ADB HANDBOOK FOR BORROWERS ON THE FINANCIAL MANAGEMENT AND ANALYSIS OF PROJECTS

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Handbook for Borrowers on theFinancial Managementand Analysis of Projects2006 ForewordSound financial management arrangements help ensure thatinvestment projects are successfully implemented and areoperationally sustainable. This Handbook contains informationand instructions for borrowers on the financial management of projectsfinanced by the Asian Development Bank (ADB).This Handbook reflects ADB policies as set out in the FinancialManagement and Analysis of Projects (the Guidelines) as updated in 2005.It supersedes all previous handbooks on financial management and takeseffect immediately.To ensure that financial management arrangements forinvestment projects meet ADB requirements, borrowers and projectexecuting agency staff should study this Handbook, particularly duringproject preparation.Asian Development BankDecember 2006 AcknowledgementsThe original publication entitled, Handbook for Borrowers on theFinancial Governance and Management of Investment Projectsfinanced by the Asian Development Bank was prepared by SarathLakshman Athukorala (Financial Management Specialist, ADB) and BarryReid (consultant).The original handbook has been updated to conform with therevised Financial Management and Analysis of Projects, 2005. This wasundertaken by a team comprising Kathleen Moktan, Director, CapacityDevelopment and Governance Division, with assistance from AndrewHead, Principal Financial Management Specialist, Anouj Mehta, FinancialManagement Specialist, Lizzette Francisco, Yvonne Osonia, Ma. CarolinaFaustino-Chan, and Portia Gonzales. ivAcronymsADBADTAAFSAPADMCEAFIIAIAASBIASIASBIFACINTOSAIISAMDFIMFIOGAUPAIPCRPMRPPARPPTARETARRPSOETATOR1Asian Development Bankadvisory technical assistanceaudited financial statementsaudited project accountsdeveloping member countryexecuting agencyfinancial institutionimplementing agencyInternational Auditing and Assurance Standards BoardInternational Accounting Standards1International Accounting Standards BoardInternational Federation of AccountantsInternational Organization of Supreme Audit InstitutionsInternational Standards on Auditingmultilateral development finance institutionmicrofinance institutionAnticorruption Unit of the Office of the General Auditorproject administration instructionproject completion reportproject management reportproject performance audit reportproject preparatory technical assistanceregional technical assistancereport and recommendation of the Presidentstatement of expenditurestechnical assistanceterms of referenceIn 2001, the IASB assumed responsibility from the International Accounting StandardsCommittee for promulgating IAS. While the IASB standards are called International Finan-cialReporting Standards (IFRS), this Handbook uses the term IAS (in the interest of continuity). vContents1 IntroductionThe Asian Development BankThe GuidelinesMDFI Harmonization EffortsADB Approach to AnticorruptionThis HandbookFurther Assistance2 User InstructionsADB Lending and Technical AssistanceEA Classifications and General Treatments3 Preparing and Appraising Investment ProjectsIntroductionForecastingThe Project Cost Estimates TableThe Project Financing PlanFinancial Cost-Benefit AnalysesFinancial Loan Covenants4 Financial Management of Executing AgenciesIntroductionADB Financial Management AssessmentsGeneral ADB Financial Management ExpectationsExpectations of Revenue-Earning EAsExpectations of Nonrevenue-Earning EAs111223455699910131415171718192124 vi5 Financial Reporting and AuditingIntroductionAccounting Standards and PoliciesFinancial ReportingAuditing Standards and Auditor EngagementSubmission of Financial ReportsAuditor Reports and OpinionsADB Assistance to Improve Accounting and Auditing6 Financial InstitutionsIntroductionGeneral Approaches and ExpectationsADB Approach to FI Reviews and MonitoringAssessing FI PerformanceFI Reporting and Auditing Issues2727273041505358595959606164AppendixesAppendix 1:Appendix 2:Appendix 3:Appendix 4:Appendix 5:Appendix 6:Appendix 7:Contents of the GuidelinesProject Investment PlanProject Financing PlanExample of Accounting PoliciesSample Project Monitoring ReportModel Financial Statements: Service OrganizationModel Financial Statements:Manufacturing OrganizationAppendix 8: Model Auditor Terms of Reference:Executing Agency AuditAppendix 9: Model Auditor Terms of Reference:Annual Project Accounts AuditAppendix 10: Model Auditor Opinion for a Nonrevenue-EarningProjectAppendix 11: Model Auditor Opinion for a Revenue-EarningAgencyAppendix 12: Useful Reference Materials677172737576808594105107109 1. IntroductionThe Asian Development Bank1.01.ADB is a multilateral development financeinstitution (MDFI) dedicated to reducing poverty inAsia and the Pacific. Our Charter (Articles ofAgreement) requires us to take measures to ensurethat the proceeds of any loan made, guaranteed orparticipated in by ADB are “used only for thepurposes for which the loan was approved with dueattention to consideration of economy andefficiency.” Moreover, ADB’s operations must beguided by sound banking principles. Accordingly, wehave developed specific financial management andreporting requirements for our borrowing members,including their executing agencies (EAs), whereapplicable.Our poverty-fightingoperations in Asia andthe Pacific …… are guided by soundbanking principlesThe Guidelines1.02.Financial Management and Analysis ofProjects, 2005 (the Guidelines) sets out ADB’srequirements and procedures for the financialmanagement of ADB-Financed projects (seeAppendix 1). They also provide guidance on applyingthese requirements.We have internalfinancial managementpolicies andguidelines …1.03.The Guidelines are primarily for internalADB use, but are available to external parties in hardcopy, via the Internet (www.adb.org/documents/guidelines/financial), and on CD-ROM.Mainbody.pmd108/11/2006, 1:46 PM 2 Handbook for Borrowers on the Financial Management and Analysis of ProjectsMDFI Harmonization Efforts… and are workinghard to harmonize thesepolicies with other MDFIsto reduce complianceburdens on our DMCs1.04.ADB and the other MDFIs—including theWorld Bank—have similar objectives and engage insimilar activities, but have different financialmanagement approaches and requirements. Thesevariances create confusion among our developingmember countries (DMCs). They also imposeunnecessary compliance costs and divert limitedresources away from key priorities. In 2000, the workbegan to reduce these differences. As of 2006,agreements have been reached on commondiagnostics, auditing arrangements, financialreporting arrangements, definitions of key ratios andcommitment to work together to improve financialmanagement of DMCs.ADB Approach to AnticorruptionCorruption places aburden on governmentsand economies ……1.05.ADB defines corruption as the abuse ofpublic or private office for personal gain. This meansany behavior in which people in the public or privatesectors improperly and unlawfully enrichthemselves or those close to them, or induce othersto do so, by abusing their positions.1.06.The purpose of ADB’s Anticorruption Policyis to reduce the burden corruption exacts from thegovernments and economies of the region. Thepolicy has three objectives: (i) support competitivemarkets and effective public administration; (ii)support explicit anticorruption efforts; and (iii)ensure ADB-financed projects and its staff adhereto the highest ethical standards.which ADB’santicorruption approachis intended to reduce1.07.The requirements and procedures set outin this Handbook support the implementation of ourAnticor ruption Policy, which is available atwww.adb.org.Mainbody.pmd208/11/2006, 1:46 PM Introduction 31.08.ADB’s integrity is one of its strongest assets.ADB affirms a zero tolerance policy when credibleevidence of fraud and corruption exists among ADBfinanced projects or its staff. You may reportallegations of fraud and corruption by contacting theAnticorruption Unit of the Office of the GeneralAuditor (OGAU) by e-mail, telephone or facsimile.Communication sent by these methods is accessibleonly by OGAU staff:E-mail:Telephone :Fax:The requirements andprocedures set out in thisHandbook support theimplementation of ourAnticorruption Policyanticorruption@adb.org(632) 632-5004(632) 636-21521.09.You may also contact OGAU at thefollowing addresses. Please mark correspondence“Strictly Confidential”.Anticorruption Unit (OGAU)Office of the General AuditorAsian Development Bank6 ADB AvenueMandaluyong City1550 Metro Manila, PhilippinesMailing Address : P.O. Box 789, 0980 ManilaPhilippinesThis Handbook1.10.This Handbook reflects progress on MDFIharmonization, explains ADB financial managementpolicies and procedures, and is aimed at borrowersand their EAs. These policies and procedures arefully consistent with our anticorruption approach.This Handbook explainsour financialmanagement policiesand requirements1.11.The provisions of this Handbook apply toinvestment projects and project EAs andimplementing agencies (IAs). For the purposes ofthis Handbook, investment projects include ADB-Mainbody.pmd308/11/2006, 1:46 PM 4 Handbook for Borrowers on the Financial Management and Analysis of Projectsloan-financed projects and the identifiableinvestment components of program and sectorloans. Please note that—unless stated otherwise—the requirements for EAs also apply to IAs.1.12.This Handbook is cross-referenced to theGuidelines. For instance, [5.2.3.1.1] refers to thatGuidelines’ paragraph or section.Further AssistanceFurther guidance onapplying theserequirements is available1.13.For further information and guidance,readers are encouraged to refer to the Guidelines inthe first instance; seehttp://www.adb.org/documents/guidelines/financial1.14.If you cannot resolve your question, pleasecontact the responsible ADB project officer.Otherwise contact:The Principal Financial Management SpecialistRegional and Sustainable Development DepartmentAsian Development BankManila, PhilippinesGeneral Information : fmguidelines@adb.orgTelephone: (632) 632-4444Fax: (632) 636-2193Mailing Address: P.O. Box 789, 0980 ManilaPhilippinesMainbody.pmd408/11/2006, 1:46 PM 2. User InstructionsADB Lending and Technical Assistance2.01.Our Charter permits us to make,participate in, or guarantee loans to our DMCs, toany of their agencies or political subdivisions, andto public or private enterprises operating within suchcountries, as well as to international or regionalentities concerned with economic development inthe region. Loans are made only for projects orprograms of high development priority [2.2.1–2.2.2].ADB gives technicalassistance and loans forprojects and programs ofhigh-developmentpriority2.02.We have four primary lending types:(i) project loans; (ii) sector loans; (iii) programloans; and (iv) private sector loans, equities, andguarantees. ADB’s technical assistance (TA)operations are classified into three developmentactivities: (i) project preparatory technical assistance(PPTA) to prepare a project, program loan, or sectorloan for financing by ADB and other external sources;(ii) advisory technical assistance (ADTA) to financeinstitution-building; plan-formulation; orimplementation, operation and management of anADB-financed project; or a sector-, policy-, or issuesoriented study; and (iii) regional technical assistance(RETA). We encourage cofinancing from officialfunding agencies, export credit agencies andcommercial finance institutions [2.2.3–2.2.5].2.03.In order to sharpen ADB’s capacity tomobilize development finance and knowledge forits DMCs, ADB has also recently introduced severalnew financial instruments and modalities under the“Innovation and Efficiency Initiative”. These areMainbody.pmd508/11/2006, 1:46 PM 6 Handbook for Borrowers on the Financial Management and Analysis of Projectsaimed at reinforcing flexibility and client orientationof ADB’s financial products.EA Classifications andGeneral TreatmentsADB classifies EAs on thebasis of their autonomyfrom government…2.04.EAs are agencies that may be involved indesigning, implementing, and/or operating a project.Such agencies may be broadly classified as:• public sector agencies, which includecentral government line ministries,departments, or agencies; andprovincial or state governmentdepartments or agencies; and localgovernments; or• semiautonomousgovernmentagencies, public sector enterprises, orparastatal bodies such as agriculture orindustrial credit banks, fertilizercorporations, public utilities, railways,and port authorities.… and whether they arecommercially oriented orgenerate substantialrevenues2.05.ADB also classifies projects and EAs intotwo distinct groups: nonrevenue-earning andrevenue-earning.2.06.The term revenue-earning is applied to EAsand projects that are implemented, and in mostcasesoperated,byautonomousorsemiautonomous EAs that are commerciallyoriented, or that generate substantial revenues eitherby consumer charges or by forms of sector-specificlocal taxation (such as water supply or drainagetaxes, and have authority to decide the use of thesefunds). EAs and projects that do not meet thesecriteria are termed nonrevenue-earning.Although ADB treatsrevenue-earning andnonrevenue-earning EAsand projectsdifferently…Mainbody.pmd608/11/2006, 1:46 PM User Instructions 72.07.Together with other MDFIs, ADBencourages borrowers and EAs to adopt uniformaccounting and financial reporting standards.However, some time will be required to achieve ahigh level of uniformity. The following table illustratesthese categories and associated treatments [2.4].SectorState-Owned (Public Sector)Private SectorType of Project,Executing Agency orImplementing AgencyNonrevenue-Earning(e.g., Health, Education)Revenue-Earning (e.g., Power Supply)Broad Approach andRequirements• Sound financial policies• Adequate accounting recordsFinancial Institutions••••Mainbody.pmd…we encourage theadoption of uniformaccounting and financialreporting standards7Proper internal control systemsTimely reporting to managementSound and timely auditingGradual improvements infinancial reporting as capacityallows• Move toward best practice privatesector management, internalcontrol and governancearrangements• Ensure that ongoing operations aresustainable• Comply with National AccountingStandards• Move toward reporting inaccordance with InternationalAccounting Standards08/11/2006, 1:46 PM 8 Handbook for Borrowers on the Financial Management and Analysis of ProjectsMainbody.pmd808/11/2006, 1:46 PM 3. Preparing andAppraising InvestmentProjectsIntroduction3.01.In some cases, ADB will appraise (review)investment projects to ensure that they aretechnically, financially and economically viable. Weconsider: (i) national, sectoral, and local needs forthe investment; (ii) economic and financialjustifications for the proposed project;(iii) sustainability; (iv) the extent to which the projectcontributes to human and technologicaladvancement; (v) good governance aspects; and(vi) whether we will be fulfilling our ownresponsibilities as set out in the ADB Charter [3.1.1].Once investment projectshave been designed, ADBgenerally appraises themto ensure that they areviableForecastingMainbody.pmd3.02.Forecasts are prepared of projectexpenses, revenues, cash flows and other financialitems. ADB works with borrower’s agencies duringproject identification, preparation and appraisal toensure that these forecasts are meaningful.The forecasts of projectcosts and revenues …3.03.These forecasts should, ideally, beprepared by the borrower’s agencies. However,where ADB staff or PPTA consultants prepareforecasts, it is essential that the borrower’s agencies… are the borrower’sresponsibility908/11/2006, 1:46 PM 10 Handbook for Borrowers on the Financial Management and Analysis of Projectsown these forecasts because they are ultimatelyresponsible for their accuracy [3.4.1.1].These forecasts will berevised periodically…3.04.ADB requires EAs to provide updatedforecasts after loan signing and at the start of projectimplementation. These will be updated forecaststo-completion or—in the case of revenue-earningprojects—updated forecasts for a specified period.The updated forecasts provide early warnings ofproject problems so that timely corrective actionscan be taken. For revenue-earning projects, ADB willdetermine the period during which EAs will berequired to provide updated forecasts, and therequirement will be specified in the loan agreement[3.4.1.2].…so that potentialproblems can beidentified and addressedin a timely mannerThe Project Cost Estimates TableAll project costs arepresented in the ProjectCost Estimates Table…3.05.A Project Cost Estimates Table, whichincludes all project costs, is prepared at the PPTAstage (see Appendix 2). It should provide anunderstanding of the principal project costcomponents during appraisal, and usefulinformation for project cost control purposes duringimplementation. It includes an allowance forcontingencies. The information provided in theProject Cost Estimates Table is considered at projectappraisal and during implementation by theborrower, the EA and ADB [3.4.3.1–3.4.4.4.5].Eligible Cost Under ADB Guidelines3.06.Under amended cost eligibility guidelines,ADB can now finance reasonable costs of taxes andduties related to project expenditures, acquisitionof land and rights of way, late payment chargesimposed by suppliers and contractors, bank charges,food expenditures, interest during construction onnon-ADB loans, second hand goods, lease financingcosts and local transport and insurance costs.Mainbody.pmd1008/11/2006, 1:46 PM Preparing and Appraising Investment Projects 11However, ADB financing of these is subject to therequirements as laid out in the Cost Sharing andEligibility of Expenditures for ADB Financing, StaffInstructions paper, 15 March 2006.Local and Foreign Costs3.07.There is no longer a distinction betweenlocal and foreign currency costs for purposes of ADBfinancing and disbursement. However, for the purposeof presentation, a summary of the costs by componentis to be provided in the main Report andRecommendation of the President (RRP), as “ProjectInvestment Plan”, while detailed costs breakdown, bylocal and foreign currency and per component and/orexpenditure category, is to be shown in the core RRPappendices as “Detailed Cost Estimates” [3.4.3.1.1].Date of the Base Cost Estimates3.08.The date of the estimates presented in theProject Cost Estimates Table will be specified in theproject RRP. ADB requires that these estimates arereasonably current. If the date of the estimates:There is no longer adistinction between localand foreign currencycosts ...The Project Cost EstimatesTable may have to berevised so that theestimates are up-to-date• is less than 6 months before the loan ispresented to ADB’s Board of Directors—the estimates are acceptable.• is 6-18 months before Boardpresentation—the estimates should berevised by indexation.