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p. 59 of 203 BACK | NEXT Foreword 1. Introduction to the Guidelines 2. User Instructions 3. Preparing and Appraising Investment Project 4. Financial Management of Executing Agencies 4.1. Financial Management Overview 4.2. Institutions and Systems 4.2.1. Introduction to Institutions and Systems 4.2.2. Major Institutional Assessments 4.2.3. Governance 4.2.4. Financial Management and Governance Arrangement 4.2.5. Country Diagnostic Studies of Accounting and Auditing 4.2.6. Executing Agencies 4.2.7. Project Objectives 4.2.8. Revenue-Earning Projects 4.2.9. Non-Revenue-Earning Projects 4.3. Financial Analysis 4.4. Measuring Performance 5. Reporting and Auditing 6. Financial Institutions 7. Knowledge Management

Financial Management and Analysis of Projects : 4. Financial Management of Executing Agencies : 4.2. Institutions and Systems

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4.2.8. Revenue-Earning Projects

4.2.8.1. Introduction

4.2.8.1.1. The public and private sectors are likely to operate many forms of revenue-earning entities. Section 3.2.1 contains a listing of typical revenue-earning entities. The delivery of goods and services by these institutions can embrace many different activities and components. Therefore, this listing should not be considered as comprehensive.

4.2.8.1.2. All public and private sector revenue-earning institutions operate under forms of law, usually substantially defined within regulations and rules. The form of law will differ extensively between public and private sectors.

4.2.8.1.3. Institutions may operate under the control or guidance of a particular ministry of department such as a Ministry of Energy, Department of Agriculture, etc. Their control/guidance activities typically impact nationwide and other ministries and departments of government are likely to be involved. For example, a Ministry of Transport is likely to be involved in reviewing and granting permissions for long-distance water, gas, oil pipelines construction. Typical examples are Ministries (or Departments) of Economic Development, Finance/Treasury, Trade and Industry, Environmental Protection, and Consumer Protection.

4.2.8.1.4. Laws, government regulations and/or rules (in relation to financial management) under which an entity operates should be examined, and the entity's observance or non-observance of them should be identified, to determine any possible effects on the project cycle. Introducing new legislation or amending any existing laws may require considerable time. Advice of the OGC and the concerned Operations Coordination Division should be sought if it appears that legislative changes may be required. If introduction of legislation proves necessary, it should be made the subject of a realistically dated loan covenant.

4.2.8.1.5. Statutory powers or requirements may relate directly to the entity's operations (e.g., power to fix tariffs and levy charges for products or services) or they may define criteria within which an entity may operate (e.g., banking laws which define borrowing/lending limits).

4.2.8.1.6. Detailed financial or accounting requirements may not be part of specific legislation relating to the entity or in the entity's "charter" but may be addressed in general laws to which the EA's "charter" may refer.

4.2.8.1.7. Most revenue-earning EAs are autonomous, or have a high degree of autonomy, with powers to determine financial policies and the design and operation of financial management and accounting systems. Some state-owned enterprises, on the other hand, may be required to conform to a national accounting plan or chart of accounts. Such plans and charts are sometimes not conducive to providing adequate information for project and EA management.

4.2.8.1.8. The following is a checklist of items to be considered when reviewing these arrangements. The reviews may take place at the time of project identification, preparation, or appraisal. As a general rule, the earlier these reviews take place the greater the opportunities for corrective or initiating actions for new systems.

4.2.8.2. Entity Status

4.2.8.2.1. Therefore, extent of an EA's autonomy and/or control by superior authorities at all levels of a national government's hierarchy should be established. This in order to determine its authority and ability to formulate and implement financial policy, and to design and install financial management systems, (and thereby indirectly to determine how much time may be needed for making changes). The following questions should be resolved:

4.2.8.3. Planning and Budgeting

4.2.8.3.1. Long-, medium-, and short-term planning should be the primary elements in financial management. Long and medium-term plans are usually referred to as corporate planning and require different planning approaches, often characterized by "rolling program" techniques, or "indicative planning only". Compared with the short-term budgeting and budgetary control procedures, which are normally based on annual plans. In addition, examination of planning and budgeting systems adopted by an EA should focus on the emphasis placed on operational efficiency compared to routine fiduciary and revenue control. Answers to the following groups of questions may provide an adequate overview of the corporate planning and budgetary systems.

4.2.8.4. Accounting Policies

4.2.8.4.1. The acceptability of an EA's accounting policies, including standards of financial reporting and general accounting practices, should be examined. If these policies do not conform to accepted international or national standards and practices, which makes comparison and performance evaluation difficult, the EA should be informed of any required modifications. In addition the EA should also be notified of the latest date for the modification's introduction (e.g., before project implementation commences, or by a date to be specified in a covenant).

4.2.8.4.2. On the other hand, if only minor items are involved (e.g., methods of apportioning overheads or valuing inventories), as long as these variances are quantified and revealed in the annual financial statements and the auditor's report, their continued use may be acceptable.

