In the context of Indonesia, fiscal decentralisation causes variation in local government financial condition. Some local governments experience financial problems, but some others are not. Such variation creates the need for local government stakeholders to have an effective instrument to monitor the soundness of local governments in managing finance (i.e planning, budgeting, executing, and monitoring). In addition, the stakeholders need to know what factors determine the variation in financial condition. Until now, in Indonesia, stakeholders have faced difficulties in knowing the soundness of local government financial conditions. The difficulties of knowing the financial condition of local government are due to lack of agreement about an effective assessment model and lack of uniformity in financial condition indicators (Chaney et al., 2002; Honadle, 2003; Kloha, et al., 2005b; Wang et al., 2007). Furthermore, there is little empirical evidence about the factors affecting the financial condition of local government (Dennis, 2004; Jones & Walker, 2007).Therefore, the objectives of this study are, firstly, to develop an instrument to measure the financial condition of local governments in Indonesia and, secondly, to determine factors affecting financial condition of local governments