• is more than 18 months before Boardpresentation—the costs should be reappraised [3.4.3.3.1].Treatment of Financial ChargesDuring Development3.09.Financial charges during development(FCDDs) can include interest, commitment chargesand front-end fees. FCDDs must be shown in theProject Cost Estimates Table [3.4.3.4.1].Mainbody.pmd1108/11/2006, 1:46 PM 12 Handbook for Borrowers on the Financial Management and Analysis of ProjectsRequests for Retroactive FinancingWe may agree toretroactively financeproject expenditures3.10.Retroactive financing refers to ADBfinancing of project expenditures incurred and paidfor by the borrower or recipient during or afterappraisal but before an ADB loan or TA agreementbecomes effective.… on the basis of prioragreement and a specialclause in the loanagreement3.11.Generally, no funds can be disbursed forexpenses incurred before the loan agreementbecomes effective. However, based on a prioragreement between ADB and the borrower, a specialclause authorizing the financing of certain expensesincurred before this date may be included in the loanagreement. This clause will show the amount of theretroactive financing, the category of expensesconcerned, and the date from which the expensesmay be incurred [3.4.3.5].Determining ContingenciesThe Project Cost EstimatesTable will includeallowances forcontingencies, comprising…3.12.Contingencies are an integral part of theexpected total project cost and normally arenecessary for all project items involving significantexpenditures. Contingency allowances shouldreflect probable (forecast) physical and pricechanges and costs arising from special risks that canreasonably be expected to increase the base costestimate. Contingency allowances should beseparately identified in the Project Cost EstimatesTable [3.4.4.1].3.13.Allowances for physical contingenciesreflect expected increases in the base cost estimatesdue to changes in quantities, methods, and periodof implementation. Physical contingencies shouldbe calculated in foreign and local cost terms, andexpressed as percentages of the foreign and localbase costs in the Project Cost Estimates Table[3.4.4.2].… physicalcontingencies and …Mainbody.pmd1208/11/2006, 1:46 PM Preparing and Appraising Investment Projects 133.14.Allowances for price contingencies reflectforecast increases in project base costs and physicalcontingencies due to changes in unit costs for thevarious project components beyond the date of thebase cost estimates. Price contingencies should beexpressed as percentages of the base costs plusphysical contingencies, separately for the local andforeign expenditures of the project, and for theproject as a whole [3.4.4.3].… price contingenciesThe Project Financing Plan3.15.The Project Cost Estimates Table identifiesthe total financing required for a project. The ProjectFinancing Plan illustrates project-fundingrequirements and identifies proposed fundingsources (see Appendix 3) [3.4.6].The Project FinancingPlan …3.16.Funds required for the proposed projectwill typically be classified into:… illustrates projectfunding requirements• capital expenditures,• operating expenditures, and• financial charges during development[3.4.6.6].3.17.Proposed project-funding sources mayinclude:•••••Mainbody.pmd… and identifiesproposed funding sourcesthe proposed ADB loan,other loans,equity or capital contributions,subsidies for operations, andinternally-generated cash [3.4.6.6].1308/11/2006, 1:46 PM 14 Handbook for Borrowers on the Financial Management and Analysis of ProjectsFinancial Cost-Benefit AnalysesADB-financed projectsmust be financially andeconomically viable …3.18.ADB requires that financial and economicanalyses be undertaken of projects. Both analyseshave the same objective—to assess whether theproposed investment is viable. Project financialanalysis examines the adequacy of returns to theproject-operating entity and to the projectparticipants. Economic analysis measures the effectof the project on the national economy, as a whole[3.5.1.1].… because DMCs shouldnot take on unproductivedebt3.19.In financial analysis, all project-relatedexpenditures and revenues are considered. This isnecessary to: (i) assess the degree to which a projectwill generate revenues sufficient to meet its financialobligations; (ii) assess the incentives for producers;and (iii) ensure that demand or output forecasts onwhich the economic analysis is based are consistentwith financial charges or available budget resources[3.5.1.3].3.20.Economic analysis attempts to assess aproject’s impact on improving economic welfare. Itassesses a project in the context of the nationaleconomy, rather than for the project participants orthe EA implementing the project [3.5.1.1–3.5.1.3].3.21.steps:ADB has a systematicapproach to financialcost-benefit analysesMainbody.pmdADB’s financial analysis process has six• preparing project cost estimates [3.4.3],• forecasting incremental project netcash flows [3.4.7],• determining the appropriate discountrate [3.5.2],• calculating the financial net presentvalue (FNPV) [3.5.3],1408/11/2006, 1:46 PM Preparing and Appraising Investment Projects 15• calculating the financial internal rate ofreturn (FIRR) [3.5.3], and• undertaking risk and sensitivityanalyses [3.5.4].Financial Loan Covenants3.22.Most DMCs are underserved byinfrastructure services, particularly in poor and ruralareas. In areas that do have service, systems areoften badly maintained and service is unreliable.Common problems include: (i) below-cost tariffsand inappropriate tariff design; (ii) inefficientoperations, with little incentive to improve efficiency;(iii) low billing and collection levels; and(iv) significant, but poorly-targeted subsidization.These problems can lead to financial losses,deterioration of facilities and limited funding for newinvestment.We seek assurance thatprojects will besustainable …3.23.To assist EAs to achieve their financialobjectives—as well as governmental economicobjectives that are being supported by ADB loans—ADB seeks assurance that the operational objectivesof an EA agreed with the borrower would be met atleast through the life of the project. These objectivesare translated into loan covenants [3.6.1.1–3.6.4.4.2].… by agreeing financialloan covenants that aredesigned to…3.24.into:… enhance EAperformance, andADB financial loan covenants are classified• operating covenants [3.6.2],• capital structure covenants [3.6.3], and• liquidity covenants [3.6.4].3.25.Financial loan covenants are designed to:(i) support socioeconomic development;(ii) promote financial viability, financial performanceand prudent financial management of the EA;Mainbody.pmd15… ensure that loanproceeds are usedeffectively08/11/2006, 1:46 PM 16 Handbook for Borrowers on the Financial Management and Analysis of Projects(iii) develop local capability; (iv) assist the EA toachieve a creditworthy status to facilitateacceptance in capital markets; (v) protect theborrower ’s and ADB’s financial interests; and(vi) provide a basis for monitoring by governmentregulatory agencies, and ADB, of the EA’s financialperformance [3.6.1.2].Mainbody.pmd1608/11/2006, 1:46 PM 4. Financial Managementof Executing AgenciesIntroductionMainbody.pmd4.01.The primary objective of the financialmanagement process is to optimize financial andeconomic benefits from an investment. Financialmanagement systems include the policies andpractices regarding financial planning,programming, accounting, reporting, auditing,funding, organization, and personnel of a project orof an EA [4.1].Sound financialmanagement systemshelp ensure that projectbenefits are optimized4.02.EAs should plan, develop and maintainfinancial management systems that can providetimely and reliable information suitable formonitoring the project’s and the EA’s progresstoward ADB-agreed objectives. The informationshould also provide early warnings of projectimplementation and EA management problems.They should providetimely and accurateinformation …4.03.EAs should also have an effective controlenvironment, including internal control systems thatprovide assurance that financial records are reliableand complete, including adherence to managementpolicies, orderly and efficient conduct of theborrower’s business, and proper recording andsafeguarding of assets and resources [4.2.1].… and operate withinan effective controlenvironment4.04.ADB assesses the financial policies and thecapacity of the financial systems practiced orproposed by the borrower/EA to support projectWe assess theeffectiveness of thesesystems1708/11/2006, 1:46 PM 18 Handbook for Borrowers on the Financial Management and Analysis of Projectsimplementation and operation. The EA should becapable of providing correct and timely informationon project implementation progress and, whereappropriate, on its operation. ADB must also beassured that the expenditures incurred on a projectare used for the purposes stated in the loanagreement [4.1–4.2.1.7].ADB Financial ManagementAssessmentsAssessment ObjectivesOur objective is to assessthe EA’s financialmanagement capacity toimplement projects4.05.The general objective of ADB assessmentsis to ensure that EAs are technically, managerially,and financially capable of efficiently and effectivelyimplementing the proposed projects or programs.The specific appraisal objectives are to: (i)determine whether institutional capacity, in termsof financial management, justifies loan approval; (ii)identify the institution’s financial managementdevelopment needs—both project related and longterm—that should be addressed either as a projectcomponent or by TA; and (iii) confirm that thefinancial management system is sustainable [4.1.3].Assessment Scope and General ApproachWhile the assessment’sexact scope will dependon our involvement withthe EA …4.06.The scope of the financial managementassessment will depend upon the extent and typeof dealings ADB has with the EA concerned, the EA’sexperience in implementing projects, and the extentand nature of previous institutional strengthening[4.2.1.7].4.07.The financial management assessmentwill generally include: (i) analyzing the EA’s structureand management framework with regard tofinancial management; (ii) assessing the agency’sresources, including the number, quality, and… it will involve areview of the EA’s financialmanagement capacityand identification of anyspecific deficienciesMainbody.pmd1808/11/2006, 1:46 PM Financial Management of Executing Agencies 19technical capabilities of its staff, the extent offinancial and budgetary support it obtains, the natureof technology, equipment, and software in use;(iii) assessing the agency’s operating results; and(iv) identifying specific performance shortfalls orvariances [4.2.1.7].4.08.Finally, ADB will examine performanceshortfalls to identify specific institutional deficienciesand possible institutional-strengthening actions.Deficiencies will be classified into those relating tothe management framework and those due toresource constraints [4.2.1.7].ADB then considerspossible actions toaddress those identifieddeficienciesGeneral ADB FinancialManagement ExpectationsFinancial Policies4.09.ADB requires that projects be designed,developed and operated within the framework ofthe financial policies, strategies and systemsprescribed by those government institutions that areresponsible for national and sectoral economic andfinancial planning [4.2.4].Project Objectives4.10.Project objectives should be clearlydefined. They should include sustainable economicgoals, financial objectives, time-bound delivery ofbenefits, and financial viability. As a minimum,financial viability means that adequate funds will beavailable to finance day-to-day operations andmaintenance [4.2.4.1.2].Project Implementation Plans4.11.ADB also recommends that borrowersdevelop project implementation plans. Project planshelp borrowers set realistic goals for each operatingMainbody.pmd19Project operations shouldbe consistent withgovernment financialpolicies …… project objectivesshould be clearlydefined …… and projectimplementation plansshould be developed08/11/2006, 1:46 PM 20 Handbook for Borrowers on the Financial Management and Analysis of Projectsperiod. They also establish the basis for preparingand implementing project financial managementrequirements, internal controls, and financialreporting arrangements.4.12.Project plans should include:• time-bound implementation tasks foreach project component (including TAand training);• procurement actions with target datesfor each step;• disbursement schedules for eachproject component and expenditurecategory;• funding schedules reflecting expectedADBfinancing,governmentcounterpart funds and cofinancingarrangements;• actions required to achieve projectdevelopment objectives; and• actions to establish project accountingand financial management systems(including auditing arrangements).Disbursement Procedures andFund-Flow MechanismsDisbursement proceduresand fund-flowmechanisms should beappropriate to DMC andproject circumstances4.13.Loan disbursement is a key element in theproject cycle. ADB expects that proposeddisbursement procedures and fund-flowmechanisms will be suitable for the particularproject. ADB procedures for withdrawal of loanproceeds are standardized to facilitatedisbursements under most loans. Disbursementprocedures comprise four major types:• direct payment procedure where ADB,at the borrower ’s request, pays adesignated beneficiary directly;Mainbody.pmd2008/11/2006, 1:46 PM Financial Management of Executing Agencies 21• commitment procedure where ADB, atthe borrower’s request, provides anirrevocable undertaking to reimbursea commercial bank for payments madeor to be made to a supplier against aletter of credit financed from the loanaccount;• reimbursement procedure where ADBpays from the loan account to theborrower’s account or, in some cases,to the project account for eligibleexpenditures which have beenincurred and paid for by the project outof its budget allocation or its ownresources; and• imprest fund procedure where ADBmakes an advance disbursement fromthe loan account for deposit to anImprest Account to be used exclusivelyfor ADB’s share of eligibleexpenditures.1Expectations of Revenue-Earning EAs4.14.This section describes relevant ADBexpectations of revenue-earning EAs and projects(see paragraphs 2.05–2.07).Planning and Budgeting4.15.Long-, medium- and short-term planningshould be the primar y elements in financial1Mainbody.pmdWe expect revenueearning EAs andprojects …… to have satisfactoryplanning and budgetingprocedures …The Loan Disbursement Handbook describes ADB loandisbursement procedures in detail (see www.adb.org).Furthermore, the Loan Financial Information Web Service (http://lfis.adb.org) is designed to meet users’ needs for accurate, ondemand financial information about loans to facilitate decisionmaking. The website provides detailed loan portfolio data andselected reports with facilities for downloading. Estimated debtservice payments and disbursement manuals directly related toloan operations are also available to specified users.2108/11/2006, 1:46 PM 22 Handbook for Borrowers on the Financial Management and Analysis of Projectsmanagement. Long- and medium-term plans areoften referred to as corporate plans. Short-termfinancial plans are usually called budgets. ADB willseek assurance that satisfactory plans and budgetswill be prepared in a regular, orderly and timelymanner [4.2.8.3].Accounting Policies… and consistentaccounting policies4.16.ADB will consider the acceptability ofaccounting policies, including standards of financialreporting and general accounting practices. ADBexpects these policies to be materially consistentwith accepted national or international standardsand practices [4.2.8.4].Financial Regulations4.17.A sound accounting system is underpinned by financial regulations. These are usuallydesigned to define the objectives of—and responsibilities within—the financial management system.ADB expects acceptable financial regulations to bein place [4.2.8.5, 4.2.8.9].Acceptable financialregulations should be inplace …Accounting Information Systems… and accountinginformation systems mustbe adequateMainbody.pmd4.18.To ensure accountability for projectimplementation funds, each project (and, whereapplicable, each EA) should have an adequateaccounting and internal control system for recordingand reporting project-related financial transactionsfrom the time that project expenditurescommence—which could be before ADB Boardapproval of the loan. There are no exceptions to thisrequirement [4.2.8.6.3].2208/11/2006, 1:46 PM Financial Management of Executing Agencies 234.19.Specifically, accounting informationsystems should:• be simple to operate;• require staff to operate with minimumsupervision, and have the necessarypersonnel trained to operate the systemfrom project start-up;• at a minimum, provide records ofproject receipts and expendituresgenerally from the date of firsttransactions;• where available, have informationtechnology systems that are modern,efficiently managed, and fullyresponsive to the needs ofmanagement of the EA and theproposed project;• have adequate internal checks andcontrols; be able to balance financialdata frequently and to report projectfinancial results at intervals and withinthe time frame required by ADB;• where needed, meet requirements forStatements of Expenditure (SOEs) andImprest Fund records; and• be capable of expansion, whennecessary, to meet the increasingdemands for financial data arising fromexpanding project activities or entityoperations.Internal Controls and Internal Audit4.20.ADB’s primary concern is to be assuredthat internal controls exist and are monitoredregularly to ensure they are efficient and responsiveto current operations [4.2.8.7–4.2.8.8.5].Mainbody.pmd23Accounting informationsystems should be simpleto operate and beappropriate to EA andproject needsInternal controls shouldbe effective …08/11/2006, 1:46 PM 24 Handbook for Borrowers on the Financial Management and Analysis of ProjectsManagement Accounting… and managementaccounting systemsshould be adequate4.21.A management accounting system shouldcollect and promptly report financial and relatedstatistical information on all aspects of the operatingperformance of an agency’s operations to thevarious management levels, supplying each levelwith the necessary details at the appropriate times.4.22.ADB seeks assurance that the EA’smanagement accounting system can produce theannual and periodic financial statements, includingthe statements for audit. It should also incorporateprocedures for recording current budgeting andfinancial planning data, record keeping and reports,and cost accounting (including cost control andanalysis) for recording costs [4.2.8.10].Expectations of Nonrevenue-Earning EAsMany nonrevenueearning projects will havesimple financialmanagementarrangements4.23.The financial management arrangementsof nonrevenue-earning projects and EAs can varysubstantially between DMCs. Many will use simple,cash-based accounting. This section describesrelevant ADB expectations of nonrevenue-earningprojects and EAs (see paragraphs 2.05–2.07).Financial Management and Accounting Systems4.24.For nonrevenue-earning EAs, the financialmanagement system should support accountingprocedures throughout project implementation [4.2.9.2].Nevertheless, basicaccounting records shouldbe maintained…Mainbody.pmd4.25.In nonrevenue-earning projects, the systemshould be kept simple. An analytical cashbook,showing receipts and payments (classified by projectactivity and payee), could form a satisfactory basicaccounting tool. It could be supplemented byadditional documents (e.g., asset registers, contractregisters, and inventory systems) as the needs forthese arise during implementation [4.2.9.2.3].2408/11/2006, 1:46 PM Financial Management of Executing Agencies 254.26.A basic system should include internalcontrols, which separate responsibilities betweenthose who approve budgets, authorize allotments,approve budgeted expenditures, make cashpayments, keep the books of account, and reconcilecash and bank balances with the books of account.Where staff numbers are too small to adequatelyseparate responsibilities, alternative arrangementsshould be implemented. For instance, actions mightbe jointly executed by two people (e.g., twosignatures on checks) [4.2.9.2.5].Planning and Budgeting4.27.ADB’s expectations of planning andbudgetary control for revenue-earning EAs (seeparagraph 4.15) are the same for nonrevenueearning EAs [4.2.9.5].