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Financial Management and Analysis of Projects : 7. Knowledge Management
7.18. Model Terms of Reference for an Auditor
7.18.1. The following terms of reference are not meant to be either prescriptive
nor applicable to all circumstances. The obligation remains on the
auditor to determine the nature and extent of audit evidence required
in order to form an audit opinion. For audits to be conducted in
accordance with International Standards on Auditing, evidenciary
requirements are as stipulated in the standards. Detailed terms
of reference, including specific audit procedures to be followed,
should clearly indicate that the audit "should include but
not be limited to" the prescribed procedures. Furthermore,
the detailed terms of reference should be limited to those cases
where the ADB and/or EA has concerns with respect to audit capacity.
Summary
of Contents
- Name
of employing authority or entity,
- Delivery
of opinion and report,
- Clear
description of the entity for which the service is to be provided,
- Clear
description of the material and data to be provided for the audit
and timing of provision,
- Scope
and detail of the audit required,
- Management
Letter,
- Statement
of access available to the auditor,
- Independence
requirements,
- Auditor and audit staff competence (Curriculum Vitae), and
- Submission
of Proposal and Work Plan by auditor.
Detailed
Contents of Terms of Reference
7.18.2. The name and address of the
proposed contractors of the auditor's services, Email address, facsimile
and telephone number(s) should be given. If the employer is acting
on behalf of, or is a constituent part of, a larger authority or
entity, this should be disclosed, to assist prospective auditors
in determining their independence.
7.18.3. The auditor should be invited
to submit a proposal for the delivery of an opinion and report based
on the scope and detail of the audit as set out in 7.18.6. The proposal
should be in respect of the annual financial statements specified
in 7.18.5 of the entity described in 7.18.4. A management letter
containing an opinion of the auditor on the financial management
accounting and internal control systems of the entity, with recommendations
for any changes needed to improve performance within (specify) ___
(days) (weeks) (months) after the provision of the annual financial
statements to the auditor will also be provided. This section should
specify whether the engagement is for one or more fiscal years (or
for a specific period). It is preferable that the period be fixed
to give the auditor an opportunity for a medium-term contract. This
will enable them to become familiar with the entity (e.g., 3-4 years),
while the contract can still be terminated at a fixed date to enable
the employer to consider alternative auditors. Also, the contract
should allow for termination on grounds of inadequate performance,
but not on grounds of a qualified report or disclaimer.
7.18.4. A detailed description-both
legal and generally informative-should
be provided to enable the auditor to understand fully the nature,
location and objective of the entity under audit. Any widespread
geographic characteristics should be revealed, together with: (i)
Organization charts; (ii) Names of senior managers; (iii) Name and
qualification of the person(s) responsible for financial management,
accounting, and internal audit; (iv) Name and address of any existing
external auditor; (v) Computing or other data processing facilities
in use; (vi) A copy of the latest published financial statements;
and (vii) Internal facilities (if any) available to an external
auditor (e.g., office accommodation, calculators, computers).
7.18.5. The exact form of the annual
financial statements and supporting documentation that will be supplied
to the auditor on which they are to give an opinion and a report
will be specified. The estimated time of the provision of these
documents to the auditor should be given (e.g., 3 months after the
close of the fiscal year). The annual financial statements must
consist of a balance sheet, income statement and cash flow statement
for a revenue-earning entity accompanied by supplementary statements
or schedules supporting the basic statement (e.g., inventories,
schedule of assets, outstanding loans, aging of receivables, etc.).
In a nonrevenue-earning entity, or for the audit of project accounts,
the annual financial statement may consist of the Statement of Receipts
and Payments only on project transactions. Other schedules of value
or cumulative work-in-progress, assets and inventories and a summarized
reconciled bank statement are to be attached.
7.18.6. The scope and detail of the
audit should be given in sufficient detail to enable an auditor
to understand particularly if there are any requirements beyond
those of a "normal" or routine audit. Typical requirements
could be:36
- The
audit should be carried out in accordance with generally accepted
auditing standards, which include professional or general standards,
standards of fieldwork and reporting. The auditor should indicate
the extent (if any) that an auditor would not conform to those
standards and indicate any alternative standards to which they
may (be required to) conform.
