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p. 108 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 5. Reporting and Auditing 5.1. Financial Reporting and Auditing Overview 5.2. Accounting Standards and Policies 5.3. Financial Reporting 5.4. Auditing Standards and Auditor Engagement 5.5. Reviewing Financial Reports 5.6. Reviewing Auditors' Reports 6. Financial Institutions 7. Knowledge Management

Financial Management and Analysis of Projects : 5. Reporting and Auditing

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5.6. Reviewing Auditors' Reports

5.6.1. Introduction

5.6.1.1. ADB requires the borrower and the project EA to have the required financial statements for each year audited by an independent auditor acceptable to ADB, and in accordance with standards on auditing that also are acceptable to ADB. An audit of such financial statements includes:

• An assessment of the adequacy of accounting and internal control systems with respect to project expenditures and other financial transactions, and to ensure safe custody of project financed assets.
• A determination as to whether the borrower and project implementing entities have maintained adequate documentation on all relevant transactions.
• Confirmation that expenditures submitted to ADB are eligible for financing and identification of any ineligible expenditures.
• Compliance with loan covenants and ADB's requirements for project management.

5.6.1.2. The examination of the annual financial statements of EAs is an important feature of project supervision and should be conducted in the same way as financial appraisal. Additional attention, however, should be given to actual performance against appraisal forecasts, compliance with financial covenants and review mission financial reports. Interim reports and unaudited annual financial statements may be the only uptodate monitoring documents available on project progress, and their accuracy should be tested both during review missions and against audited annual financial statements. It is reasonable to expect that there should be no change between unaudited and audited financial statements.

5.6.1.3. It is useful to gain experience with individual EAs to identify those where ADB staff can reasonably depend on unaudited annual financial statements, and later to examine audited statements for exceptions. Before beginning this latter examination for a completed fiscal year, however, a review of the auditor's opinion on the statements is essential to ensure that the published results are likely to be valid.

5.6.1.4. The auditor's reports may not contain enough essential information for ADB to be able to rely on the data in the statements and thereby evaluate performance. Three principal features should be addressed when examining an auditor's report: (i) authenticity, form and timeliness of the report; (ii) quality, or tenor, of the opinion; and (iii) scope, significant accounting policies, auditing practices, qualifications, and other matters addressed by the auditor.

5.6.1.5. The wide sectoral coverage of ADB projects precludes giving advice for examining the opinions for each type of project. For general guidance, a checklist of matters that a reviewer of an auditor's report should consider is provided in the Knowledge Management section of these Guidelines (its application is discussed further in section 5.6.11). The checklist is not universally appropriate and staff will need to draw their own conclusions about its applicability to each project and related audit reports. While extensive, the checklist is not exhaustive and reviewers must exercise their own skills and common sense in deciding the adequacy of the completed audit. Similarly, reviewers should decide whether the auditor, in the manner of framing comments, is trying to convey a message of concern, which may be difficult to express explicitly.

5.6.1.6. If there are any "no" answers on the checklist, especially in areas of key concern to the project, then clarifications of the auditor's report should be sought from the borrower and/or the EA unless the audit itself is under development by use of technical assistance. If the omissions are serious and/or the quality of the report unacceptable, the matter should be discussed with the Operations Coordination Division and the OGC.

5.6.1.7. The borrower and/or the entity should be advised that the audit does not conform to standards and practices acceptable to ADB. The monitoring records should be annotated accordingly.

5.6.1.8. If a qualified opinion and report by an auditor is received, the materiality and extent of the qualification should be determined, particularly as regards accountability for project funds and the agency's financial position. In the case of substantial qualifications, the financial analyst should ascertain as soon as possible what remedial measures the borrower proposes to take.

5.6.1.9. If the borrower is unable or unwilling to take corrective action, staff should, after investigating the reasons, follow the course of action recommended in cases of noncompliance with covenants.

5.6.1.10. Qualifications which appear not to be of a material nature (limited inadequacies in accounting subsystems, failure by accounting staff to respond to inquiries, etc.) should be followed up with the borrower by correspondence or during review missions, to ensure that appropriate corrective action is taken.

5.6.1.11. In the same way that accounting systems need to be designed and installed over a period of time, auditing capability often also needs gradual development. In such cases, loan agreements should refer to the form and timing of this process.