… appropriate internalcontrols should beestablished …… and planning andbudgeting systems shouldbe adequateFinancial Accounting and Costing4.28.ADB prefers that an EA maintains at leastthe records described in paragraphs 4.31–4.33, butin some accounting systems many such records—particularly control accounts—may not bemaintained [4.2.9.6.1].4.29.EA systems must support timely disclosureof: (i) cumulative and annual project costs bycomponents agreed on between ADB and the EAfor each project, (ii) operating costs analyzed insufficient detail to provide control of incrementalcurrent expenditures, and (iii) the basis for all typesof claims for disbursement of ADB loans [4.2.9.6.4].Internal Control4.30.If internal control mechanisms areunsatisfactory, and the effectiveness of the externalaudit is not established, then the project will generallynot be allowed to proceed until the borrower/EAagrees to strengthen these mechanisms [4.2.9.7].Mainbody.pmd25EA systems shouldsupport timely disclosureof project transactionsProjects will generally notproceed until controlmechanisms aresatisfactory08/11/2006, 1:46 PM 26 Handbook for Borrowers on the Financial Management and Analysis of ProjectsA Simple System for a Nonrevenue-Earning ProjectA simple system for anonrevenue-earningproject will be based onunsophisticatedaccounting records…4.31.The following is a simple system for anonrevenue-earning project. It should be modifiedas necessary to meet specific project and ADBrequirements.…which will ideally besupplemented by ageneral ledger thatincludes additionalbalances and information4.32.It is also desirable that a simple generalledger be used to record payment totals and receipttotals (by week or by month). This ledger, in additionto recording summary amounts for the aboveaccounts, should record assets, liabilities, contractsand currency transactions [4.2.9.8.2].• Project Entity Bank Account Record, bycategories of expenditures• Project Entity Cash Payment Record, bycategories of expenditures¡ Record ofProject Expenditures incurred but notpaid by categories of expenditures• Record of Project Expenditures by ThirdParties by categories of expenditures• A Summary of the above to produceTotal Project Expenditures bycategories of expenditures• Record of Sources of Project Financingincluding ADB (and other lenders’)loan disbursement claims [4.2.9.8.1]4.33.Corrections and adjustments to the dataentered in the basic records can be made at anytime before entries are summarized in generalledger entries. Changes to data already recorded inthe General Ledger will need special entries in thatledger, preferably using journals [4.2.9.8.3].Mainbody.pmd2608/11/2006, 1:46 PM 5. Financial Reportingand AuditingIntroduction5.01.ADB requires accurate and timely financialinformation from its borrowers to be assured thatproject expenditures were used for the purposesstated in the loan agreement and to satisfy ADBregarding project and EA economy and efficiency.To ensure that ADBreceives accurate andtimely financialinformation…5.02.To support this requirement, ADB reviewsaccounting and auditing arrangements duringproject preparation to ensure that these meetacceptable standards and practices. Moreover, ADBloan and project agreements include relevantfinancial management and audit covenants.… we review accountingand auditingarrangements and agreerelevant covenantsAccounting Standards and PoliciesIntroduction5.03.ADB is concerned about the accurateinterpretation of the financial position andperformance of its borrowers and EAs. However, thepreparation and reporting of accounting informationvary widely among countries and contributes to asubstantial lack of transparency and consistency infinancial reporting [5.2.1].Because financialreporting practices varywidely among DMCs …5.04.ADB, together with other MDFIs,encourages borrowers and EAs to adopt uniformstandards of accounting and financial reporting. Inthis respect, ADB recommends that:Mainbody.pmd2708/11/2006, 1:46 PM 28 Handbook for Borrowers on the Financial Management and Analysis of Projects• Revenue-earning EAs comply withnational accounting standards andmove toward reporting in accordancewith the International AccountingStandards (IA S), as capacity andresources allow. However, some timewill be required to achieve a high levelof uniformity.• Nonrevenue-earning EAs in the publicsector should follow and maintainsound financial policies, adequateaccounting records, proper internalcontrol systems, timely reporting tomanagement, and sound auditingpractices [5.2.1.3].… ADB encourages theadoption of uniformstandards of accountingand financial reportingADB Accounting Policy RequirementsFinancial statementsmust include a statementof accounting policies5.05.Accounting policies are the specificprinciples, bases, conventions, rules and practicesadopted by an entity in preparing and presentingfinancial statements. Financial statements mustinclude a Statement of Accounting Policies. Anexample is presented in Appendix 4 [5.2.3.5].… that is acceptable toADB5.06.ADB will seek to agree the acceptableaccounting standards and policies governing thepreparation of financial statements not later than atloan negotiations [5.2.3.1.2].Nonrevenue-Earning EAsThis may be quite simplefor a nonrevenue-earningEAMainbody.pmd5.07.In the case of nonrevenue-earning EAs,Statements of Accounting Policies are likely to besimple. For instance, they may cover only cashrecognition policies [5.2.3.5].2808/11/2006, 1:46 PM Financial Reporting and Auditing 29Revenue-Earning EAsMainbody.pmd5.08.In general, financial statements for privatesector companies and organizations, and forrevenue-earning public sector EAs, should beprepared in accordance with IAS-compliantaccounting policies. Alternatively, ADB may acceptaudited annual financial statements of projects orEAs that are based on national or other definedstandards, provided that the Notes to the FinancialStatements include realignments and adjustmentsof the financial information in the audited annualfinancial statements to provide a report inaccordance with IASs [5.2.3.1.2].But, for most revenueearning EAs, ADB expectsIAS-compliant accountingpolicies …5.09.ADB therefore recommends that all publicand private sector revenue-earning EAs should moveto account and report for ADB-financed projects onthe basis of IAS-compliant accounting policiescurrent at the date of loan negotiations, or any otherdate in the project implementation period agreedbetween ADB and the borrower (see paragraph5.04). Borrowers and EAs should adopt IAScompliant accounting policies by an agreed date.Until this time, financial statements should beprepared in accordance with a set of accountingpolicies acceptable to ADB and noted in the minutesof loan negotiations [5.2.3.1.3].… these may take timeto be introduced5.10.In some cases, national accountingstandards and practices will not conform toaccepted international standards. Where only minoritems are involved (for instance, overhead allocationmethods or inventory-valuation policies), thecontinued use of these standards and practices maybe acceptable so long as the variances are quantifiedand disclosed in the Notes to the Financial Statementand in the Auditor’s Report [5.2.3.2.2–5.2.3.2.3].All significant variancesshould be quantified2908/11/2006, 1:46 PM 30 Handbook for Borrowers on the Financial Management and Analysis of ProjectsFor existing projects, theintroduction of theserequirements will benegotiated on a case-bycase basis5.11.ADB recognizes that some time will berequired for borrowers and EAs to adopt IAScompliant accounting policies and will negotiatewith existing borrowers on a project-by-project basisfor the timing of their introduction [5.2.3.2.4].Financial ReportingIntroductionADB seeks to receiveacceptable interim andannual audited financialstatements5.12.To ensure that adequate, timely, andreliable information is provided for projectmonitoring purposes, ADB seeks early agreementto receive acceptable interim and annual AuditedFinancial Statements for each financial year [5.3.1.1].Periodic progress reportsare required on financialmatters and compliancewith agreed covenants5.13.ADB typically requires the submission ofperiodic progress reports, including financial reports,covering:• the progressive interim, annual, andfinal costs of a project;• the financial performance and financialposition of an EA (where appropriate);• accountability for the funds, includingADB loans, provided for projectimplementation;• the bases for disbursements of ADBloan proceeds;• the extent of compliance with financialand related covenants; and• the effectiveness of project-relatedfinancial management and accountingsystems as specified by ADB andagreed to by the borrower [5.3.1.2].5.14.Borrowers and EAs should notify relevantparties of ADB’s requirements, including:(i) responsible government ministries;(ii) government auditors mandated by law to auditMainbody.pmd3008/11/2006, 1:46 PM Financial Reporting and Auditing 31EA accounts; and (iii) private auditors acting onbehalf of government auditors [5.3.1.4].Content and Timing of Financial ReportingUniversal ADB Requirements5.15.The following basic principles apply to allinterim and annual project financial statementsissued by borrowers:• English-language presentation [5.3.2.6and 5.3.2.8];• disclosure of full accountability for allfunds of the borrower, other donorsand lenders, and ADB;• compliance with loan covenants and ADBrequirements for project management;• adequate disclosure of all materialinformation; and• a true and fair view, or a fairpresentation in all material respects, ofthe financial performance and statusof the project and of the EA (whereapplicable) [5.3.2.2].Mainbody.pmdAll interim and annualfinancial statementsmust be presented inEnglish …5.16.In addition, the following fundamentalprinciples apply to annual financial statements: (i)a clear statement on the accounting policies andaccounting standards adopted; and (ii) the resultsof an independent review of the financial accountsand financial management systems by an auditoracceptable to ADB [5.3.2.3].… and annual financialstatements must beaudited5.17.Interim and annual financial statementsrelating to each project should show sufficientinformation to identify separately the transactionsrelating to the reporting year and the cumulativetransactions from the start-up date [5.3.2.4].Annual and cumulativebalances should bedisclosed ...3108/11/2006, 1:46 PM 32 Handbook for Borrowers on the Financial Management and Analysis of Projects5.18.Interim and annual statements maycombine financial transactions of a project withthose of the EA, where the EA was established solelyto develop the project [5.3.2.6].… and separatefinancial statementsshould be provided foreach subproject5.19.Where an EA is responsible forimplementing defined subprojects, separatefinancial statements should be provided for eachdefined component together with a consolidatedfinancial statement for the complete project. Wherean EA is responsible for developing more than oneproject, common or joint project financialtransactions of the agency may be apportioned andallocated to each project on a basis defined in theNotes to the Financial Statements [5.3.2.7].Audited FinancialStatements should besubmitted to ADB notmore than 6 monthsfollowing the end of thefiscal year or projectclosing date5.20.Borrowers are asked to provide interimand audited Annual Financial Statements inaccordance with an ADB-agreed timetable. Interimfinancial reports are normally required at intervalsof 3, 4 or 6 months of each financial year. Auditedfinancial statements (for the EA, project accounts,and imprest fund as applicable) should be submittedto ADB not more than 6 months following the endof the fiscal year or project closing date (whicheveris first) [5.3.2.9].5.21.Where Audited Financial Statements areto be first submitted to a government legislature—with the risk of delaying provision of the AuditedFinancial Statements to ADB—a draft thereof(certified by the chief financial officer and theauditor) should be submitted to ADB within therequired reporting timetable, with subsequentconfirmation after they have been ratified by thelegislature [5.3.2.10].Mainbody.pmd3208/11/2006, 1:46 PM Financial Reporting and Auditing 335.22.Interim and annual financial statementsshould normally be presented in the local currency,with the basis for translation of any foreign exchangetransactions or commitments explicitly stated[5.3.2.11].Specific Requirements forNonrevenue-Earning Projects5.23.ADB recognizes that many projectfinancial statements—particularly those prepared fornonrevenue-earning projects—are of a specialpurpose nature. Consequently, ADB requires thatfinancial information submitted by nonrevenueearning entities adhere to an appropriately designedformat acceptable to ADB [5.3.2.1].Financial statements should(normally) be presented inthe local currencyFor nonrevenue-earningprojects, audited annualstatements are requiredfor each year of projectdevelopment andimplementation5.24.Audited annual financial statements ofnonrevenue-earning projects are required for eachfinancial year of project development andimplementation [5.3.2.6].Specific Requirements for Revenue-Earning Projects5.25.For a revenue-earning project, ADBrequires audited annual financial statements of theproject and of the EA for the period of the loan. Alongwith the audit report which expresses the auditopinion following the audit of the annual financialstatement, ADB also requires a management letter,by agency if there is more than one EA, from theauditors. The reports on the project may beincorporated within EA financial statementsprovided that the statements explicitly describe theproject’s financial status and performance for thefinancial year, the previous financial year and fromstart-up. Interim financial reporting should follow theformat of the annual financial statements, but shouldcease on completion of ADB disbursements[5.3.2.8].Mainbody.pmd33The financial statementsof revenue-earningprojects may beincorporated within theEA’s financial statements08/11/2006, 1:46 PM 34 Handbook for Borrowers on the Financial Management and Analysis of ProjectsAccounting Statements and Financial ReportsThe financial reportingrequirements for revenueand non-revenueprojects…5.26.The table on the opposite page summarizes the financial reporting requirements forprojects and EAs. While the reporting requirementsfor revenue-earning projects and EAs are uniform,those for nonrevenue-earning projects and EAs arenot [5.3.3.1].5.27.The most significant difference among thefinancial reports of nonrevenue-earning projects andEAs depends on whether entities use the accrual orthe cash accounting basis.… and EAs usuallydiffer…• Under the cash basis of accounting,nonfinancial assets (for instance, fixedassets, receivables, and inventories)will not be systematically recorded.Consequently, the information that isnecessar y to prepare IncomeStatements and Balance Sheets will notbe available; instead, Statements ofCash Receipts and Payments will beprepared.… the most significantdifference is that manynonrevenue-earningprojects and EAs use cashaccounting• Where accrual accounting is used,Statements of Income and Expenseswill be prepared along with BalanceSheets. Accrual statements shouldalways be supplemented with a CashFlow Statement. While many ADBDMCs have signaled their intention toadopt the accrual basis of accounting,this will take many years. However,nonrevenue-earning entities in somecountries that have historically used theSoviet Accounting System (e.g.,Uzbekistan), may prepare accrualbased financial statements [5.3.3.2].Mainbody.pmd3408/11/2006, 1:46 PM Financial Reporting and Auditing 355.28. Statement of Accounting or Financial Policies.Irrespective of whether the cash or accrualaccounting basis is used, a clear statement of theaccounting or financial policies that underlie theaccounting statements must be provided [5.3.3.4].A clear statement ofaccounting policies mustbe provided5.29. The Statement of Income (Cash Receipts)shows the year’s complete financial information andcumulative data from project start-up. Where thecash accounting basis is followed, the opening andclosing cash balances should be shown [5.3.3.5]Accounting Statements and Financial ReportsNonrevenue-EarningProjects and EAsAccounting StatementStatement of Accounting/Financial PoliciesInterim(PMRs)AnnualAudited…Revenue-EarningProjects and EAsInterim(PMRs)AnnualAudited…Statement of Income(Cash Receipts)……Statement of Expenses(Cash Payments)……Cash Flow Statementnote (a)note (a)Imprest AccountStatementStatement of ExpendituresThese statements areusually not prepared, asmost nonrevenue-earningprojects currently use thecash basis of accountingIncome StatementBalance SheetNotes to the FinancialStatementsnote (b)note (b)note (b)note (b)Other Informationnote (c)note (c)note (c)note (c)EA = executing agency; PMR = project management report.(a) The content and format of Cash Flow Statements for nonrevenue-earning projects (and EAs) willnot necessarily conform to IAS or to national accounting standards.(b) The notes to the financial statements provide further breakdowns or explanations of the informationprovided in the main financial statements.