- The
auditor should comment on the accounting principles adopted by
the entity under audit, particularly to confirm the extent that
generally accepted accounting principles have been and are being
consistently applied. The adoption of other principles and their
effect on the annual financial statements should be indicated.
In particular, the auditor should show the impact on the financial
statements arising from deviations from international accounting
standards issued by the International Accounting Standards Committee.
They should be required to comment on the basis of accounting
changes, either during a fiscal year, or from one year to another.
- The
auditor should provide a confirmation, or otherwise, of the borrower's
compliance with covenants in the loan agreement and with ADB's
specific requirements with respect to the financial management
of the EA.
- The
auditors should be required to plan and conduct their work on
the basis of a sufficient audit program that will cover the entity's
activities and enable them to express an opinion and furnish the
reports they are tasked to provide.
- In
devising the audit program, the auditor should be required to
take into consideration not only the nature and scale of the expenditure
and income operations, but also the scale, effectiveness and reliability
of the accounting and administrative procedures. Also, the financial
and administrative internal controls and checks should be considered.
Systems of internal controls and checks, including internal audit,
should be reviewed and evaluated. This process will determine
the degree of reliance that can be placed upon the existing arrangements,
and the extent of testing that needs to be performed by the auditor.
- The
auditor's activities should include dialogue with independent
board members. Among other things, the dialogue should cover the
adequacy of bad-debt provisions, contingent liabilities, related-party
transactions, internal control systems, management and board reporting,
and management systems, integrity and capability.
- The
auditor should be required to appraise the procedures for:
- Safeguarding
assets between operating, custodial, accounting and internal
audit duties, and assurance that such duties and responsibilities
are clearly defined and that sufficient staff are available
to perform the function accurately and efficiently.
- Ensuring
that assets and resources are used in accordance with instructions
or regulations in the most effective and economical manner.
- Ensuring
that all transactions are accounted for accurately and properly.
- Compilation
and certification of Statements of Expenditures (where used
for loan disbursements).
- Any
other matter required by ADB to assure satisfactory financial
management of the project (and EA).
- The
auditors should satisfy themselves as to the fairness and accuracy
of the financial statements and the supplementary statements provided
by obtaining sufficient supporting evidence through the examination
of accounting records and supporting corroborative material, direct
physical inspection, general observation, inquiry and confirmations,
including:
- A
verification to ascertain that all assets and liabilities
are properly recorded, and that holdings, in particular, inventory
and stock accounts, have been verified by physical inspections
and counts, when feasible.
- Ensuring
that expenditures are in accord with budgetary provision,
and that the appropriate regulations and directives have been
observed.
- Tests
of calculations, e.g. payrolls; check of disbursement percentages
in claims for withdrawals of ADB loans.
- Verification
of systems of commitments and payments to confirm entitlements
and actual discharges by creditors, and/or receipts to ascertain
that all dues have been received, or amounts receivable properly
brought to account; these verifications should include obtaining
certificates or other forms of confirmation from debtors and
creditors.
- A
verification of securities and moneys recorded in the books
as being on deposit through certificates issued by the depositories,
including appropriate reconciliations.
- Verification
of efficacy of data processing.
- The
verification of the financial statements against the entries
in the main books of account, supplemented by tests of the
latter with subsidiary books, records and vouchers, contracts,
purchase orders and other original documents.
- The
auditor should be required to verify Statements of Expenditure
(SOE) or copies thereof, where these are used, against the
records of prime entry (e.g., operating expenses accounts,
inventories records and job cards), supplemented by tests
against both initial documentation (e.g., invoices, salary
sheets with receipts) and physical inspection of work done,
or goods and services acquired;
- To
the extent not addressed in a Management Letter, the auditor should
be required to conduct a review and provide a report on the following:
- Efficiency and economy in the use of resources.
- Determination of whether planned results of a project are
being achieved.
- Compliance, or otherwise, with financial and other performance
covenants and other obligations of the borrower and the EA
as specified by ADB and the extent of actual compliance or
noncompliance of each covenant and obligation by reference
to performance criteria agreed with ADB.
- Defined areas of systems (e.g., improvements in accounting
and data processing operations which may be under development)
on which the auditor's comments are necessary to ensure accuracy,
efficiency and provision of adequate audit trails.