5.6.1.12. The analyst should participate in review work in a manner that fosters improvement of the auditor's work. Early audit reports that lack quality and depth of performance should not readily be rejected. Instead, the EA and the auditor should be informed in writing of possible deficiencies and encouraged to produce either an improved audit report, or to improve presentation of next year's financial statements. Under such circumstances, it is important that the financial management and accounting functions of the entities involved be carefully supervised, so as to compensate as far as possible for inferior auditing ability. The foregoing does not, however, preclude ADB from requesting the replacement of an auditor, particularly if training or other support is unlikely to achieve short-run improvements.

5.6.2. Auditors' Reports and Opinions

5.6.2.1. ISA 700 advises auditors in detail on the form and content of an auditor's report, and ADB would expect an auditor to closely follow this advice. In particular, paragraph 17 of ISA 700 addresses the Opinion Paragraph of an auditor's report as follows:

"The auditor's report should clearly state the auditor's opinion as to whether the financial statements give a true and fair view (or are presented fairly, in all material respects,) in accordance with the financial reporting framework and, where appropriate, whether the financial statements comply with statutory requirements".

5.6.3. Model Audit Opinions

5.6.3.1. Audit opinion below is a representative sample from the International Standard on Auditing (ISA 700) issued by IFAC. The form and content of this is subject to change based on the standard. Changes need to be checked against the latest standard which the independent auditor should be familiar with.

5.6.3.1. Model Audit Opinion for a Nonrevenue-Earning Project

To: Borrower (or designated agency)

We have audited the accompanying financial statements (pages____ to ____) of the ___________ Project financed under the Asian Development Bank Loan #______ as of December 31, 20___, and for the year then ended.

These financial statements are the responsibility of the management of the ________ EA.

Our responsibility is to express an opinion on the accompanying statements based on our audit.

We conducted our examination in accordance with International Standards on Auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of misstatement. Our audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audit also includes assessing the accounting principles and significant estimates made by management, as well as evaluating the overall statement presentation. We believe that our audit provides a reasonable basis for our opinion.

The ____ (EA's) policy is to prepare the accompanying statements in the format agreed between the Asian Development Bank and the Government of ________ as noted in the Minutes of Negotiations for the Loan, [on a cash receipts and disbursements basis in which cash is recognized when received and expenses are recognized when paid, rather than when incurred] / [on an accruals basis in which expenses are recognized when incurred and revenue is reported when income is due.]

In our opinion, (A) the aforementioned financial statements and appended notes that were also the subject of the audit, fairly present in all material respects the financial position of the _________ project as at__________20__and the results of its operations for the year ended _________ 20__, in conformity with _____________accounting standards, applied on a basis consistent in all material respects with that of the previous year; (B) the [Borrower] [EA] has utilized all proceeds of the loan withdrawn from the Asian Development Bank only for purposes of the Project as agreed between the Asian Development Bank and [the Borrower] in accordance with the Loan Agreement; and no proceeds of the loan have been utilized for other purposes; and (C) the [Borrower] [EA] was in compliance as at the date of the balance sheet of the year of audit with all financial covenants of the Loan Agreement.

In addition:

1. (1) With respect to Statements of Expenditures, adequate supporting documentation has been maintained to support claims to the Asian Development Bank for reimbursements of expenditures incurred; and (2) which expenditures are eligible for financing under Loan Agreement No. ____.
2. (1) The Imprest Accounts (page __) give a true and fair view of the receipts collected and payments made during the year ending ____ ; and (2) these receipts and payments support Imprest Account liquidations/replenishments during the year.

5.6.3.2. Model Audit Opinion for a Revenue Earning Project

To: Borrower (or designated agency)

"We have examined the Balance Sheet of __________as of ________ 20__ , and the Income Statement, Cash Flow Statement and related statements and Notes (see pages____ to ____ of our Report) of the _________________ Project financed under the Asian Development Bank Loan #________________ as of December 31, 20___, and for the year then ended.

These financial statements are the responsibility of the management of the ________ EA. Our responsibility is to express an opinion on the accompanying statements based on our audit.