(c) The scope and nature of other information will be negotiated between ADB and the borrower.Mainbody.pmd3508/11/2006, 1:46 PM 36 Handbook for Borrowers on the Financial Management and Analysis of Projects5.30.The Statement of Expenses (CashPayments) shows the year’s financial informationand cumulative totals from project start-up to thecurrent date. Where the accrual basis of accountingis used, this statement will include noncash items,such as depreciation [5.3.3.6].5.31.The Cash Flow Statementshould disclose financingsources and payments inaccordance withdisbursement categoriesThe Cash Flow Statement should include:• sources of project financing (forexample, ADB and governmentcontributions) by disbursementmethods (for example, direct payment,imprest account);• uses of funds summarized underproject disbursement categories as perthe loan agreement (for example:equipment, civil works, consultantservices and training;• others, which may be furthersubdivided following start of projectimplementation); and• the opening and closing cash balances[5.3.3.7].5.32.The Imprest Account Statementsummarizes ADB’s advances and replenishments,less amounts withdrawn by the project entity,showing the remaining cash balance in the ImprestAccount [5.3.3.8].The Imprest AccountStatement summarizesadvances andreplenishments, lesswithdrawals and theremaining cash balancein the Imprest AccountMainbody.pmd5.33.Bank statements should be provided foreach Imprest Account (where used). Each bankstatement should summarize the current year’sadvances and replenishments, interest earned onbalances, less withdrawals for project expenditures.The first account is used to receive money from ADBfor the credit of the “Project Imprest Account” andthe second may be used by the project for local3608/11/2006, 1:46 PM Financial Reporting and Auditing 37operating purposes (Second Generation ImprestAccount, SGIA). The Project Imprest Account is tobe used to replenish the SGIA (when used). It isnecessary to attach Reconciliation Statements toreflect in-transit items between ADB and the ImprestAccount and between Imprest Account and theSGIA. The third financial statement is a detailedstatement of transactions of the Imprest Account’sOperating Account(s). This is to be generated by theEA, where the Imprest Account is used to makedirect payments in local and foreign currency[5.3.3.9].5.34.The Statement of Expenditures (SOE)procedure is an ADB reimbursement procedure thatdoes not require submission of supportingdocumentation. The SOE form should includecertification, confirming existence of registration formobilization and secured advances/deposits. ADB’sLoan Disbursement Handbook describes the use ofthis method and associated reporting and auditingprocedures [5.3.3.10].Income Statements reflectfinancial performance…5.35.Income Statements and Balance Sheetsmay not be necessary where cash accounting isused. Income Statements show the financial resultsof activities for a period. Balance Sheets show allfinancial items owned and owed at a certain pointin time [5.3.3.11].… and Balance Sheetsshow financial position5.36.The Notes to the Financial Statementsshould be explanatory notes and/or supplementaryfinancial statements that analyze or qualifyimportant heads of account, or that present theinformation in conformity with generally acceptedaccounting practices of the country [5.3.3.12].Mainbody.pmd3708/11/2006, 1:46 PM 38 Handbook for Borrowers on the Financial Management and Analysis of ProjectsInterim Financial Statements andProject Management ReportsADB requires regularsubmission of PMRs5.37.During the course of each financial year,ADB requires project management reports (PMRs)as part of the system for monitoring a project’sperformance. The PMR is required on a periodicbasis, and is designed to assist the EA to maintainregular control of project performance. The PMRfinancial statement is an interim financial statementthat is a useful tool for reviewing progress and forplanning, and is recommended for all projects. Asample PMR is attached as Appendix 5 [5.3.4.1].Appendix 5 provides anexample of a PMRPMRs compare actualand budgetedamounts …5.38.The information in the PMR should beprovided in respect of: (i) the most recent completedfinancial period (normally a quarter or half-year),(ii) the year-to-date totals, and (iii) cumulativetotals-to-date from the beginning of the project[5.3.4.2].… and identify andexplain significantvariances5.39.The PMR should also show, for each lineitem, the planned or budgeted amounts forcomparison with the actual reported information,with variances shown between actual and the plan.Explanations should be attached to the PMR withrespect to significant variances for use in managingand monitoring the project [5.3.4.3].Audited Annual Financial StatementsOur expectations ofaudited annual financialstatements depend onwhether projects arerevenue or nonrevenueearningMainbody.pmd5.40.Audited annual financial statementsshould be provided to ADB to fulfill the fiduciaryrequirements of the borrower, cofinanciers, donorsand ADB. These financial statements may beclassified into two broad categories:• Annual financial statements for nonrevenue-earning projects. The statementsmay also include information on theperformance and status of the EA3808/11/2006, 1:46 PM Financial Reporting and Auditing 39where the EA has no other financialperformance commitments to ADBunder a loan agreement; and• Annual financial statements for revenue-earning projects and for projectEAs, where the EA is an autonomousor semiautonomous revenue-earningentity with responsibility for projectimplementation [5.3.5.1].Annual Statements for Nonrevenue-Earning Projects5.41.EAs should only prepare annual financialstatements for projects, particularly where theproject is nonrevenue-earning and is implementedby organizations of national, provincial, state orregional and/or local governments. EA-relatedfinancial transactions may be included as line itemsin project income and expenses [5.3.6.1].For nonrevenue-earningprojects, ADB generallyexpects financialstatements only for theproject—not for the EA5.42.The statements may take the followingforms and may be produced in the local budgetaryand accounting formats for the project and, whereapplicable, for the EA concerned:• Statement of Income (or Cash Receipts),• Statement of Expenses (or Cash Payments), and• Notes to the Financial Statements[5.3.6.2].Annual Statements for Revenue-EarningProjects and EAs5.43.Borrowers are asked to provide ADB withannual financial statements in respect of eachautonomous or semiautonomous EA that plays asubstantive role in implementing and/or operatinga project having revenue-earning characteristics.These financial statements should contain detailssufficient to identify the financial performance andMainbody.pmd39… whereas, for revenueearning projects, wegenerally expect EA financialstatements that incorporateproject information08/11/2006, 1:46 PM 40 Handbook for Borrowers on the Financial Management and Analysis of Projectsstatus of the project or EA. Normally these shouldcomprise:• a Balance Sheet showing the financialposition of the entity, including theproject, at financial year-end,• an Income (or Operating, or Incomeand Expenditure, or Profit and Loss)Statement,• a Cash Flow Statement that shoulddisclose the cash flows during eachfinancial year, and• notes to the Financial Statements [5.3.7.1].5.44.Financial statements should includecomparative figures for the preceding financial yeartogether with supporting schedules and explanatorynotes. Supplementary financial statements shouldbe provided containing ADB-requested informationregarding items requiring additional disclosure orexplanation [5.3.7.2].In both cases, financialstatements shouldinclude comparativefigures and explanatorynotesSupplementary Financial Statements5.45.ADB will normally specify the form andcontent of supplementary financial statements to beattached to the standard annual financialstatements, but borrowers should include allinformation that is considered informative andappropriate to illustrate the performance of projectimplementation and operation [5.3.8.1].Model Financial Statements forRevenue-Earning EAs5.46.Appendix 6 and Appendix 7 present modelfinancial statements for a service and amanufacturing organization, respectively [5.3.11,7.16–7.17].Mainbody.pmd4008/11/2006, 1:46 PM Financial Reporting and Auditing 41Auditing Standards andAuditor EngagementIntroduction5.47.An audit’s overall objective is for theauditor to express an opinion as to whether thefinancial statements present a true and fair view ofthe project(s) and, where applicable, of the EA, orare similarly presented fairly in all material respects,in conformity with IAS or other ADB-acceptedstandards, and applied on a basis consistent withthat of the preceding year [5.4.1.1].Auditors examinefinancial statements …5.48.The auditor’s opinion is necessary toestablish the credibility, or otherwise, of the financialstatements of an EA. The examination should be ofsuch scope and depth to allow the auditor to givean opinion and make a report on the veracity,accuracy and fairness as regards the presentationof the financial statements of an EA or a defined partthereof (such as a project, a project unit, or adepartment or division). These financial statementsmay be annual, periodic, or ad hoc (i.e., relating tospecial reports) [5.4.1.2].… and express anopinion on their veracity,accuracy and fairnessADB Audit Requirements5.49.ADB requires the borrower and the EA tohave the required financial statements for each yearaudited by an independent auditor acceptable toADB, and in accordance with standards on auditingthat also are acceptable to ADB. An audit of suchfinancial statements includes:• an assessment of the adequacy ofaccounting and internal controlsystems with respect to projectexpenditures and other financialMainbody.pmd41We require annualfinancial statements to beaudited …… in accordance withacceptable auditingstandards08/11/2006, 1:46 PM 42 Handbook for Borrowers on the Financial Management and Analysis of Projectstransactions, and to ensure safecustody of project-financed assets;• a determination as to whether theborrower and project implementingentities have maintained adequatedocumentation on all relevanttransactions;• confirmation that expendituressubmitted to ADB are eligible forfinancing and identification of anyineligible expenditures; and• compliance with loan covenants andADB’s requirements for projectmanagement [5.4.2].Auditing StandardsADB recognizes IAASBand INTOSAI auditingstandards …5.50.ADB recognizes the InternationalStandards on Auditing (ISA) promulgated by theInternational Auditing and Assurance StandardsBoard (IAASB) of the International Federation ofAccountants (IFAC) and the auditing standards ofthe International Organization of Supreme AuditInstitutions (INTOSAI). ISAs are widely adopted bythe international accounting profession and manynational professions. They form the benchmark forstandards on auditing acceptable to ADB for auditsin the public and private sector. Many auditorsgeneral and their equivalents use the INTOSAIauditing standards [5.4.2.2].… and prefers thatauditors conform to thesestandardsMainbody.pmd5.51.ADB prefers borrowers to engage auditorswho will conform to ISA. However, it recognizesthat—in some countries—auditors apply local,generally accepted auditing standards that may notconform to, or fully comply with, the ISA, but thathave been prescribed by a country’s law, or havebeen adopted by public accountants or associationsof accountants in the country concerned [5.4.2.3].4208/11/2006, 1:46 PM Financial Reporting and Auditing 435.52.Supplementary auditing and reportingprocedures may be requested by ADB, if necessary,to confirm accountability and financial performancein cases where ADB considers that local auditingstandards need to be supplemented. ADB wouldexpect auditors to indicate in their report the extentof differences, and the impact of the audit, of use oflocal auditing standards compared with theapplication of ISAs [5.4.2.4].Auditing ProceduresMainbody.pmdADB may requiresupplementary auditingprocedures in some cases5.53.Auditors should understand the projectand the entity being audited, including the contentsof the RRP and legal agreements. Further guidanceis available from the: (i) ADB Loan DisbursementHandbook; (ii) ADB Sample bidding documents;and (iii) ADB Procurement Handbook [5.4.3.2].ADB expects auditors …5.54.Auditors should ensure that any countryspecific variations in accounting standards andpractices that are adopted by the borrower, and thatdiffer substantially from IAS, should be disclosed.Any significant effects on project financialperformance or status, because of nonconformance with IAS, should be disclosed [5.4.3.7].… to identify theimpacts of variances inaccounting practices …5.55.ADB expects audits to include: (i) anexamination of assets and liabilities; (ii) anexamination of commitments and contingentliabilities; (iii) confirmation of debtors, creditors andinventory; (iv) an examination of variations from IAS;(v) a review of the periodic PMR for each year; (vi)an audit of SOEs (where required) as a part of theoverall project audit; and (vii) an audit of the ImprestAccounts [5.4.3].… and to conduct workof acceptable scope43… to understand theauditee and ADB policiesand procedures …08/11/2006, 1:46 PM 44 Handbook for Borrowers on the Financial Management and Analysis of ProjectsAuditor Selection and AppointmentAlthough borrowers areresponsible for auditorselection, appointmentand performance …… auditors must beacceptable to ADB5.56.ADB will ask borrowers to removeunacceptable restrictions, or otherwise arrange foran acceptable audit to be conducted. A borrower isresponsible for the selection, appointment andperformance of an auditor. ADB wishes to beinformed by a borrower of an ongoing or proposedappointment of an auditor, who should meetrequired standards in terms of independence,experience and competence. More specifically, ADBwill indicate the acceptability of an auditor in theform of a “no objection” [5.4.4.2].ADB expects auditors …5.57.…to be independent…• impartial and independent of thecontrol of the entity to be audited andof the person appointing them. Inparticular, they should not—during theperiod covered by the audit—beemployed by, serve as directors of, orhave family, financial, or close businessrelationships with the entity, except asauditors, during the period of the audit;• well established and reputable, useprocedures and methods conformingwith ISA or INTOSAI standards, andemploy adequate staff with appropriateskills and competence required fortheir responsibilities;• experienced in the types ofassignments they are to undertake forthe ADB project; and• able to fulfill their terms of reference(TOR) within the specified timetable[5.4.4.2].… to be reputable …… and to have relevantexperienceMainbody.pmdTo be acceptable to ADB, auditors must be:4408/11/2006, 1:46 PM Financial Reporting and Auditing 455.58.ADB requires that the borrower and EAselect and appoint an acceptable auditor withinsufficient time to carry out its responsibilities,including a review of the financial managementsystems at the beginning of project implementation,and periodically thereafter [5.4.4.3].ADB requires that auditorappointments be made ina timely manner …5.59.ADB does not normally advise on theselection of auditors, but prefers to review a list ofseveral auditors submitted from whom anappointment will be made by the borrower, andindicate any auditor who may not meet ADB’scriteria. ADB will indicate its agreement to a proposalto engage an auditor when it is satisfied that anexisting auditor, or the auditor under considerationfor engagement, would be acceptable to ADB interms of independence and competence to carryout the audit [5.4.4.4].… and prefers to reviewa list of auditors andindicate those who maynot meet our criteriaIssues in Auditor Selection5.60.The scope and detail of an audit maydepend upon laws or regulations that constrain agovernment auditor from providing the depth ofexamination required by ADB [5.4.5.1].5.61.The following are unlikely to be acceptableauditors for ADB lending operations:We expect auditors to actindependently …• government auditors whose staff maybe required by laws or regulations toparticipate in the processing offinancial transactions,• auditors who assist EAs to prepare theannual financial statements, or• auditors who design and constructcomponents of the EA’s financialmanagement system [5.4.5.1].Mainbody.pmd4508/11/2006, 1:46 PM 46 Handbook for Borrowers on the Financial Management and Analysis of Projects… but where this is justnot possible, we expectauditors to distancethemselves from decisionmaking andmanagement5.62.In certain instances, resource constraintsmay cause the borrower and EA to request auditorsto compile part or all of the financial statements.When this occurs, to be eligible to carry out the audit,the auditor should have no part in any aspect of EAdecision-making or management. The extent of theauditor’s involvement in accounting should bediscussed in the Management Letter [5.4.5.2].Auditors must be able tocommence work atproject start-up5.63.Auditors must be able to commence workat project start-up. Therefore, borrowers shouldappoint auditors before the start of each financialyear. Borrowers are expected to provide ADB withan assurance that the auditor has been notified ofADB’s requirements, including the timing of the auditand issuance of the auditor’s report. This will be nolater than the project start date, or the date on whichthe ADB Board approves the loan, whichever isearlier [5.4.5.3].ADB will acceptgovernment auditors forrevenue-earning projectson the basis of a capacityreview5.64.Where a government auditor is to serveduring execution and operation of a revenue-earningproject until the loan period expires, the borroweris expected to assure ADB that the governmentauditor will begin and complete the audit operationswithin the required timetable [5.4.5.4].5.65.Auditors for public sector projects andpublic sector EAs may be drawn from commercialor state audit practitioners. Government auditors willnot be acceptable for private sector projects and forpublic sector EAs of revenue-earning entities, unlessconfirmed by ADB when a review of capacity,capability, and ongoing performance has beenconducted [5.4.6.1].5.66.The EA (or its controlling authority) isnormally responsible for selecting and appointingauditors, except where a government auditor isMainbody.pmd4608/11/2006, 1:46 PM Financial Reporting and Auditing 47required by law to provide the service. Therefore,where no auditor is currently engaged, early stepsshould be taken to ensure that borrowers engagean acceptable auditor by the date of loan signing orproject start-up [5.4.6.2].5.67.Auditors’ engagements should be keptunder review to ensure consistent quality ofperformance, including the ability to adapt tochanges in an entity’s accounting and generaloperations, and to adopt improved audit techniques[5.4.6.7].Borrowers should monitorauditor performance …5.68.Consequently, ADB encourages borrowersto restrict audit engagements to relatively short-termassignments [5.4.6.8].