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Financial Management and Analysis of Projects :
7. Knowledge Management
Auditor Terms Of Reference: Annual Financial Statements
ENTITY NAME: XYZ
AUDIT OF ANNUAL FINANCIAL STATEMENTS (AFS)
AUDITOR TERMS OF REFERENCE
Guidance This template is appropriate for the audit of an EA/IA. It should be completed—by the borrower, EA, or PPTA consultants—and provided to ADB for comments before fact finding. This template can be applied to the audit of either a revenue-earning or nonrevenue-earning EA.
Introduction
Guidance: Briefly describe the audit assignment. Specify whether the engagement is for one or more financial years. A longer period (e.g., 3–5 years) will enable the auditor to become familiar with the entity. The actual contract should allow for termination for inadequate performance, but not for issuing a qualified, adverse, or disclaimer opinion.
The management of XYZ requires an auditor to carry out the following audit services for the [X] years ended 31 December 20xx:
- An audit of XYZ Annual Financial Statements (AFS).
This letter describes the assignment scope and terms and invites you to submit a proposal for delivery of these services.
General Background
Guidance Briefly describe the project in the context of its contribution to achievement of the EA’s economic goals. The auditor must understand the "purpose for which the funds are intended" in the context of the broad project objectives as well as in terms of the specific project budget.
Guidance Briefly summarize relevant accounting and financial management practices. Various diagnostic reports are available that describe accounting and financial management practices (e.g., ADB Diagnostic Studies of Accounting and Auditing, World Bank Country Financial Accountability Assessments). Emphasis should be placed on issues raised and risks identified in these reports.
Employing Authority or Entity
Guidance The details of the proposed contractor of the auditor’s services should be provided. If the contractor is acting on behalf of, or is part of, a larger authority or entity, this should be disclosed, to assist prospective auditors to determine their independence.
The audit services will be contracted by:
Delivery of Opinions and Reports
Guidance The required opinions and documents should be clearly specified, together with delivery timeframes.
The auditor will provide the following opinions and reports to management (with copies to ADB), in accordance with the following timeframes:
- Audit Opinion on Annual Financial Statements of [XYZ], and
- Management Letter relating to [XYZ].
All reports must be provided in the English language.
Objectives
The primary objective of the AFS audit is to enable the auditor to express an independent opinion on whether the AFS present fairly, in all material respects the financial position of XYZ as of 31 December 20xx, and of the results of its operations and its cash flows for the year then ended in accordance with agreed accounting standards (see terms and definitions).
Secondary objectives include confirming compliance, or otherwise, with: (i) each financial covenant contained in the legal documents for the project (see section terms and definitions), and (ii) all other financial assurances contained in the legal documents for the project (see terms and definitions).
Description of XYZ
Guidance 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. Geographic characteristics should be described, 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, computer facilities). A general summary of the financial management assessment of the EA should be included, together with a reference that the full financial management assessment will be made available to the auditor. Detailed information should be appended.
Description of Materials and Timing of Delivery
Guidance The AFS and supporting documentation that will be supplied to the auditor, and on which they are to give an opinion and a report, should be specified. The estimated time for providing these documents to the auditor should be stated (e.g., 1 month after financial year-end). This schedule helps the auditee and the auditor plan for the accounts-preparation and the audit process.
The AFS (see terms and definitions) and supporting documentation will be provided to the auditor on the following estimated dates:
Audit Scope
Guidance The scope of the audit should be sufficiently clear to properly define what is expected of the auditor but not in any way restrict the audit procedures or the techniques the auditor may wish to use to form an opinion. This section will not generally have to be customized to a particular audit situation.
Auditing Standards and Program. The audit will be carried out in accordance with the agreed auditing standards (see terms and definitions), including professional or general standards, standards of fieldwork, and reporting standards.
The audit program will consider the risk of material misstatements resulting from fraud or error. It should include procedures that are designed to provide reasonable assurance that material misstatements (if any) are detected.
Internal Control Systems. The auditor will assess the adequacy of financial management systems, including internal controls.
The auditor should communicate with independent board members (where present). Among other things, this 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.
Accounting Policies and Changes. The auditor should comment on the entity’s accounting policies, and confirm the extent to which the agreed accounting standards (see terms and definitions) have been applied. In particular, the auditor should note the impact on the AFS arising from any material deviations from agreed accounting standards. The auditor should also comment on any material accounting policy changes, either during a financial year, or from one year to another.
Compliance with Financial Covenants. The auditor will confirm compliance with each financial covenant contained in the legal documents for the project (see terms and definitions). Where present, the auditor should indicate the extent of any noncompliance by comparing required and actual performance measurements for each financial covenant for the financial year concerned.
Compliance with Financial Assurances. The auditor will confirming compliance with all financial assurances contained in the legal documents for the project (see terms and definitions). Where present, the auditor should indicate the extent of any noncompliance by comparing required and actual performance of the borrower in respect of these ADB requirements for the financial year concerned.
Management Letter
On conclusion of the audit, the auditor will prepare a management letter, detailing:
- Any material weaknesses in the accounting and internal control systems that were identified during the audit, including those regarding SOEs and Imprest Accounts (if applicable);
- Recommendations to rectify identified weaknesses;
- Status of significant matters raised in previous management letters and any corrective actions taken by the organization;
- Practical recommendations on the steps that the organization could take to become materially compliant with the agreed accounting standards (see terms and definitions), together with a time frame for making these changes;
- Any other matters that the auditor considers should be brought to the attention of the organization’s management; and
- Any significant matters that the auditor considers should be brought to ADB’s attention.