We conducted our examination in accordance with International Standards on Auditing [auditing standards of the country of ______].²³ Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of misstatement. Our audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audit also includes assessing the accounting principles and significant estimates made by management, as well as evaluating the overall statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, (A) the aforementioned financial statements and appended notes that were also the subject of the audit, fairly present separately (i) the financial position of the ___________ project and (ii) the overall operations of the ___________ [name of EA] as at__________20__ and the separate results of the project operations and the EA's operations for the year ended _________ 20__, in conformity with international accounting standards [accounting standards of the country of___________],²⁴ applied on a basis consistent in all material respects with that of the previous year; (B) the [Borrower] [EA] has utilized all proceeds of the loan withdrawn from ADB only for purposes of the Project as agreed between the Asian Development Bank and [the Borrower] in accordance with the Loan Agreement; and no proceeds of the loan have been utilized for other purposes; and (C) the [Borrower] [EA] was in compliance as at the date of the balance sheet of the year of audit with all financial covenants of the Loan Agreement.

1. (1) With respect to Statements of Expenditures, adequate supporting documentation has been maintained to support claims to the Asian Development Bank for reimbursements of expenditures incurred; and (2) which expenditures are eligible for financing under Loan Agreement No. _________________. (Required where an SOE audit is required under the Loan Agreement.)
2. The Imprest Accounts (page____) gives a true and fair view of the receipts collected and payments made during the year ending __________________.

[(a) and (b) above to be provided where a separate Imprest Account audit is required under the Loan Agreement.]

5.6.4. Compliance with Loan Covenants

5.6.4.1. Borrowers and EAs enter into financial performance covenants with ADB. The auditor is required to confirm, or otherwise, compliance with each financial covenant contained in the legal documents for the project. The auditor should also indicate, where present, the extent of any noncompliance, by reference to the specified (required) and actual performance measurements for each financial covenant for the fiscal year concerned.

5.6.5. Compliance with ADB's Requirements

5.6.5.1. Borrowers and EAs enter into agreement with ADB in the loan documents to provide all appropriate financial management, accounting and financial reporting requirements necessary to support effective management of the project. The auditor should also indicate the extent of any noncompliance with the loan agreement, by reference to the specified (required by the loan documents) and actual performance of the borrower in respect of these requirements of ADB for the fiscal year concerned.

5.6.6. Types of Auditors' Opinion

5.6.6.1. An unqualified opinion indicates the auditor's satisfaction in all material respects with the following matters:

• The financial information has been prepared in accordance with (a) for a project-the reporting format agreed; and (b) for a revenue-earning entity-accounting standards and practices acceptable to ADB have been consistently applied;
• The financial information complies with relevant regulations and statutory requirements;
• The view presented by the financial information as a whole is consistent with the auditor's knowledge of the project/entity;
• There is adequate disclosure of all material matters relevant to the proper presentation of the financial information. Any changes in accounting principles or method of their application and effects thereof have been properly determined and disclosed; and
• Additional requirements that may have been requested in the TOR have been met.

5.6.6.2. When a qualified opinion, adverse opinion, or a disclaimer of opinion is given, the audit report should state in a clear and informative manner all of the reasons for such opinion. ISA provides guidance to auditors on the form and content of the auditor's report issued in connection with the independent audit of the financial statements of any organization.

5.6.6.3. A qualified opinion is issued when the auditor concludes that an unqualified opinion cannot be issued, but that the effect of any disagreement, uncertainty or limitation of scope of the audit is not so material as to require an adverse opinion or a disclaimer of opinion. The subject of the qualification and its financial effect must be clearly stated in the auditor's report.

5.6.6.4. An adverse opinion is issued when the possible effect of a disagreement is so pervasive and material to the financial statements that the auditor concludes that a qualification of the report is not adequate to disclose the misleading or incomplete nature of the financial statements.

5.6.6.5. A disclaimer of opinion is issued when the possible effect of a limitation on the scope of the audit or of an uncertainty is so significant that the auditor is unable to express an opinion on the financial statements.

5.6.7. Materiality

5.6.7.1.ISA 320 states among other things:

"Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item of error judged in the particular circumstances of its omission or misstatement. Thus materiality provides a threshold or cut-off point, rather than being primarily qualitative characteristic which information must have if it is to be useful"

5.6.7.2. Some auditors (particularly government auditors) provide reports listing all mistakes, irrespective of their materiality. ADB requires a clear opinion. Thus irregularities and instances of noncompliance with government or institutional rules and regulations that do not give rise to a qualified or disclaimed opinion should not be subjects of the report of the auditor. Where an auditor has comments that are not material to the opinion, these should be set out in the Management Letter.