… and auditorappointments should befor a suitable period5.69.Some countries appoint auditors eachyear. However, engagements should be long enoughto enable the auditor to become familiar with theauditee, but short enough to facilitate a change ofauditor, if necessary. Engagements of 3–5 years arein the optimum range [5.4.6.9].Terms of Reference for an Auditor5.70.ADB requires that auditors’ opinions be ofsuch scope and detail as ADB may reasonablyrequest, and requires that a TOR acceptable to ADBbe prepared for each audit. For different types ofaudits, the scope of the audit will vary according tothe nature of the EA and the type of operation beingaudited. For example, the TOR for a financialinstitution audit will require the auditor to payparticular attention to the loan portfolio, while apublic utility audit will usually focus on fixed assetsand accounts receivable [5.4.7.1].Mainbody.pmd47The TOR prepared foreach audit …… must be acceptableto ADB …08/11/2006, 1:46 PM 48 Handbook for Borrowers on the Financial Management and Analysis of Projects… but should notrestrict auditorindependence or limittheir ability to meet otherobligations5.71.ISAs suggest that auditors determine thescope of financial statement audits in accordancewith the requirements of legislation, regulations andgenerally accepted auditing standards. The TORshould not restrict auditors’ obligations in theserespects, nor should they give reasons for auditorsto claim that adherence to the TOR preventedadequate statutory, regulatory or professionalperformance [5.4.7.2, 5.4.7.8].A management letter isalways required5.72.Nevertheless, the audit TOR provides anopportunity to draw attention to areas of concern thatmay not be covered or emphasized under a normalaudit, such as compliance with loan covenants or aspecial review of procurement documents. The TORshould always include the requirement to give anopinion on any specific items. A management letterwill always be required [5.4.7.3].Model auditor TOR areappended5.73.Model TORs for an EA audit and for aproject audit are provided in Appendix 7 andAppendix 9, respectively. However, these modelTORs should not be regarded as universallyapplicable [5.4.7.6].Contract or Engagement Letter of Auditor5.74.ADB recommends that contracts or auditengagement letters be prepared. Where a formalcontract is used, it is normally prepared by the EA.Auditors often prepare a simple engagement letter.The contract or letter sets out the auditor ’sresponsibilities and should include:To clarify expectations,we recommend thatcontracts or auditengagement letters beprepared• confirmation of acceptance of theappointment including reference to theTOR;• the borrowers’ responsibilities,particularly the preparation of financialinformation;Mainbody.pmd4808/11/2006, 1:46 PM Financial Reporting and Auditing 49• the provision of access to whateverpremises, records, documentation andany other information the auditor mayrequest in connection with the audit;• the form of audit reports;• arrangementsregardingtheinvolvement of internal auditors andany other external auditors (such as thegovernment auditor);• the expected issuance date of theAudited Financial Statements; and• the fees basis and billing arrangements[5.4.8].Government Auditors5.75.In some countries—where projects areexecuted by government-controlled or sponsoredentities—statutory requirements may specify the useof the government auditor. Under suchcircumstances, ADB will require that (i) the auditoris independent and competent, (ii) the auditor hasthe capacity and professional capability to provideaudit reports and opinions of the quality requiredby ADB, and (iii) is generally acceptable to ADB.Normally, the independence of a governmentauditor would not be questioned if the auditor’sposition is established under constitutional or legalprovisions designed to assure independence[5.4.10.1].ADB requires governmentauditors to beindependent, competentand to have suitablecapacity …5.76.In some cases, government auditors areinvolved in pre-expenditure and revenue-collectiondecision-making. This compromises theirindependence. In these cases, ADB may seek toagree with a borrower that the auditor, or ADB, willbe provided with opinions and reports prepared byan independent commercial auditor in addition tothe government auditor’s report [5.4.10.3].Mainbody.pmd4908/11/2006, 1:46 PM 50 Handbook for Borrowers on the Financial Management and Analysis of Projects… consequently, ADBmay sometimes requestaudits to be conducted byprivate auditors5.77.Where ADB has concerns about thegovernment auditor ’s independence orcompetence, ADB will seek the borrower ’sagreement for the government auditor tosubcontract the audit to an independent andcompetent private auditor to conduct the audit ontheir behalf [5.4.10.4].Submission of Financial Reports5.78.EAs are required to submit Audited ProjectAccounts (APA) regularly during projectimplementation and—in some cases—until the loanhas been fully repaid. In addition, EAs of revenueearning entities are required to submit AuditedFinancial Statements (AFS). This enables ADB tomonitor loan use and satisfy itself about the EA’sfinancial viability [5.5].ADB requires that APAand AFS be submitted…5.79.The APA and AFS should be submitted toADB—together with the auditor’s opinion andreport—immediately upon completion of the audit.These should be accompanied by any other materialissued by the auditor that is relevant to theinterpretation of the audit, such as a managementletter. An audit opinion should also be made by theauditor and submitted to ADB on the use of theImprest Fund and SOEs in projects where these havebeen used. Delays in submitting financial reports willdirectly affect the project’s overall rating [5.5.2].… immediately on auditcompletion5.80.ADB identifies the following compliancecategories:• Complied is when the sole EAsubmitted acceptable APA/AFS inEnglish by the due date; and where allEAs submitted acceptable APA/AFS inEnglish by the due date.Mainbody.pmd5008/11/2006, 1:46 PM Financial Reporting and Auditing 51• Partly Complied is where several EAsare involved and only one or a fewsubmitted acceptable APA/AFS eitherby the due date or late.• Complied Late is when APA/AFS meetthe complied status but are submittedlate.• Not Yet Due is when APA/AFS are notyet due and are only applicable untilthe first APA/AFS for the project becomedue.• Not Required is if submission of APA/AFS are not included in the loancovenants, and are only applicable tosome exceptional program loans.• Not Complied is when:In determining whetherAPA/AFS comply withADB requirements …… we considertimeliness, language,and acceptability– APA/AFS are submitted in the locallanguage,– APA/AFS are submitted but hasmaterial audit qualifications,– the sole EA submitted partial orincomplete APA/AFS, or– only unaudited project accountsand financial statements aresubmitted.Mainbody.pmd5108/11/2006, 1:46 PM 52 Handbook for Borrowers on the Financial Management and Analysis of Projects5.81.The following table provides guidance onhow ADB classifies audit opinions for the purposesof determining compliance.Type of AuditOpinionExampleClassificationUnqualifiedOpinion“In our opinion, the financial statementsgive a true and fair view….” (ISA 700,para. 21)AcceptableQualifiedOpinion“In our opinion, except for the effect on thefinancial statements of the matter referredto in the preceding paragraph, the financialstatements give a true and fair view of thefinancial position ….” (ISA 700, para. 46)Will depend on the natureof the audit qualificationand will be considered ona case-by-case basis.AdverseOpinion“In our opinion, because of the effects ofthe matters discussed in the precedingparagraph, the financial statements do notgive a true and fair view of….” (ISA 700,para. 46).UnacceptableDisclaimer ofOpinion“Because of the significance of the mattersdiscussed in the preceding paragraph, wedo not express an opinion on the financialstatements.” (ISA 700, para. 44)UnacceptableADB Policy on Late or Unacceptable Financial ReportsWhen acceptable APA/AFS are not received by due dates, ADB will writeimmediately to the EA stating they are overdue and warning that, if they arenot received within 6 months, Imprest Accounts will not be replenishedand further reimbursement requests, commitment letters, and contractawards will not be processed.When acceptable APA/AFS are not received within 6 months after thedue dates, ADB will initiate stopping replenishment of Imprest Accounts,and processing of reimbursement requests, commitment letters and contractawards. ADB will then advise the EA of ADB’s actions and state that if thesituation does not improve within 6 months, loans may be suspended.When acceptable APA/AFS are not received within 12 months after thedue dates, ADB may suspend the loan.Mainbody.pmd5208/11/2006, 1:46 PM Financial Reporting and Auditing 53Auditor Reports and Opinions5.82.ADB requires the borrower and the projectEAs to have the required financial statements foreach year audited by an independent auditoracceptable to ADB, and in accordance withstandards on auditing that also are acceptable toADB. An audit of such financial statements includes:• Assessing the adequacy of accountingand internal control systems withrespect to project expenditures andother financial transactions, and toensure safe custody of project financedassets.• Determining whether the borrower andEAs have maintained adequatedocumentation on all relevanttransactions.• Confirming that expendituressubmitted to ADB are eligible forfinancing and identification of anyineligible expenditures.• Confirming compliance with loancovenants and ADB’s projectmanagement requirements [5.6.1.1].5.83.An audit report must include: (i) title of theauditor; (ii) date of the report; (iii) addressee (EAand/or borrower); (iv) identification of the financialinformation audited; (v) a reference to auditingstandards or practices followed; (vi) an expressionof opinion, including a qualification; disclaimer ordeclining of an opinion, on the financial information;(vii) the auditor’s signature; (viii) auditor’s address;and (ix) date of signing of the report [5.6.2.2].ADB expects auditorreports to consider…… the adequacy ofsystems and recordkeeping …… the eligibility ofexpenditures …… and whether ADBrequirements have beenmetThe appendices illustrateour expectations ofauditor reports5.84.Appendix 10 and Appendix 11 provideexamples of typical auditor reports and unqualifiedMainbody.pmd5308/11/2006, 1:46 PM 54 Handbook for Borrowers on the Financial Management and Analysis of Projectsopinions for: (i) a nonrevenue-earning project, and(ii) a revenue-earning project. The auditor shouldappropriately restate each example whenqualifications or other modifications are necessary[5.6.2.3].5.85.Audited Financial Statements provided toADB in accordance with a loan agreement shouldbe accompanied by the report of the auditor thatcontains their opinion on the financial statements[5.6.2.4].Audit reports shouldindicate auditcoverage…5.86.The auditor should indicate whether anyattached supplementary financial statements andNotes to the Financial Statements have beensubjected to the same auditing procedures as in thecase of the basic financial statements [5.6.2.6].… additional mattersshould be addressed inmanagement letters ordetailed reports5.87.Additional matters may be addressed in adetailed auditor’s report, where these are notaddressed in the Management Letter. Asexamples: (i) implementation of the auditor’srecommendations made in prior years audit reports;(ii) efficacy of, and improvements required inbudgetary control; (iii) reliability of field and financialcontrols; and (iv) any payroll, procurement, orinventory problems [5.6.2.7].The audit report shouldconsider reportingformats and bases …5.88.The auditor’s opinion for a project shouldrefer to the reporting format agreed between theborrower and ADB, noting the basis of accountingfollowed (e.g., cash basis) [5.6.2.8].5.89.The auditor ’s opinion for a revenueearning entity, including a commercial type entityin the private sector, should refer to the accountingstandards adopted and any significant departuresfrom IASs, with a reference to a quantified impactof such departures on the Balance Sheet and theMainbody.pmd5408/11/2006, 1:46 PM Financial Reporting and Auditing 55Income Statement prepared by the EA in the Notesto the Financial Statements. An example of theabove would be where government regulationslegislate the basis for bad debt provision rather thanrelying on an actual assessment [5.6.2.9].5.90.Borrowers and EAs enter into financialperformance covenants with ADB. The auditor isrequired to confirm, or otherwise, compliance witheach financial covenant contained in the legaldocuments for the project. The auditor should alsoindicate, where present, the extent of anynoncompliance, by reference to the specified(required) and actual performance measurementsfor each financial covenant for the financial yearconcerned [5.6.4].… and indicate theextent of noncompliancewith financial covenants5.91.Borrowers and EAs enter into agreementwith ADB in the loan documents to provide allappropriate financial management, accounting andfinancial reporting requirements necessary tosupport effective management of the project. Theauditor should also indicate the extent of anynoncompliance with the loan agreement, byreference to the specified (required by the loandocuments) and actual performance of theborrower in respect of these ADB requirements forthe financial year concerned [5.6.5].Auditors should alsoindicate any othernoncompliance with ADBrequirementsUse of Technical Experts5.92.For certain types of expenditures to befinanced from ADB loans, the auditor may need torely on an independent technical expert whonormally would be engaged by the EA. An examplewould be civil works executed by the regular laborforce of an entity (e.g., “force account” carried outby the Ministr y of Works); or fixed-pricereimbursements for measured units of work to besupervised by independent experts such as anMainbody.pmd55Where auditors rely onthe work of technicalexperts …08/11/2006, 1:46 PM 56 Handbook for Borrowers on the Financial Management and Analysis of Projects… appropriatecertification should beprovidedengineering or architectural firm. In addition to thenormal responsibility of such experts to check thatthe work is performed in accordance with the plansand specifications, an appropriate certification bythe expert of the value of the work executed mustbe acceptable to ADB [5.6.8.1].The auditor’s reportshould state anydissatisfaction with thework of technical experts…5.93.The acceptability of the certification woulddepend on the independence and competence ofthe firm and its staff engaged in the verification. Sucha certification, where used, should normally beattached to the related documentation supportingthe expenditure. Any dissatisfaction with the workof the expert that concerns the auditor should bestated in the auditor’s report [5.6.8.2].… and identify extent ofreliance that was placedon technical experts5.94.The content of the certificate might covermatters such as whether the goods and serviceswere procured, received, paid for and used in theproject in conformity with the loan agreement. Inthe above instances, the auditor should include anote under the scope paragraph of the opinion,stating the extent and amount involved with respectto their reliance on the technical expert (who shouldbe identified and expertise noted in the Notes to theFinancial Statements prepared by the EA) [5.6.8.3].Statements of Expenditure and Imprest AccountsAudit opinions mustconsider SOEs andImprest Accounts, wherethese are used5.95.Where the legal agreement of a projectrequires the separate audit of the SOEs and theImprest Accounts, respectively, additionalparagraphs should be included in the audit opinionof the project:• referring to the SOE financialstatement, certifying to the eligibility ofthose expenditures against which SOEdisbursements were made; andMainbody.pmd5608/11/2006, 1:46 PM Financial Reporting and Auditing 57• referring to the Imprest Accountfinancial statements attached [5.6.9.1].Audit Management LettersMainbody.pmd5.96.ADB requires auditors to provide amanagement letter with reference to the EA. This isa report on the internal controls and operatingprocedures of the entity, covering all aspects includedduring the normal course of the audit. Because anauditor is unlikely to cover all activities of a clientduring an annual audit, the management letter mayaddress only those specific matters that came to theattention of the auditor during the review [5.6.10.1].ADB requires amanagement letter oninternal controls andoperating procedures5.97.The borrower and the auditor may agreeat the commencement of the audit on particularsubjects (including those at the request of ADB) tobe included in the TOR and addressed in themanagement letter. These may include the reviewof compliance with financial covenants, and actualversus planned performance indicators. However,it should be the prerogative of the auditor to addressany matter not agreed upon, but which, in theauditor’s opinion, should be drawn to the borrower’sattention. In addition, the auditor should commenton all significant variations between the PMR andthe annual Audited Financial Statements [5.6.10.2].Although the TOR shouldidentify the managementletter’s focus andscope …5.98.ADB wishes to review all managementletters. The EA should provide copies of themanagement letter to ADB at the same time as theaudited annual financial statements are issued[5.6.10.4].management letters mustbe provided to ADB withthe audited financialstatements57… this should notconstrain the auditorfrom commenting onother matters08/11/2006, 1:46 PM 58 Handbook for Borrowers on the Financial Management and Analysis of ProjectsADB Assistance to Improve Accountingand AuditingFinancing of Audit ExpendituresThe incremental costs ofannual audits are eligiblefor ADB financing5.99.The costs of annual audits may beincluded in project costs and are eligible for ADBloan financing for those borrowers for whom theaudit costs are incremental (i.e., without the projectthey would not be incurred). For other borrowers,where only part of the audit costs are incremental—particularly auditing to ADB standards, reporting oncompliance with loan covenants or for thoseborrowers that may require foreign exchange for thepurpose—these audit costs may be financed toensure that ADB will receive an auditor’s opinionand report that accord with ADB requirements.Capacity Building in Project AccountingADB will considersupporting improvementsin accounting andauditing systems …5.100.Wide disparities exist in accounting andauditing standards and capacity among borrowers.To help borrowers avoid difficulties in meeting ADB’srequirements, specific accounting and reportingrequirements to ensure proper project financialmanagement are discussed with the borrower andEAs and reflected in the loan covenants of the loanagreement. If accounting and auditing systems arefound unacceptable, corrective measures may betaken using either ADB TA funds (if available) or withsupport from other assistance agencies.