4.2.8.4.3. At loan negotiations, where financial covenants are incorporated in the loan agreement, the accounting standards that will be used as the basis for measurement of financial performance should be defined.

4.2.8.4.4. If variances exist from acceptable accounting form and practices they should be discussed with the entity's auditor, if possible, before requesting a change in practices. The auditor should be asked by the EA to address these subjects in the opinion and report on the annual financial statements.

4.2.8.5. Financial Regulations

4.2.8.5.1. The underpinning of a sound accounting system is a regularly updated set of financial regulations. These are usually designed to define the objectives of, and responsibilities within, a financial management and accounting system. Regulations should also clearly define who is responsible for implementing and updating of financial regulations.

4.2.8.5.2. The provision of new regulations or the improvement of existing ones should preferably be sought before loan negotiations.

4.2.8.5.3. Assistance to introduce or improve regulations and systems should be encouraged, where necessary, by seeking Bank consideration of a proposal for Technical Assistance to the borrower or EA.

4.2.8.6. Accounting Systems

4.2.8.6.1. ADB requires that appropriate systems of accounting and control be installed and operational for a project, and where applicable, an EA.

4.2.8.6.2. Any issues or special requirements relating to the development of these systems, particularly during project preparation, should be referred to the Regional Director. If these are not resolved before appraisal, these should be referred to in the Appraisal Mission Issues Paper.

4.2.8.6.3. To ensure accountability for project implementation funds, each project should have an adequate accounting and internal control system for recording and reporting project-related financial transactions from the time that project expenditures commence (which could be before Board approval to the loan).

There are no exceptions to this requirement.

4.2.8.6.4. Specifically, the system should:

4.2.8.6.5. Where ADB is also concerned with the financial performance and status of the EA, the latter should provide adequate financial management and accounting systems and reporting procedures for both the project and the EA responsible for project implementation from the start-up of the project. However, in cases where an EA's systems need upgrading or expansion to meet the requirements above, ADB may consider approving the use of assistance as a project component. Such assistance does not exempt the EA from providing accounting and internal control systems capable of meeting the requirements with regard to the project accounting and reporting. Given ADB's tight TA budget, the availability of cofinancing or funding from other donors should be examined.

Centralized and Decentralized Accounting Systems

4.2.8.6.6. A financial analyst may be confronted with an inefficient accounting system. The borrower may suggest a local freestanding system that would be more effective if it would be merged with large central systems with their enhanced facilities. Or it may be a centralized system would work more efficiently if it would be detached from the core system, and establish a semi-autonomous accounting unit.

4.2.8.6.7. Large industrial and commercial organizations, or large state-owned enterprises, may operate centralized financial management and accounting systems. In many such systems, all information generated at operational levels (e.g., project sites) is transferred to a central location for making payment to contractors, etc., for data processing; and for compilation of accounting records.

4.2.8.6.8. Delays and loss of data can result, which affect, inter alia, prompt and accurate reporting to ADB by the EA. In addition difficulties may arise when the external auditor is required to provide a separate report and opinion on the project operations and on the EA.

4.2.8.6.9. Conversely, decentralized systems, which permit local financial operations, usually require more extensive controls and more staff with related difficulties of obtaining good management.

4.2.8.6.10. Therefore, before recommending financial management and accounting systems changes to a borrower on project (and, where applicable, EA), it is prudent to examine the advantages and disadvantages of existing and proposed systems with regard to the efficiency of centralized or decentralized operations.

4.2.8.6.11. Key factors to be considered are the competence of management, security, internal controls, communications, and the availability of trained staff to provide routine quality performance, but also the ability to address nonstandard operations; for example, what to do when something goes wrong.

4.2.8.6.12. The financial analyst should be aware that there are snags and pitfalls when deciding how to resolve these situations. One solution may require that a consultant should be engaged under appropriate TORs to recommend most effective alternative system requiring the least cost. Another solution, dependant on the role and responsibilities of the EA, could be to recommend the hiring of an accounting firm to provide the necessary financial information during the period of project implementation. Or financial analysts can study the system(s) in detail and recommend their own solution for consideration by the EA.

4.2.8.6.13. Whatever optimum solution is recommended, it must be acceptable to the management of the EA. If management does not accept the proposed system, it is unlikely to be successful, despite its potentially successful attributes.

4.2.8.7. Financial Management and Control

4.2.8.7.1. To judge the effectiveness of an organizational structure, the following should be reviewed to judge their suitability to support project implementation and operation and the extent of their observance in practice:

• By-laws of the entity;
• Executive orders (if any);
• Statements of objectives and policies;
• Organizational structure;
• Control environment, internal control and internal auditing;
• The need to furnish financial information on an entity's performance to concerned parties within and external to, the EA and the extent of the achievement of such dissemination; and
• The impact of management and control systems on the operation of the financial management and accounting systems should be examined by seeking answers to the following:
  
  

  -	What is the background and experience of those who represent the finance function on the Board of Management?
  -	Who in management reports on financial performance to the entity's owners?
  -	Who reports on finance to the management? What is the status of this official?
  -	In what form and how frequently does management publicize its decisions on financial policy?
  -	In what form and how frequently does management requires and receives information about financial performance-type of reports and distribution of such to various levels of management?
  -	What are the control systems and linkages between top management and financial management, and between other managers and the financial managers?
  -	Do the answers to questions above add up to a system acceptable to ADB for project implementation? If not, can they be amended in a timely manner to facilitate project implementation?