- Any other activities on which an auditor may usefully report.
- The foregoing list is not exhaustive, nor should all matters be
addressed in every project. The scope and detail of an audit are
likely to be unique for each project or project entity.
7.18.7.
A Management Letter. The Auditor should be required as standards
terms of reference from ADB to provide ADB with a Management Letter.
This letter must include the assessment of the auditors as to the
state of the internal controls and operating procedures of the entity,
covering all aspects included during the normal course of the audit.
7.18.8. A Representation Letter.
While ADB does not require to see a representation letter from the
EA/entity to its auditors, it should be made clear to the auditors
that they should gain comfort during the audit on representations
from management of the entity. The auditor should be informed in
a clearly worded statement that they have full and complete access
at any time to all records and documents, including books of account,
legal agreements, bank records, and invoices. Also the auditor will
be provided with full cooperation by all employees of the entity
whose activities involve, or may be reflected in, the annual financial
statements. The auditor should be advised on their rights of access
to banks and depositories, consultants, contractors and other persons
or firms hired by the employer. In the event that an auditor may
not have unrestricted access to any person or location during the
course of an audit, this restriction should be defined in the terms
of reference.
7.18.9.
The auditors should be informed of the need for their impartiality
and independence from any aspects of management or financial interest
in the entity under audit. In particular, the auditor should be
independent of the control of entity. The auditor should not, during
the period covered by the audit, be employed by, or serve as director
for, or have any financial or close business relationship with the
entity, except as an independent professional adviser. The auditor
should not have any close personal relationship with any senior
participant in the management of the entity. It may be appropriate
to remind an auditor of any existing statutory requirements relating
to independence and to require auditors to disclose any relationship
likely to compromise their independence.
7.18.10. The auditor should be authorized
to practice in the country and be capable of using procedures and
methods that conform to generally accepted auditing practices of
the country. The auditor should have adequate staff, with appropriate
professional qualifications and suitable experience, including experience
in auditing the accounts of entities comparable in nature, size
and complexity to the entity whose audit they are to undertake.
- Curriculum vitae (CVs) should be provided to the client by the
principals of the firm of auditors who would be responsible for
providing the opinions and reports, together with the CVs of managers,
supervisors and key personnel likely to be involved in the audit
work.
- It
may be appropriate to indicate desirable minimum professional
qualifications considered necessary for the higher levels of auditors
to be responsible for the work (e.g. certified public accountant).
- CVs
should include details on audits carried out by these staff, including
ongoing assignments. The principal objective of the foregoing
is to satisfy the employer that an auditor has the capability
and capacity to execute the audit.
- The
auditor may have not only a contractual obligation but also a
statutory obligation to conduct a satisfactory audit, and it may
not be necessary to insist on the employer being notified every
time the auditor substitutes a staff member. Nevertheless, this
precaution may be invoked.
7.18.11.
The auditor should be asked to provide a proposal and a work plan
that among other things, should address:
- Whether
the audit would be conducted as a completed audit (i.e., will
the auditors carry out their audit after the close of the fiscal
year, when the books of account are, or are being, closed).
- Whether
an audit carried out after the close of a fiscal year would be
supplemented by one or more interim audits during a fiscal year.
The principal purpose is to test ongoing systems and internal
controls, and to relieve pressure on the staff of the entity and
on the auditor at year-end.
- The
manner in which the auditor proposes to address any statutory
requirements relating to audit (e.g., certifications relating
to shareholders' equity required under the companies' act) or
to which they may be implicitly bound by contractual obligations
of the employer (e.g., ADB auditing requirements, Statements of
Expenditure, Imprest Accounts).
- Procedural
requirements for certain verification procedures (e.g., checking
of stocks, inventories, assets, etc.).
- Specific
actions required on the part of the employer (e.g., access to
EDP, disclosures).
- Discussions
before signing the opinion and report on any matters arising from
the audit, and with whom these discussions would be held.
- Special
audits (e.g., review of portfolio and securities).
- Timetable for provision of opinions and reports.
_________________________
36 Financial
Analysts have discretion to agree alternative arrangements (see paragraph
2.4.3). .
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