… we also arrangetraining for projectaccountants who areunfamiliar with ourrequirementsMainbody.pmd5.101.Hands-on training for preparing projectaccounts is arranged for project accountants if theyare unfamiliar with ADB’s accounting and auditingrequirements. The cost may be included in the loanamount.5808/11/2006, 1:46 PM 6. Financial InstitutionsIntroduction6.01.Financial institutions (FIs) includecommercial banks and other financial institutions.ADB previously referred to FIs as developmentfinance institutions (DFIs). The World Bank and theAfrican Development Bank refer to FIs as financialintermediaries. They are also known by sectoraltitles, such as agricultural development banks(AgDBs), industrial development banks (IDBs) andhousing development banks (HDBs), or asdevelopment financial intermediaries, microfinanceinstitutions (MFIs) and microfinance intermediaries[6.1.2].Financial institutions,such as commercialbanks, act asintermediaries to provideloans and equity toorganizationsGeneral Approaches and Expectations6.02.ADB expects FIs to generate an interestrate spread (the difference between lending andborrowing rates) that covers all operating costs,including provisions for bad and doubtful debts, andin appropriate circumstances provides a profit. ADBcan support FI operations in both the public and theprivate sectors [6.1.3].ADB expects FIs togenerate an adequateinterest rate spread6.03.In general, ADB-supported FI loans aim toremove or substantially reduce the use of directedcredits, as these lead to resource allocation outsidemarket mechanisms [6.2.4.1].6.04.However, ADB may support directed-creditprograms to promote sustainable financing—forsectors such as microfinance institutions or the ruralMainbody.pmd59In certain situations, ADBmay support directedcredit programs …08/11/2006, 1:46 PM 60 Handbook for Borrowers on the Financial Management and Analysis of Projectssector—provided they are accompanied by reformsthat address underlying institutional problems andany market imperfections that inhibit the marketbased flow of funds to those sectors [6.2.4.3–6.2.4.4].… or programsinvolving subsidies6.05.ADB only supports programs involvingsubsidies if they (i) are transparent, targeted, andcapped; (ii) are funded explicitly through thegovernment budget or other sources subject toeffective control and regular review; (iii) are fiscallysustainable; (iv) do not give an unfair advantage tosome FIs over other qualified and directly competinginstitutions; and (v) are economically justified, orcan be shown to be the least-cost way of achievingpoverty reduction objectives [6.2.5.1].ADB Approach to FI Reviews andMonitoringBefore providing supportto FI operations …6.06.ADB appraises proposed FI loans to ensurethat their objectives include (i) supporting reformprograms in the financial sector or related real sectors;(ii) financing real sector investment needs;(iii) promoting private sector development;(iv) helping to stabilize, broaden, and increase theefficiency of financial markets and their allocation ofresources and services; (v) promoting thedevelopment of the participating FIs; and(vi) supporting poverty reduction objectives [6.3.2.4].… ADB considers theextent to which FIoperational performanceis effective, efficient andsustainable6.07.ADB reviews an FI’s operationalperformance to assess its ability to (i) deliversubloans to achieve defined country or sectoreconomic objectives; (ii) efficiently recoversubloans; and (iii) cover all operating costs andmake a reasonable profit on the invested capital. FIshave numerous forms of performance indicatorsthat can provide an understanding of past andongoing performance [6.2.1.2].Mainbody.pmd6008/11/2006, 1:46 PM Financial Institutions 616.08.At least once each year duringimplementation, ADB will conduct a formal reviewof the condition and performance of participatingFIs—including a review of their Audited FinancialStatements—to determine their continuedcompliance with eligibility criteria [6.3.4.5.4].… and monitorsperformance duringimplementationAssessing FI PerformanceIntroduction6.09.Suitable indicators for measuring FI performance include, among other things,(i) adequacy of capital; (ii) quantity and quality ofearnings; (iii) quality of assets; (iv) sufficiency of liquidity; (v) extent of subsidy dependence;(vi) effectiveness of FI loan administration (appraisal, supervision, and collection performance);and (vii) adequacy and timeliness of audited financial statements [6.3.4.5.3].6.10.The most important criteria fordetermining the appropriateness of an FI to act as afinancial intermediary are its solvency, profitabilityand liquidity. In this respect, the Basel Committee2on Banking Supervision of the Bank of InternationalSettlements provides guidance in assessing an FI[6.4.1.3].The most importantcriteria for determining FIperformance aresolvency, profitability andliquidityAssessing Microfinance Institutions6.11.The World Council of Credit Unionsrecommends a set of financial ratios coveringProtection, Effective financial structure, Asset quality,Rates of return and costs, and Liquidity and Signs ofgrowth (PEARLS) to monitor the financial stabilityof credit unions, including MFIs. The PEARLS2Mainbody.pmdFurther information on the Basel Committee can be found at http://www.bis.org.6108/11/2006, 1:46 PM 62 Handbook for Borrowers on the Financial Management and Analysis of Projectsmethodology is specifically designed for evaluatingcredit unions [6.4.2.1].3Assessing FI RisksADB’s main concern isthat FIs manage their riskexposure6.12.ADB’s main concern is that FIs managetheir exposure to potential risks. Capital markets aredynamic—their activities can generate rapid anddangerous movements that need to be anticipatedand managed. The ability of traditional performancemeasurement criteria to indicate declining or poorFI performance is limited [6.4.4.1.1].ADB will seek to identifypotential risks to whichan FI is exposed …6.13.Furthermore, in many cases, the FIs thatADB deals with are attached to the public sector andhave multiple objectives (e.g., sectoral developmentobjectives in addition to profitability objectives). Therisk factors associated with these FIs are likely to bemore significant than for single-objectivecommercial banks. Consequently, ADB will seek to(i) identify the principal potential risks that an FI isexposed to and (ii) agree an appropriate set ofindicators that will provide FI management and ADBwith an early warning of problems [6.4.4.1.3].… and agree anappropriate set ofindicators to monitorthese risksThe major FI-related risksinclude market,exchange, maturity, andcontagion risk6.14.• market risk—the potential that aborrower or counterparty will fail toperform on an obligation [6.4.4.2.1];• exchange risk—the potential changesin assets and liabilities caused byforeign exchange movements[6.4.4.3.1];• maturity risk—the mismatching ofinvestments and borrowing operations[6.4.4.4.1]; and3Mainbody.pmdThe major FI-related risks include62Further information on the PEARLS methodology can be found atwww.woccu.org.08/11/2006, 1:46 PM Financial Institutions 63• contagion risk—contagion can arise inregions, in countries, in regions withincountries, or within a class or categoryof financial institutions [6.4.4.5.1].6.15.Financial sector supervisors and regulatorsare best able to identify, anticipate, and avoidcontagion risk. They should monitor the financialsectors and economic developments with theobjective of providing early warnings, not only tofinancial institutions, but also to ministries witheconomic management responsibilities [6.4.4.5.3].Specialized FI Internal Controls6.16.Internal controls for FIs (i) shouldcomprise a set of rules and procedures designed toprovide qualitative standards that complementquantitative risk analyses; (ii) are becomingincreasingly employed by banks and securitiesinstitutions; (iii) should be used to internally manageoperational risk, agency risk, and legal risk; and(iv) should be exercised by an independent controlunit reporting to the board of directors that has nooperating linkages with risk-creating tradingactivities [6.4.6.1].6.17.ADB expects FIs to establish and maintainan appropriate risk management environment by,for instanceADB will seek assurancethat appropriate internalcontrols are in place• requiring transparency of reports anddocumentation of the risk controlprocess,• monitoring the content and theefficiency of the vertical and horizontalinformation flows,• monitoring and reporting onaccountability,Mainbody.pmd6308/11/2006, 1:46 PM 64 Handbook for Borrowers on the Financial Management and Analysis of Projects• ensuring remuneration policy rewardsefficient risk management through highreturns and minimum risk,• monitoring observance of trading limitsand market procedures,• establishing rules for dealing withchanges in volatilities,• testing the soundness of models,• examining the quality and uniformityof data input, and• validating and back-testing procedures[6.4.6.2].FI Reporting and Auditing IssuesIntroductionFinancial reporting andauditing requirements forFIs are also specialized6.18.Financial reporting by, and audits of, FIsrequire individual specifications for each institutionso that financial reporting and auditing requirementswill be appropriate to the type, nature, and form ofthe institution [6.6.1.1].6.19.For example, an industrial FI and an MFIhave few common characteristics and the reportingrequirements and the auditing specifications willdiffer sharply [6.6.1.2].Financial Reporting… additional financialstatements will generallybe required6.20.In addition to the standard statements(Balance Sheet, Income Statement and Cash FlowStatement), an FI will generally be required toprovide the additional statements listed below. Thislisting is not all-inclusive and may be amended toaddress the objectives and operations of theparticular FI:• The income statement and balancesheet adjusted for subsidies;Mainbody.pmd6408/11/2006, 1:46 PM Financial Institutions 65• Portfolio Report for current and past 2years;• Portfolio Report showing aging ofreceivables (arrears);• Portfolio Report showing aging ofportfolio at risk;• Portfolio Report showing market andsectoral exposure;• Capital Adequacy Analysis;• Assets Structure by Income;• Related party transactions; and• Table of Contingencies, Guarantees,Commitments showing correspondingsecurities and collateral [6.6.2.2].FI Auditing6.21.ADB expects that the TOR for an FI auditwill be tailored to the particular FI. For instance, theTOR for a commercial bank audit will differ fromthose for an MFI audit. Moreover, auditors shouldhave appropriate experience in auditing theparticular FI [6.6.3.1].ADB expects that auditorsof FIs will haveappropriate experience6.22.In addition to the standard requirementsfor auditor selection and appointment (see part 5),including providing a report and an opinion on theannual financial statements, the auditor should berequired to include in the report confirmation, orotherwise, that the additional financial statementsand performance indicators can be relied on[6.6.3.2].Mainbody.pmd6508/11/2006, 1:46 PM Mainbody.pmd6608/11/2006, 1:46 PM Appendix 1 67Appendix 1 Contents of the GuidelinesThis appendix presents the Guidelines’ contents for information andreference purposes (see paragraph 1.02, page 1).1. Introduction to the Guidelines1.1. Introduction1.2. Rationale1.3. Objectives1.4. Structure1.5. Project File1.6. Guideline Updates1.7. Roles of Financial AnalysisSpecialists and FinancialManagement Specialists2. User Instructions2.1. Overview2.2. ADB Lending and TechnicalAssistance2.3. Applying these Guidelines2.4. Project Types and GeneralTreatments2.5. An Overview of Project ProcessingSteps2.6. Step 1: Identification and EarlyPreparation2.7. Step 2: Loan Preparation2.8. Step 3: Project Examination2.9. Step 4: Loan Negotiations2.10. Step 5: Project Implementation2.11. Step 6: Project Completion3. Preparing and Appraising InvestmentProjects3.1. Investment Projects Overview3.2. Possible Investment Projects3.2.1. Possible Revenue-EarningProjects3.2.2. Possible NonrevenueEarning Projects3.3. Appraisal Checklists3.4. Forecasting3.4.1. Introduction to Forecasting3.4.2. Using the COSTAB Model3.4.3. Preparing Project CostEstimates3.4.4. DeterminingContingencies3.4.5. Disbursement Profiles3.4.6. Preparing Financing Plans3.4.7. Computing IncrementalProject Cash Flows3.5. Preparing Financial Benefit-CostAnalyses3.5.1. Introduction3.5.2. Determining the DiscountRate -WACC3.5.3. Calculating the FinancialInternal Rate of Returnand Net Present Value3.5.4. Undertaking Sensitivityand Risk Analyses3.6. Loan Covenants3.6.1. Introduction to LoanCovenants3.6.2. Operating Covenants3.6.3. Capital Structure Covenants3.6.4. Liquidity Covenants3.7. ADB Reports3.7.1. Introduction to ADB Reports3.7.2. Project PreparatoryTechnical Assistance Stage3.7.3. Report and Recommendationof the President3.7.4. Miscellaneous ADB Reports4. Financial Management of ExecutingAgencies4.1. Financial Management Overview4.2. Institutions and Systems4.2.1. Introduction to Institutionsand Systems4.2.2. Major InstitutionalAssessments4.2.3. Governance4.2.4. Financial Managementand GovernanceArrangement4.2.5. Country Diagnostic Studiesof Accounting andAuditing4.2.6. Executing Agencies4.2.7. Project Objectives4.2.8. Revenue-Earning Projects4.2.9. Nonrevenue-EarningProjects4.3. Financial Analysis4.3.1. Introduction to FinancialAnalysis 68 Handbook for Borrowers on the Financial Management and Analysis of Projects4.3.2. Financial AnalysisObjectives4.3.3. Linkages with CostRecovery and Tariffs4.3.4. Preparing Financial Tables4.3.5. Determining Fiscal PeriodCoverage4.3.6. Forecasting and FinancialProjections4.3.7. Forecasting Assumptions4.4. Measuring Performance4.4.1. Introduction to MeasuringPerformance4.4.2. Objectives of MeasuringPerformance4.4.3. Performance Indicators4.4.4. Using BenchmarkingIndicators4.4.5. Selecting Indicators andCovenants4.4.6. Operating Indicators andCovenants4.4.7. Capital StructureIndicators4.4.8. Liquidity Indicators5. Reporting and Auditing5.1. Financial Reporting and AuditingOverview5.2. Accounting Standards and Policies5.2.1. Introduction5.2.2. International AccountingStandards5.2.3. ADB Accounting PolicyRequirements5.3. Financial Reporting5.3.1. Introduction5.3.2. Content and Timing ofFinancial Reporting5.3.3. Accounting Statementsand Financial Reports5.3.4. Interim FinancialStatements and the ProjectManagement Report5.3.5. Audited Project FinancialStatements5.3.6. Annual Financial Statementsfor a Nonrevenue-EarningProject5.3.7. Annual Financial Statementsfor Revenue-Earning Projectsand EAs5.3.8. Supplementary FinancialStatements5.3.9. Designing FinancialReports for RevenueEarning Projects5.3.10. Designing Financial Reportsfor Nonrevenue-EarningProjects5.3.11. Examples of Model FinancialStatements5.4. Auditing Standards and AuditorEngagement5.4.1. Introduction5.4.2. ADB Requirements5.4.3. Auditing Procedures5.4.4. Auditor Selection andAppointment5.4.5. Issues in Auditor Selection5.4.6. Selecting Auditors5.4.7. Terms of Reference for anAuditor5.4.8. Contract or EngagementLetter of Auditor5.4.9. International Standards onAuditing5.4.10. Government Auditors5.5. Reviewing Financial Reports5.5.1. Introduction5.5.2. The Review Process: Lateor Unacceptable FinancialReports5.5.3. Compliance With FinancialPerformance Covenants5.5.4. Communication withGovernment Auditors5.6. Reviewing Auditors’ Reports5.6.1. Introduction5.6.2. Auditors’ Reports andOpinions5.6.3. Model Audit Opinions5.6.4. Compliance with LoanCovenants5.6.5. Compliance with ADB’sRequirements5.6.6. Types of Auditors’ Opinion5.6.7. Materiality5.6.8. Use of Technical Experts5.6.9. Statements of Expenditureand Imprest Accounts5.6.10. Reviewing AuditManagement Letters5.6.11. Audit ReportQuestionnaire Appendix 1 696. Financial Institutions6.1. FI Introduction and Overview6.2. Reviewing FI Financial Management6.2.1. General OperationalIssues6.2.2. Policy Framework for FIsand FI Loans6.2.3. Treatment of Interest RateDistortions6.2.4. Treatment of DirectedCredit Programs6.2.5. ADB Policy on Subsidies6.2.6. Eligibility Criteria for FIs6.3. FI Investments6.3.1. Introduction6.3.2. Investing in FIs6.3.3. Selecting ParticipatingInstitutions6.3.4. Appraising an FI Investment6.4. Assessing FI Performance6.4.1. Introduction6.4.2. Assessing MicrofinanceInstitutions6.4.3. Applying the CAMELFramework6.4.4. Assessing FI Risks6.4.5. Determining FI CreditRatings6.4.6. Specialized FI InternalControls6.5. Appraisal Checklist6.6. FI Reporting and Auditing Issues6.6.1. Introduction6.6.2. FI Financial Reporting6.6.3. FI Auditing6.6.4. MFI Financial Reportingand Auditing7. Knowledge Management7.1. Useful Websites7.2. Operations Manual7.3. Project Administration Instructions7.4. International Standards7.5. International Accounting andAuditing Architecture7.6. Financial Review Checklist for RRPs7.6.1. Lessons from Past Projects7.6.2. Project Cost Estimates7.6.3. Financing Plan7.6.4. Executing Agencies andImplementing Agencies7.6.5. Financial Projections7.6.6. Financial Analyst7.6.7. Project Justification7.6.8. Accounting and Auditing7.6.9. Procurements andDisbursement Arrangements7.6.10.Finance-Related Risk7.6.11.Assurances7.7. Appraisal Checklist: NonrevenueEarning Project7.8. Appraisal Checklist: RevenueEarning Project7.9. Appraisal Checklist: Private SectorProject7.10. Appraisal Checklist: FinancialInstitution7.11. Undertaking Sensitivity and RiskAnalyses7.11.1.Step 1: Identify the KeyVariables7.11.2.Steps 2 and 3: CalculateEffects of Changing Variables7.11.3.Step 4: Analyze KeyVariable Changes7.11.4.Undertaking Risk Analysis7.12. Model Operating Covenants7.12.1.Rate of Return (see 3.6.2.2)7.12.2.Self-Financing Ratio(see 3.6.2.3)7.12.3.General Price Level(see 3.6.2.4)7.12.4.Operating Ratio (see 3.6.2.5)7.12.5.Breakeven Covenant(see 3.6.2.6)7.13. Model Capital Structure Covenants7.13.1.Debt Service Coverage(Version A: HistoricalOrientation) (see 3.6.3.3)7.13.2.Debt Service Coverage(Version B: Forecastorientation) (see 3.6.3.3)7.13.3.Debt-Equity Ratio(see 3.6.3.4)7.13.4.Capital Adequacy Ratio(see 3.6.3.6)7.14. Model Liquidity Covenants7.14.1.Current Ratio (see 3.6.4.2)7.14.2.Quick Ratio Covenant(see 3.6.4.3)7.14.3.Dividend Limitation(see 3.6.4.4)7.15. Commonly Used Ratios7.15.1.Operating Indicators7.15.2.Capital Adequacy Indicators7.15.3.Liquidity Indicators 70 Handbook for Borrowers on the Financial Management and Analysis of Projects7.16. Model Financial Statements:Service Organization7.17. Model Financial Statements:Manufacturing Organization7.18. Model Terms of Reference for anAuditor7.19. Audit Report Questionnaire7.19.1. Using the Audit ReportQuestionnaire7.19.2. Authenticity, Form, andTimeliness7.19.3. Audit Opinion7.19.4. Matters Addressed7.19.5. Auditor’s Opinion andReport7.19.6. Conclusion and FurtherAction (if any)Knowledge Management – AddendumRevisionsGlossaryTopical Index Appendix 2 71Appendix 2 Project Investment PlanParagraph 3.05 (page 8) refers to this appendix.Std. CodeTotalCOMPONENTS ***03060912151821242730Base CostCivil WorksSurvey, Investigation, Design, MappingResearch and Development (Extension and Demonstration)Institutional Development and StrengtheningEquipment, Vehicles and Furniture (Purchase and Maintenance)MaterialsConsulting ServicesTraining and FellowshipsOperations and MaintenanceFinancing of Nongovernment Organizations (NGOs)– Implementation Assistance– Land– Capital Goods– Incremental Administrative Costs– Initial Working Capital– Taxes and Duties0.000.000.000.000.000.000.000.000.000.000.000.000.000.000.000.00Base Costs as at...