5.6.8. Use of Technical Experts

5.6.8.1. For certain types of expenditures to be financed from ADB loans/credits, the auditor may need to rely on an independent technical expert who normally would be engaged by the EA. An example would be civil works executed by the regular labor force of an entity (e.g., "force account" carried out by the Ministry of Works); or fixed-price reimbursements for measured units of work to be supervised by independent experts such as an engineering or architectural firm. In addition to the normal responsibility of such experts to check that the work is performed in accordance with the plans and specifications, an appropriate certification by the expert of the value of the work executed may be acceptable to ADB.

5.6.8.2. The acceptability of the certification would depend on the independence and competence of the firm and its staff engaged in the verification. Such a certification, where used, should normally be attached to the related documentation supporting the expenditure. Any dissatisfaction with the work of the expert that concerns the auditor should be stated in the auditor's report.

5.6.8.3. The content of the certificate might cover matters such as whether the goods and services were procured, received, paid for and used in the project in conformity with the loan agreement. In the above instances, the auditor should include a note under the scope paragraph of the opinion, stating the extent and amount involved with respect to their reliance on the technical expert (who should be identified and expertise noted in the Notes to the Financial Statements prepared by the EA).

5.6.9. Statements of Expenditure and Imprest Accounts

5.6.9.1. Where the legal agreement of a project requires the separate audit of the SOE and the Imprest Accounts, respectively, additional paragraphs should be included in the audit opinion of the project:

• referring to the SOE financial statement, certifying to the eligibility of those expenditures against which SOE disbursements were made; and
• referring to the Imprest Account financial statements attached.

5.6.10. Reviewing Audit Management Letters

5.6.10.1. The scope of the engagement as set out in the TOR should require the auditor to provide a Management Letter with reference to the EA. This is a report on the internal controls and operating procedures of the entity covering all aspects included during the normal course of the audit. Because an auditor is unlikely to cover all activities of a client during an annual audit, the Management Letter may address only those specific matters that came to the attention of the auditor during the review. (It should be noted that a Representation Letter is different to a Management Letter and is purely a representation of issues from the EA to its auditor. ADB does not need to nor should it request a representation letter from the auditors).

5.6.10.2. The borrower and the auditor may agree at the commencement of the audit on particular subjects (including those at the request of ADB) to be included in the TOR and addressed in the Management Letter. These may include the review of compliance with financial covenants, and actual versus planned performance indicators. However, it should be the prerogative of the auditor to address any matter not agreed upon, but which, in the auditor's opinion, should be drawn to the borrower's attention. In addition, the auditor should comment on all significant variations between the PMR and the annual audited financial statements.

5.6.10.3. An auditor may use the Management Letter as a means of obtaining financial management and accounting systems and internal control improvements that would likely make the audit work easier and less time consuming to complete. An effective Management Letter, properly responded to by a client can reward the latter with a less expensive audit operation.

5.6.10.4. ADB wishes to review all Management Letters, and the project officer, financial analyst or Financial Management Specialist should ensure that copies are forwarded to ADB by the EA concerned at the same time as the audited annual financial statements are issued.

5.6.10.5. The Project Officer should ensure that a financial analyst or Financial Management Specialist reviews each Management Letter. The financial analyst should advise the Project Officer of any matters to which the auditor has drawn attention that may adversely affect the operation of the EA and project implementation.

5.6.11. Audit Report Questionnaire

5.6.11.1. The Audit Report Questionnaire that is provided in the Knowledge Management section of these Guidelines is provided only as an example of the nature and type of questions that should be considered when reviewing the report of an auditor. Financial analysts should have regard to the nature of the organization under audit and frame their questions accordingly.

5.6.11.2. Agencies operate in a wide range of sectors and activities, and therefore the form and nature of their financial statements will vary equally widely. Furthermore, approaches to, and the quality of auditing is variable. Therefore, the questions set out in the questionnaire should be regarded with some caution, because these may not have sufficient breadth or depth for some institutional statements and audits. Conversely, these may also be considered too extensive for some EAs, their activities and the audit services available.

5.6.11.3. Nevertheless, by using this questionnaire, or a suitably modified version thereof to reflect the nature and form of the EA concerned, a financial analyst should be able to obtain a reasonable view of the acceptability of the financial statements concerned and the audit thereof.

_________________________

²² Financial Analysts have discretion to agree alternative arrangements (see paragraph 2.4.3).
²³ Financial Analysts have discretion to agree alternative arrangements (see paragraph 2.4.3).
²⁴ Financial Analysts have discretion to agree alternative arrangements (see paragraph 2.4.3).

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