Statement of Access
The auditor will have full and complete access, at all reasonable times, to all records and documents including books of account, legal agreements, bank records, invoices, and any other information associated with the project and deemed necessary by the auditor.
The auditor will be provided with full cooperation by all employees of [XYZ] and the project-implementing units, whose activities involve, or may be reflected in, the annual financial statements. The auditor will be assured rights of access to banks and depositories, consultants, contractors, and other persons or firms hired by the employer.
Independence
The auditor will be impartial and independent from any aspects of management or financial interest in the entity under audit. In particular, the auditor should be independent of the control of the 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. The auditor should not have any close personal relationships with any senior participant in the management of the entity. The auditor must disclose any issues or relationships that might compromise their independence.
Auditor and Audit Staff Competence
The auditor must be authorized to practice in the country and be capable of applying the agreed auditing standards (see terms and definitions). 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.
To this end, the auditor is required to provide curriculum vitae (CV) of the auditors who will provide the opinions and reports, together with the CVs of managers, supervisors, and key personnel likely to be involved in the audit work. These CVs should include details of audits carried out by these staff, including ongoing assignments.
Submission of Proposal and Work Plan
You are invited to submit a proposal and a work plan to provide the audit services described in this letter. Proposals should address, among other things:
- The extent (if any) that you would not conform to the agreed auditing standards (see terms and definitions) and indicate any alternative standards to which the auditor may (be required to) conform.
- Whether the audit would be conducted as a completed audit (i.e., will you carry out the audit after financial year-end, when the books of account are, or are being, closed).
- Whether an audit carried out after the close of a financial year would be supplemented by one or more interim audits during a financial 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 computer systems and records, disclosures).
- Discussions before signing the opinion and report on any matters arising from the audit, and with whom these discussions would be held.
- The timetable for provision of opinions and reports.
Terms and Definitions
This section defines the terms used in this document.
1. Annual Financial Statements (AFS)
Guidance The EA will prepare Annual Financial Statements (AFS). Most revenue-earning EAs (e.g., Utilities) will prepare accrual-based financial statements. EA reporting requirements will usually be specified in the RRP and in the loan agreements. The component parts of the AFS should be specified in this section.
The Annual Financial Statements (AFS) comprise:
[Option A: Generally IAS-Compliant Accrual-Based Financial Statements]:
- Statement of Accounting Policies,
- Statement of Financial Performance (or income statement),
- Statement of Financial Position (or balance sheet),
- Statement of Movements in Equity,
- Statement of Cash Flows,
- Notes to the Financial Statements, and
- Other Information (Specify)
[Option B: Other Financial Reports]:
- Statement of Accounting/Financial Policies,
- Statement of Income/Cash Receipts,
- Statement of Expenses/Cash Payments,
- Statement of Cash Flows/Cash Receipts and Payments,
- Notes to the Financial Statements, and
- Other Information (Specify).
This section defines the terms used in this document.
2. Agreed Accounting Standards
Guidance The accounting standards that govern AFS preparation will normally be agreed and documented in the RRP and loan agreement. Choose the appropriate option.
“Agreed accounting standards” regarding the preparation of the AFS, means:
- [Option A: International Accounting Standards] the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) (commonly known as international accounting standards).
- [Option B: National Accounting Standards] the accounting standards issued by [national authority].
- [Option C: Modified National Accounting Standards] the accounting standards issued by [national authority], with the following modifications and/or additional disclosures:
- [Option D: Cash-Based International Public Sector Accounting Standards] the cash-based International Public Sector Accounting Standard (IPSAS) promulgated by the International Federation of Accountants (IFAC).
- [Option E: Accrual-Based International Public Sector Accounting Standards] the accrual-based International Public Sector Accounting Standards (IPSASs) promulgated by the International Federation of Accountants (IFAC).
- [Option F: Specific Government Accounting Standards] describe these standards.
3. Agreed Auditing Standards
Guidance The agreed auditing standards will normally be documented in the RRP and loan agreement. Choose the appropriate option.
“Agreed auditing standards” means:
- [Option A: International Standards on Auditing] the International Standards on Auditing (ISA) promulgated by the International Auditing and Assurance Standards Board (IAASB).
- [Option B: INTOSAI Auditing Standards] the auditing standards promulgated by the International Organization of Supreme Audit Institutions (INTOSAI).
- [Option C: National Auditing Standards] the auditing standards promulgated by [national authority].
4. Financial Covenants Applicable to [XYZ]
Guidance The financial covenants that are applicable to the EA will be included in the loan agreement (e.g., Self-financing Ratio). This section should list, describe and fully reference all applicable financial covenants.
The following financial covenants, regarding [XYZ], have been agreed:
5. Financial Assurances Applicable to [XYZ]
Guidance The financial assurances that are applicable to the EA—such as a commitment to employ suitably qualified accounting personnel—will be included in project legal documents. This section should list, describe and fully reference all applicable financial assurances.
The following financial assurances, regarding [XYZ], have been given:
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