(date)…0.00Contingencies ***878481PhysicalPriceOther (Identify)0.000.000.00SUB-TOTAL0.00Financing Charges During Development***6669InterestOther0.000.00TOTAL PROJECT COST AND FINANCING REQUIRED0.00*** Footnotes to be used as necessary, particularly for contingencies’ explanation and rates used forcalculating financing changes. 72 Handbook for Borrowers on the Financial Management and Analysis of ProjectsAppendix 3 Project Financing PlanParagraph 3.15 (page 10) refers to this appendix.Total%Funds RequiredProposed ProjectCapital expendituresOperating expendituresInterest during construction0.000.000.00TOTAL PROJECT REQUIREMENTS0.00100Sources of FundsProposed ADB loanOther loansEquity or capital contributionsGovernmentOther sources0.000.00Subsidies for operationsInternal cash generation0.000.00TOTAL SOURCES0.000.000.00100 Appendix 4 73Appendix 4 Example of Accounting PoliciesParagraph 5.05 (page 22) refers to this appendix. The following tableprovides guidance on General Accounting Policies. Particular accountingpolicies should set out the policies applicable to revenues, expenses, assetsand liabilities. A model set of IAS-based accounting policies and financialstatements is available at www.iasplus.com. An IAS disclosure checklistis also available from this website.IssueDetailsExampleReporting EntityThe accounting policiesshould clearly define thereporting entity.These are the consolidated financialstatements of ABC Limited and itssubsidiaries: DEF Limited, GHI Limitedand JKL Limited.Reporting PeriodThe reporting period shouldbe stated.These financial statements apply tothe financial year ended 31 December20X2.Legislative BasisThe legal basis under whichthe financial statementshave been prepared shouldbe clearly stated.These financial statements have beenprepared in accordance with Article 123of the Companies Act 20X1.AccountingPolicy BasisThe accounting policy basisshould be stated.These accounting policies are basedupon the International AccountingStandards (IASs) issued by theInternational Accountants StandardsBoard (IASB) as at 30 September20X2. Where no IAS has been issuedon specific topics, the accounting policyis based on other authoritative sources.MeasurementBaseThe measurement baseused to prepare the financialstatements should bedescribed.These financial statements have beenprepared using the accrual basis ofaccounting. The measurement baseapplied is historical cost adjusted forrevaluation of assets.Changes inAccountingPoliciesChanges in accountingpolicies should be noted.There have been no material changes inaccounting policies during the financialyear.Going ConcernThere should be a clearstatement as to whetheror not the entity is a goingconcern.The financial statements have beenprepared on a going concern basis. 74 Handbook for Borrowers on the Financial Management and Analysis of ProjectsIssueDetailsExampleIndirect Taxesand DutiesThe treatment of indirecttaxes and duties should beclearly stated.Revenue and expense items arerecognized net of Value Added Tax (VAT).The net amount receivable in respectof VAT is included as part of accountsreceivable. Assets are recorded net ofVAT if the tax is recoverable.ComparativesWhere there have beenchanges of format orpresentation from oneaccounting period to thenext, comparatives shouldbe restated, and that factdisclosed in the Notes tothe Financial Statementstogether with any explanationnecessary for the readerto understand the changeswhich have occurred.Where there is any change of formator presentation from one accountingperiod to the next, comparatives are tobe restated, and that fact disclosed inthe notes to the financial statementstogether with any explanation necessaryfor the reader to understand thechanges that have occurred.Basis ofCombination(Consolidation)Where consolidated financialstatements have beenprepared, the combinationbasis should be stated.Controlled entities are consolidatedusing the purchase method ofcombination. Corresponding assets,liabilities, revenues and expenses areadded together line by line. Transactionsand balances between these subentities are eliminated on combination.Related PartiesThe policy applied to thedisclosure of related-partytransactions should bestated.There were no related-party transactionsduring the financial year.Foreign CurrencyThe basis for recordingforeign currency transactionsand translating thesetransactions and balancesshould be stated.Foreign currency transactions aremeasured and recorded in UnitedStates dollars (US$) using the exchangerate in effect at the date of thetransaction. However, where short-termtransactions are covered by a forwardexchange contract, the forward ratesspecified in those contracts have beenused to translate the transactions intoUS$. At the end of each reportingperiod any foreign currency monetarybalances (money being held and assetsand liabilities to be received or paid inmoney) have been translated into US$using the spot exchange rate in effecton that date. Exchange differences,arising when there is a change in theexchange rate between the transactiondate and the date of settlement, havebeen recognized as either revenues orexpenses. Appendix 5 75Appendix 5 Sample Project Monitoring ReportThis appendix presents sample PMR formats (see paragraph 5.37 on page 29).Government of Pacifica: Education Sector Improvement ProjectCash Receipts and PaymentsAsian Development Bank (ADB) Loan No. 1234-ATLFor the Quarter ended 31 March 2003(Pp ’000s)aQuarterCash ReceiptsGovernment FundsADB Funds24,000129,795Total FinancingLess: Expenditures byComponentInstitutional StrengtheningIncreasing AccessTeacher DevelopmentProject DevelopmentOther (including Loan Fee)260,000623,245153,79594,69560,0002,5001,600..Total ExpendituresReceipts Less ExpendituresAdd: Foreign Exchange DifferenceNet Change in CashOpening Cash balancesLocal Currency Bank AccountForeign Currency Bank AccountCumulativeForecast:Next 6 months75,000175,000883,245569,045220,00017,4506,50012,250250,000185,00024,2515,5002,95212,000158,795825,245229,703-5000-100058,000-1400020,297..-600044,00020,2972,00048,000....4,00040,000Total Opening CashAdd: New Change in Cash50,000-6000..44,00044,00020,297Net Cash Available44,00044,00064,297Closing Cash BalancesLocal Currency Bank AccountForeign Currency Bank AccountTotal Closing Cash Balances4,00040,0004,00040,00044,00014,29750,00044,00064,297Pp = Pacific Pesos.Notes: a The following rates were used for conversion:– Opening balance of Foreign Currency Bank Account in Quarter: US$1 = PPs14:7.– ADB fund received and any foreign currency expenditures made are converted at the rate ofexchange on the date of the transaction. The weighted average of these rates since projectinception is approximately 14.5.– Closing balance of Foreign Currency Bank Account: US$1 = PPs14.9. 76 Handbook for Borrowers on the Financial Management and Analysis of ProjectsAppendix 6 Model Financial Statements: Service OrganizationParagraph 5.46 (page 31) refers to this appendix. This model setof summary financial statements is appropriate for use by a service-typeorganization. When using these financial statements it is essential that:(i) an appropriate Statement of Accounting Policies be developed andagreed between ADB and the borrower; (ii) appropriate Notes to theFinancial Statements supplement the financial statements; and (iii) whereappropriate, the Financial Statements should be tailored so that theyadequately reflect the organization’s performance and position.The format used for this particular model set of summaryfinancial statements is appropriate for forecasting (projecting) financialstatements (for instance, during project preparation).Example Service OrganizationForecast Income Statements[Format for financial projections] for the years ended 31 December($’000)NotesOperating RevenuesRevenues from servicesInvestment income1Other operating revenue20X1Actual20X2Actual20X3Actual20X4Actual20X5Actual20X6Forecast20X7Forecast35,0521,15736,7481,07339,2881,12641,2021,24341,2021,24341,2021,24341,2021,24331733227926926926926936,52638,15340,69342,71442,71442,71442,714Operating ExpensesWages, salaries and employee benefitsSupplies and consumables usedRepairs and maintenanceDepreciation and amortization expenses12,9604,0221,00079113,3634,2851,00087213,9754,5821,00091814,5044,6871,00092614,5044,6871,00092614,5044,6871,00092614,5044,6871,000926Other operating expenses18,67720,39520,60121,28021,28021,28021,28037,45039,91541,07642,39742,39742,39742,397Surplus/(Deficit) from Operating ActivitiesProject-related interest costsOther interest costsGains on sale of fixed assets-9242,373....-1,7622,527....-3832,588....3172,512....3172,512....3172,512....3172,512....Total non-operating expenses2,3732,5272,5882,5122,5122,5122,512Surplus/(Deficit) from Ordinary Activities1,4497652,2052,8292,8292,8292,829..............1,4497652,2052,8292,8292,8292,829Minority interest share of surplus/(deficit)Net surplus/(deficit) before extraordinary itemsExtraordinary items..............Income tax expense..............1,4497652,2052,8292,8292,8292,829Net Surplus/(Deficit) for the Year after Tax Appendix 6 77Example Service OrganizationForecast Balance Sheets[Format for financial projections] as at 31 December($’000)NotesCurrent AssetsCash and cash equivalentsMarketable securitiesReceivablesInventoriesWork in progressInvestmentsLess: Current LiabilitiesPayables and provisionsShort-term borrowingsCurrent portion of borrowingsEmployee benefitsWORKING CAPITALPlus: Non-current AssetsInvestmentsProperty, plan and equipmentIntangible assetsLess: Non-current LiabilitiesPayablesBorrowingsEmployee benefitsNet AssetsEQUITYIssued and paid-up capitalReservesAccumulated surpluses/(deficits)Total Equity20X1Actual20X2Actual20X3Actual20X4Actual20X5Actual20X6Forecast20X7Forecast21010,4405,5202743,9959311,2795,4903294,768979,9295,5593485,5191009,4735,5933796,0321009,4735,5933796,0321009,4735,5933796,0321009,4735,5933796,0323383419542,2102,2102,2102,21020,77722,30022,40623,78723,78723,78723,7874,7162,2367,2084,5882,4137,6484,4282,4137,5334,4012,4137,5284,4012,4137,5284,4012,4137,5284,4012,4137,52883285785785685685685614,99215,50615,23115,19815,19815,19815,1985,7856,7947,1758,5898,5898,5898,58914,39225,25215,20425,86116,10225,78716,93025,85116,93025,85116,93025,85116,93025,85123028301,3221,3221,3221,32239,64641,36742,71944,10344,10344,10344,10352428,83351030,59149230,13148930,11348930,11348930,11348930,1137,4917,7107,7167,7067,7067,7067,70636,84838,81138,33938,30838,30838,30838,3088,5839,35011,55514,38414,38414,38414,3841,0007,2011,0007,1901,0007,1901,0007,1901,0007,1901,0007,1901,0007,1903821,1603,3656,1946,1946,1946,1948,5839,35011,55514,38414,38414,38414,384 78 Handbook for Borrowers on the Financial Management and Analysis of ProjectsExample Service OrganizationForecast Cash Flow Statements[Format for financial projections] for the years ended 31 December($’000)NotesOPERATING CASH FLOWSReceiptsCash receipts from customersOther receiptsPaymentsEmployeesSuppliersOther payments20X1Actual20X2Actual20X3Actual20X4Actual20X5Actual20X6Forecast20X7Forecast34,79334136,60326539,17728941,11827941,11827941,11827941,118279-12,615-19,750-13,043-20,920-13,428-20,848-13,917-21,167-13,917-21,167-13,917-21,167-13,917-21,167-369-490-1,088-1,684-1,684-1,684-1,684Net Cash Flows from Operating Activities 22,4002,4154,1024,6294,6294,6294,629INVESTING CASH FLOWSReceiptsInterest receivedSales of fixed assetsSales of investmentsPaymentsInterest paid1,0702501,98383512557834681,07190159244901592449015924490159244-2,507-2,516-2,561-2,502-2,502-2,502-2,502Purchases of fixed assetsPurchases of investments-1,469-130-2,459-55-2,808-102-3,181-98-355-98-355-98-355-98-803-4,013-3,498-4,577-1,751-1,751-1,751..275..1,477..353..56..56..56..56..-1,900......-953..-105..-105..-105..-105Net Cash Flows from Investing ActivitiesFINANCING CASH FLOWSReceiptsCapital contributions from ownersProceeds from new borrowingsPaymentsCapital withdrawalsRepayment of borrowingsDividends paid........-2,829-2,829-2,829-1,6251,477-600-49-2,878-2,878-2,8782308210493..97..100..100..100..Net increases/(decreases) for period-28-12143......Balances as at 31 December2109397100100100100Net Cash Flows from Financing ActivitiesCASH AND CASH EQUIVALENTSBalances as at 1 JanuaryCurrency changes on opening balances Appendix 6 79Example Service OrganizationNotes to the Financial Statements [Format for financial projections]for the years ended 31 December($’000)Note 1: Revenues by Service TypeService Type AService Type BService Type C20X1Actual20X2Actual20X3Actual20X4Actual20X5Actual37634,03535335,74837938,27438740,19538740,19520X6Forecast38740,19564164763562062062035,05236,74839,28841,20241,20241,2021,4497652,2052,829....-66-1,0702,507-87-8352,516..-8342,561..-9012,502............791-78723918..926..................Note 2: Reconciliation of Income Statement to Operating Cash FlowsNet Surplus/(Deficit) per Income StatementItems included in net surpluses but not innet cash flows from operations:Unrealized net foreign exchange gainsInterest receivedInterest paidAsset movementsDepreciationGains/(losses) on sales of assetsOther non-cash itemsMovements in employee benefit liabilitiesMovements in working capitalNet Cash Flows from Operations-9361108641,134-286-929-1,612-1,8612,4002,4154,1024,629 80 Handbook for Borrowers on the Financial Management and Analysis of ProjectsAppendix 7 Model Financial Statements:Manufacturing OrganizationParagraph 5.46 (page 31) refers to this appendix. This model setof summary financial statements is appropriate for use by a manufacturingtype organization. When using these financial statements, it is essentialthat: (i) an appropriate Statement of Accounting Policies be developedand agreed between ADB and the borrower; (ii) appropriate Notes to theFinancial Statements supplement the financial statements; and (iii) whereappropriate, the Financial Statements should be tailored so that theyadequately reflect the performance and position of the organization. Theformat used for this particular model set of summary financial statementsis appropriate for year-end reporting.Example Manufacturing OrganizationIncome Statement[Format for year-end reporting]for the year ended 31 December 20X2For the Year Ended 31 December 20X2Cumulative Since Project Start-DateActualNotes $’000Forecast$’000Variance$’000%Actual$’000Forecast$’000Variance$’000%SALES1893,1211,431,093-537,972-37.61,976,5222,173,098-196,576-9.0Less Cost of Goods Sold2813,6731,296,081482,40837.21,760,8231,932,016171,1938.9GROSS PROFIT79,448135,012-55,564-41.2215,699241,082-25,383-10.5Operating CostsAdministrative SalariesDepreciationAmortizationAdministration Costs27,3263,91712,35756,03737,7427,33512,35788,25910,4163,418..32,22227.646.60.036.539,9508,55412,35792,67241,5067,95312,35797,3061,556-601..4,6343.7-7.60.04.8Marketing Expenses3,1094,9851,87637.66,9047,5966929.1102,746150,67847,93231.8160,437166,7186,2813.8-23,298-15,666-7,63248.755,26274,364-19,102-25.71,000..1,080-1,570-801,570-7.4-100.01,166-1,5641,260-1,845-94281-7.5-15.2-22,298-42,672..-16,156-63,657..-6,14220,985..38.0-33.00.054,864-52,343..73,779-39,604..-18,915-12,739..-25.632.20.0OPERATING PROFITOther incomeForeign exchange gains/(losses)Net Income beforeInterest and TaxesProject-related interest expensesOther interest expensesIncome tax expenseNet Income after Interest and TaxesGross Margin (% of Sales)Operating Margin (% of Sales)......0.0..-8,189-64,970-79,81314,843-18.62,52125,986-23,4658,189 -100.0-90.38.9-2.69.4-1.1-0.5-1.5....10.92.811.13.4-0.2-0.6.... Appendix 7 81Example Manufacturing OrganizationBalance Sheet[Format for year-end reporting]as at 31 December 20X2Current AssetsCash and bankBills receivableAccounts receivableInventoriesFor the Year Ended 31 December 20X2Cumulative Since Project Start-DateNotesActual$’000Actual$’0003425,30856,11418,705365,150Prepayments and othercurrent assetsLess: Current LiabilitiesAccounts payableShort-term debtNotes and bills payableAdvances from customersAccrued wages and salariesTaxes payableAccruals and other currentLiabilitiesCurrent portion of term debtWORKING CAPITALPlus: Non-current AssetsFixed assetsCapital work in progress (Assets underconstruction)Intangibles and deferralsOther non-current assetsLess: Non-current LiabilitiesTerm loansPayablesOther non-current liabilitiesNET ASSETSForecast$’00010,37359,94319,981402,058Variance$’000%Forecast$’00034,08582,79127,597427,488Variance$’000-62,16591,02530,342455,796120,193120,193120,193120,193585,470612,548692,154635,19193,174207,6105,00013,084184,42772,607103,203207,6105,00013,084184,42772,648140,826207,6105,00013,084184,42772,890156,768207,6105,00013,084184,42781,16747,74947,74947,74947,7493,00013,57828,82471,070626,651647,299700,410766,875-41,181-34,751-8,256-131,684800,2631,222,024445,10849,426169,39037,06930,57215,5721,325,3691,444,055443,7007,646621,3497,6461,136,482 1,056,928520,88024,712913,74012,355....1,682,074 1,983,023554,1327,646670,5177,64649,25049,25049,25049,250500,596678,245611,028727,413783,592731,0591,062,790 1,123,926EQUITYIssued and paid-up capital315,147342,427671,637706,787Accumulated surpluses/(deficits)468,445388,632391,153417,139783,592731,0590.930.160.640.950.140.93Current RatioQuick RatioLong-term Debt: Equity1,062,790 1,123,9260.990.210.570.830.080.65% 82 Handbook for Borrowers on the Financial Management and Analysis of ProjectsExample Manufacturing OrganizationStatement of Cash Flows[Format for year-end reporting]for the year ended 31 December 20X2NotesOPERATING CASH FLOWSReceiptsCash receipts from customersTax rebatesOther receiptsPaymentsEmployees and suppliersTaxes paidFor the Year Ended 31 December 20X2Cumulative Since Project Start-DateActual$’000Forecast$’000Variance$’000%Actual$’000Forecast$’000Variance$’000%915,14623,2601,0001,448,53727,2801,080-533,391-4,020-80-36.8-14.7-7.41,972,08430,9901,1662,173,62135,1501,260-201,537-4,160-94-9.3-11.8-7.5-896,292 -1,387,934-5,942-7,508491,6421,566-35.4-20.9-1,811,168-10,212-2,019,189-11,414208,0211,202-10.3-10.5Other paymentsNet Cash Flows from Operations5INVESTING CASH FLOWSReceiptsInterest receivedSales of fixed assetsSales of investmentsPaymentsInterest paidCapital expenditures..0.0..0.037,17281,455-44,283-54.4182,860179,4283,4321.9..................0.00.00.0..................0.00.00.0-28,482..-42,370-219,39013,888219,390-32.8-100.0-41,700-351,490-39,604-392,860-2,09641,3705.3-10.5..0.0..0.0Purchases of investmentsNet Cash Flows from InvestingActivities-28,482-261,760233,278-89.1-393,190-432,46439,274-9.1FINANCING CASH FLOWSReceiptsCapital contributions from ownersProceeds from new borrowings......168,370..