, the average score of quality

of local government statements in Indonesia is 37.78 or approximately 68.69% of the

total score. This result is quite good considering the local government begin to

implement full accrual basis since 2015. The application of accrual-based accounting

is expected to improve government performance in preparing the budget and budget

realization. The successful implementation of accrual-based accounting requires

collaboration from various parties to produce financial statements that are more

transparent and accountable [34]. The result of comparison of local government

characteristics to quality of financial statement shows that that larger size of local

governments has better quality of financial reports compared to smaller size of local

governments. On the other hand, local governments with greater wealth, longer age,

and large rmember of legislative have lower quality financial reports compared to local

governments with smaller wealth, shorter age, and smaller member of legislative.

The implication of this research is that the local government with greater wealth,

longer administrative age, and also the greater number of legislative members need to

increase the quality of their financial reports. This higher quality of financial reports

will increase the transparency and accountability of government financial reports and

maximize the function and role of oversight by the legislatives. The limitation of this

study are: first, this study only uses mean difference tests based on the several

characteristics of the local government, further research could add other variables and

also test the causality. Second, the results for wealth characteristics are quite interesting.

These results could have been due to the low attention and demands of the public on

quality financial reports. Further studies can explore to the extent of public attention to

quality financial reports and their usefulness.

Acknowledgement. This research is funded by HIBAH PITMA B UI 2019.

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