4.2.8.8. Internal Audit

4.2.8.8.1. The following is an extract from the INTOSAI's Advisory Document on Standards for Internal Controls:

4.2.8.8.2. The above advice was developed for use in public sector institutions, but the key principles are equally applicable to private sector operations, except for the suggestion that legislation may be necessary to underpin the provision of internal controls. The key principles are:

• It is management's responsibility to implement and monitor the specific internal controls for its operations
• While internal auditors can be a valuable resource to educate and advise on internal controls, the internal auditor should not be a substitute for a strong internal control structure; and
• Management can also use its internal audit unit to help monitor the effectiveness of internal controls. The closeness of internal auditors to the day-to-day operations usually places them in a position to continually assess the adequacy and effectiveness of internal controls and the extent of compliance.

4.2.8.8.3. Internal audit units and operations are most likely to be found in public and private sector enterprises. The units may be centrally located with a mandate to monitor the operation and efficiency of all units throughout the area of operation of the enterprise. Exceptions may occur in very large operational units, where subunits of an enterprise's internal audit group may have a high degree of autonomy.

4.2.8.8.4.It is unlikely that a nonrevenue-earning Project Implementing Unit (PIU) would have an internal audit unit specifically installed, although a central unit of a ministry or department of government may have been awarded the responsibility to review and monitor internal controls of the PIU.

4.2.8.8.5. ADB's primary concern is to be assured that internal controls not only exist but also are the subjects of regular review and monitoring for efficiency and responsiveness to current operations. Therefore, if an enterprise has an efficient means of achieving this objective, the engagement of a specific internal audit unit may not be appropriate.

4.2.8.8.6. Where reviews and monitoring of ongoing operations of an enterprise are inefficient, ADB should discuss with senior management of the enterprise the need to introduce improvements, one of which may be the use of an internal audit operation. Such a recommendation will require an expert to advise and evaluate a cost/benefit study prepared for that purpose.

4.2.8.9. Financial Regulations

4.2.8.9.1. Financial regulations are usually designed to define the objectives of, and responsibilities within, a financial management and accounting system. They may form part of Standing Orders or Operating Rules or be a preface or appendix to a Manual of Accounting, or they may be restricted to limited definitions of budgetary accounting or internal auditing responsibility within an entity. They may range from government statutory regulations to financial managers' informal rules with no legal status, and should facilitate the examination of the financial management systems by defining their structure and subsystems, and by designating responsibilities.

4.2.8.9.2. Regulations, if any, should be reviewed for their form and content and for their observance. Normally, before appraisal, the extent to which Financial Regulations satisfactorily address the following should be examined:

4.2.8.9.3. Regulations should also clearly define who is responsible for their implementation. The provision of new regulations or the improvement of existing ones should preferably be sought before loan negotiations. Assistance to introduce or improve regulations and systems should be encouraged through a project Technical Assistance component.

4.2.8.10. Management Accounting

4.2.8.10.1. A management accounting system should collect and promptly report financial and related statistical information on all aspects of the operating performance of an agency's operations to the various management levels, supplying each level with the necessary details at the appropriate times.

4.2.8.10.2. The management accounting system should produce the annual and periodic financial statements, including the statements for audit. It should incorporate procedures for recording current budgeting and financial planning data, record keeping and reports, and cost accounting (including cost control and analysis) for recording costs. Desirably, but not mandatory, it should use activity-based costing to report detailed costing of all activities of the EA by allocating the maximum amounts of management, supervision, and maintenance costs to each activity as costs of production. Such a system, which is often best illustrated in chart form, should include adequate internal checks, controls and internal auditing.

4.2.8.10.3. In the absence of a chart of a management accounting system, an organization chart of the entity's operating structure should be obtained or drawn up by the financial analyst. This should be suitably redrafted to illustrate the areas of management served, or to be served during project implementation by the management accounting system. The chart should show the linkages between the system and the management center of the EA, and to a central organization, if the agency or system is a decentralized unit. The chart should also show the main and subordinate activity areas. The following is a hypothetical example.

4.2.8.10.4. Organizations have many differing forms of management - in some the Controller may not have a responsibility for Programming and Budgeting:

4.2.8.10.5. Finally, it should show established posts/salary levels, and posts occupied and vacant. The borrower should be notified of any concerns about inadequacies, or changes required in the management accounting system to achieve satisfactory project implementation.

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