-168,3700.0-100.0..247,620..185,610..62,0100.033.4-3,000-3,000..0.0-13,578-28,82415,246-52.9......0.0......0.0Net Cash Flows from FinancingActivities-3,000165,370-168,370-101.8234,042156,78677,25649.3CASH AND CASH EQUIVALENTSBalances as at 1 JanuaryCurrency changes on opening balances19,618..25,308..10,373..34,085..5,690-14,93525,30810,373PaymentsRepayment of borrowingsDividends paidNet increases/(decreases) for periodBalances as at 31 December-20,625-138.123,712-96,25034,085-119,962 -124.6-62,165 Appendix 7 83Example Manufacturing OrganizationNotes to the Financial Statements[Format for year-end reporting]for the year ended 31 December 20X2Note 1: Gross Margin by ProductSales by Product:Product AProduct BProduct CProduct DFor the Year Ended 31 December 20X2Cumulative Since Project Start-DateActual$’000240,318230,868262,416149,919Forecast$’000Variance$’000%Actual$’000284,659258,132586,880287,022-44,341-27,264-324,464-137,103-15.6-10.6-55.3-47.8394,096357,413812,700397,913Forecast$’000433,618393,240894,080437,760Variance$’000-39,522-35,827-81,380-39,847%-9.1-9.1-9.1-9.1Product E9,60014,400-4,800-33.314,40014,400..0.0Total893,1211,431,093-537,972-37.61,976,5222,173,098-196,576-9.0203,418203,418260,375138,324311,059336,981414,746220,334107,641133,563154,37182,01034.639.637.237.2352,165316,948739,546334,556405,723367,083734,166405,72353,55850,135-5,38071,16713.213.7-0.717.5Cost of Sales by Product:Product AProduct BProduct CProduct DProduct E8,13812,9614,82337.217,60819,3211,7138.9Total813,6731,296,081482,40837.21,760,8231,932,016171,1938.936,90027,4502,04111,595-26,400-78,849172,13466,68863,300106,299-170,093-55,093-239.8-134.8-98.8-82.641,93140,46573,15463,35727,89526,157159,91432,03714,03614,308-86,76031,32050.354.7-54.397.8Product E1,4621,439231.6-3,208-4,9211,713-34.8Total79,448135,012-55,564-41.2215,699241,082-25,383-10.515.411.90.87.7-9.3-30.529.323.224.642.4-28.6-15.5........10.611.39.015.96.46.717.97.34.24.7-8.98.6........Product E15.210.05.2..-22.3-34.211.9..Total8.99.428.2..10.911.120.5..424,751238,73479,63935,257690,624416,461121,77566,012265,873177,72742,13630,75538.542.734.646.6945,534592,612118,93776,9881,039,383679,561112,41371,60193,84986,949-6,524-5,3879.012.8-5.8-7.5Gross Profit by Product ($’000):Product AProduct BProduct CProduct DGross Margin by Product (%):Product AProduct BProduct CProduct DNote 2: Cost of Goods SoldRaw MaterialsUtilitiesDirect LaborDirect DepreciationOther Variable CostsPlus opening finished goods22,75038,11715,36740.352,18257,3665,1849.0801,13193,4371,332,98980,895531,858-12,54239.9-15.51,786,253117,8031,960,324143,233174,07125,4308.917.8Less closing finished goods-80,895-117,803-36,90831.3-143,233-171,541-28,30816.5Cost of Goods Sold813,6731,296,081482,40837.21,760,8231,932,016171,1938.9 84 Handbook for Borrowers on the Financial Management and Analysis of ProjectsExample Manufacturing OrganizationNotes to the Financial Statements[Format for year-end reporting]for the year ended 31 December 20X2For the Year Ended31 December 20X2Note 3: ReceivablesBy Organization Type:Related partiesState-owned organizationsOther organizationsActual$’000Forecast$’00057610,2569,744Variance$’000Cumulative Since ProjectStart-DateForecast$’000Variance$’00070012,5009,00075017,20012,50075019,00014,000%Actual$’000Gross Receivables20,57622,20030,45033,750By AgeLess than 30 days old30–60 days old60–90 days old90–180 days oldMore than 180 days old10,0005,0002,5002,0001,07611,0005,5002,5002,0001,20015,0007,0005,0002,0001,45019,0009,0004,0001,000750Gross Receivables20,57622,20030,45033,750-1,871-2,219-2,853-3,40818,70519,98127,59730,342100,00080,000100,00060,00020,00015,150120,00090,00095,00060,00030,00017,058125,00095,00095,00070,00035,00017,488160,000150,00090,00040,00020,0005,796375,150412,058437,488465,796Less: Provision for Obsolete Inventories -10,000Net Inventories per balance sheet 365,150-10,000402,058-10,000427,488-10,000455,796....Less: Provision for Doubtful DebtsNet Receivables per balanceNote 4: InventoriesBy AgeLess than 2 months old2–4 months old4–6 months old6–9 months old9–12 months oldMore than 12 months oldGross InventoriesNote 5: Reconciliation of Income Statement to Operating Cash FlowsNet Surplus/(Deficit) per Income Statement....Items included in net surpluses but not innet cash flows from operations:Unrealized net foreign exchange gainsInterest revenuesInterest expensesAsset movementsDepreciationGains/(losses) on sales of assetsOther non-cash itemsMovements in employee benefit liabilitiesMovements in working capitalDecrease/(increase) in receivablesDecrease/(increase) in inventoriesDecrease/(increase) in work in progressIncrease/(decrease) in payablesNet Cash Flows from Operations........................................................................................% Appendix 8 85Appendix 8 Model Auditor Terms of Reference:Executing Agency AuditParagraph 5.73 (page 37) refers to this appendix.ENTITY NAME: XYZAUDIT OF ANNUAL FINANCIAL STATEMENTSAUDITOR TERMS OF REFERENCEGUIDANCE: This template is appropriate for the audit of executing agencies(EAs) or implementing agencies (IAs). It should be completed—by theborrower, EA or project preparatory technical assistance (PPTA)consultants—and provided to ADB for comments before fact finding. Thistemplate can be applied to the audit of either a revenue-earning ornonrevenue-earning EA.IntroductionGUIDANCE: Briefly describe the audit assignment. Specify whether theengagement is for one or more financial years. A longer period (e.g., 3–5years) will enable the auditor to become familiar with the entity. The actualcontract should allow for termination for inadequate performance, butnot for issuing a qualified, adverse or disclaimer opinion.1.The management of XYZ requires an auditor to carry out thefollowing audit services for the [X] years ended 31 December 20xx:• An audit of XYZ Annual Financial Statements (AFS).2.This letter describes the assignment scope and terms and invitesyou to submit a proposal for delivery of these services.General BackgroundGUIDANCE: Briefly describe the project in the context of its contribution toachievement of the EA’s economic goals. The auditor must understandthe “purpose for which the funds are intended” in the context of the broadproject objec-tives as well as in terms of the specific project budget. 86 Handbook for Borrowers on the Financial Management and Analysis of Projects3.…GUIDANCE: Briefly summarize relevant accounting and financialmanagement practices. Various diagnostic reports are available thatdescribe accounting and financial man-agement practices (e.g., ADBDiagnostic Studies of Accounting and Auditing, World Bank CountryFinancial Accountability Assessments). Emphasis should be placed onissues raised and risks identified in these reports.4.…Employing Authority or EntityGUIDANCE: The details of the proposed contractor of the auditor’s servicesshould be provided. If the contractor is acting on behalf of, or is part of, alarger authority or entity, this should be disclosed, to assist prospectiveauditors to determine their independence.5.The audit services will be contracted by:Delivery of Opinions and ReportsGUIDANCE: The required opinions and documents should be clearlyspecified, together with delivery time frames.6.The auditor will provide the following opinions and reports tomanagement (with copies to ADB), in accordance with the following timeframes:• Audit Opinion on Annual Financial Statements of [XYZ]• Management Letter relating to [XYZ]7.All reports must be provided in the English language.Objectives8.The primary objective of the AFS audit is to enable the auditor toexpress an independent opinion on whether the AFS present fairly, in allmaterial 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 thenended in accordance with agreed accounting standards (see Terms andDefinitions). Appendix 8 879.Secondary objectives include confirming compliance, orotherwise, with: (i) each financial covenant contained in the legaldocuments for the project (see Terms and Definitions); and (ii) all otherfinancial assurances contained in the legal documents for the project (seeTerms and Definitions).Description of XYZGUIDANCE: 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 characteristicsshould be described, together with: (i) organization charts; (ii) names ofsenior managers; (iii) name and qualification of the person(s) responsiblefor financial management, accounting and internal audit; (iv) name andaddress of any existing external auditor; (v) computing or other dataprocessing facilities in use; (vi) a copy of the latest published financialstatements; and (vii) internal facilities (if any) available to an externalauditor (e.g., office accommodation, calculators, and computer facilities).A general summary of the financial management assessment of the EAshould be included, together with a reference that the full financialmanagement assessment will be made available to the auditor. Detailedinformation should be appended.10.…Description of Materials and Timing of DeliveryGUIDANCE: The AFS and supporting documentation that will be suppliedto the auditor, and on which they are to give an opinion and a report,should be specified. The estimated time for providing these documents tothe auditor should be stated (e.g., one month after financial year-end).This schedule helps the auditee and the auditor plan for the accountspreparation and the audit process.11.The AFS (see Terms and Definitions) and supportingdocumentation will be provided to the auditor on the following estimateddates: 88 Handbook for Borrowers on the Financial Management and Analysis of ProjectsAudit ScopeGUIDANCE: The scope of the audit should be sufficiently clear to properly definewhat is expected of the auditor but not in any way restrict the audit proceduresor the tech-niques the audi-tor may wish to use to form an opinion. This sectionwill not generally have to be customized to a particular audit situation.12.Auditing Standards and Program. The audit will be carried outin accordance with the agreed auditing standards (see Terms andDefinitions), including professional or general standards, standards offieldwork and reporting standards.13.The audit program will consider the risk of materialmisstatements resulting from fraud or error. It should include proceduresthat are designed to provide reasonable assurance that materialmisstatements (if any) are detected.14.Internal Control Systems. The auditor will assess the adequacyof financial management systems, including internal controls.15.The auditor should communicate with independent boardmembers (where present). Among other things, this dialogue should coverthe adequacy of bad-debt provisions, contingent liabilities, related-partytransactions, internal control systems, management and board reporting,and management systems, integrity and capability.16.Accounting Policies and Changes. The auditor should commenton the entity’s accounting policies, and confirm the extent to which theagreed accounting standards (see Terms and Definitions) have beenapplied. In particular, the auditor should note the impact on the AFS arisingfrom any material deviations from agreed accounting standards. Theauditor should also comment on any material accounting policy changes,either during a financial year, or from one year to another.17.Compliance with Financial Covenants. The auditor will confirmcompliance with each financial covenant contained in the legal documentsfor the project (see Terms and Definitions). Where present, the auditorshould indicate the extent of any noncompliance by comparing requiredand actual performance measurements for each financial covenant forthe financial year concerned. Appendix 8 8918.Compliance with Financial Assurances. The auditor will confirmcompliance with all financial assurances contained in the legal documentsfor the project (see Terms and Definitions). Where present, the auditorshould indicate the extent of any noncompliance by comparing requiredand actual performance of the borrower in respect of these ADBrequirements for the financial year concerned.Management Letter19.On conclusion of the audit, the auditor will prepare amanagement letter, detailing:• any material weaknesses in the accounting and internalcontrol systems that were identified during the audit,• recommendations to rectify identified weaknesses,• the status of significant matters raised in previousmanagement letters and any corrective actions taken by theorganization,• practical recommendations on the steps that the organizationcould take to become materially compliant with the agreedaccounting standards (see Terms and Definitions), togetherwith a time frame for making these changes,• any other matters that the auditor considers should be broughtto the attention of the organization’s management, and• any significant matters that the auditor considers should bebrought to ADB’s attention.Statement of Access20.The auditor will have full and complete access, at all reasonabletimes, to all records and documents including books of account, legalagreements, bank records, invoices and any other information associatedwith the project and deemed necessary by the auditor.21.The auditor will be provided with full cooperation by allemployees of [XYZ] and the project-implementing units, whose activitiesinvolve, or may be reflected in, the annual financial statements. The auditorwill be assured rights of access to banks and depositories, consultants,contractors and other persons or firms hired by the employer. 90 Handbook for Borrowers on the Financial Management and Analysis of ProjectsIndependence22.The auditor will be impartial and independent from any aspectsof management or financial interest in the entity under audit. In particular,the auditor should be independent of the control of the entity. The auditorshould not, during the period covered by the audit, be employed by, orserve as director for, or have any financial or close business relationshipwith the entity. The auditor should not have any close personal relationshipswith any senior participant in the management of the entity. The auditormust disclose any issues or relationships that might compromise theirindependence.Auditor and Audit Staff Competence23.The auditor must be authorized to practice in the country andbe capable of applying the agreed auditing standards (see Terms andDefinitions). The auditor should have adequate staff, with appropriateprofessional qualifications and suitable experience, including experiencein auditing the accounts of entities comparable in nature, size andcomplexity to the entity whose audit they are to undertake.24.To this end, the auditor is required to provide curriculum vitae(CV) of the auditors who will provide the opinions and reports, togetherwith the CVs of managers, supervisors and key personnel likely to beinvolved in the audit work. These CVs should include details of auditscarried out by these staff, including ongoing assignments.Submission of Proposal and Work Plan25.You are invited to submit a proposal and a work plan to providethe audit services described in this letter. Proposals should address, amongother things:• the extent (if any) that you would not conform to the agreedauditing standards (see Terms and Definitions) and indicateany alternative standards to which the auditor may (berequired to) conform;• whether the audit would be conducted as a completed audit(i.e., will you carry out the audit after financial year-end, whenthe books of account are, or are being, closed);• whether an audit carried out after the close of a financial yearwould be supplemented by one or more interim audits during Appendix 8 91•••••a financial year. The principal purpose is to test ongoingsystems and internal controls, and to relieve pressure on thestaff of the entity and on the auditor at year-end;the manner in which the auditor proposes to address anystatutory requirements relating to audit (e.g., certificationsrelating to shareholders’ equity required under thecompanies’ act) or to which they may be implicitly bound bycontractual obligations of the employer (e.g., ADB auditingrequirements, 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 anymatters arising from the audit, and with whom thesediscussions would be held; andthe timetable for provision of opinions and reports.Terms and Definitions26.This section defines the terms used in this document.1.Annual Financial StatementsGUIDANCE: The EA will prepare Annual Financial Statements (AFS). Mostrevenue-earning EAs (e.g., Utilities) will prepare accrual-based financialstatements. EA reporting requirements will usually be specified in theReport and Recommendation of the President and in the loan agreement.The component parts of the AFS should be specified in this section.27.The AFS comprises:[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, abdOther Information (specify). 92 Handbook for Borrowers on the Financial Management and Analysis of Projects[Option B: Other Financial Reports]:••••••2.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, andOther Information (specify).Agreed Accounting StandardsGUIDANCE: The accounting standards that govern AFS preparation willnormally be agreed and documented in the RRP and/or loan agreement.Choose the appropriate option.28.“Agreed accounting standards” regarding the preparation of theAFS, means:• [Option A: International Accounting Standards] theInternational Financial Reporting Standards (IFRS) issued bythe International Accounting Standards Board (IASB)(commonly known as international accounting standards).• [Option B: National Accounting Standards] the accountingstandards issued by [national authority].• [Option C: Modified National Accounting Standards] theaccounting standards issued by [national authority], with thefollowing modifications and/or additional disclosures:• [Option D: Cash-based International Public Sector AccountingStandards] the cash-based International Public SectorAccounting Standards (IPSA S) promulgated by theInternational Federation of Accountants (IFAC).• [Option E: Accrual-based International Public SectorAccounting Standards] the accrual-based International PublicSector Accounting Standards (IPSAS) promulgated by theInternational Federation of Accountants (IFAC).• [Option F: Specific Government Accounting Standards]describe these standards. Appendix 8 933.Agreed Auditing StandardsGUIDANCE: The agreed auditing standards will normally be documentedin the RRP and/or loan agreement. Choose the appropriate option.29.“Agreed auditing standards” means:• [Option A: International Standards on Auditing] theInternational Standards on Auditing (ISA) promulgated by theInternational Auditing and Assurance Standards Board(IAASB).• [Option B: INTOSAI Auditing Standards] the auditingstandards promulgated by the International Organization ofSupreme Audit Institutions (INTOSAI).• [Option C: National Auditing Standards] the auditingstandards promulgated by [national authority].4.Financial Covenants Applicable to [XYZ]GUIDANCE: The financial covenants that are applicable to the EA will beincluded in the loan agreement (e.g., Self-financing Ratio). This sectionshould list, describe and fully reference all applicable financial covenants.30.The following financial covenants, regarding [XYZ], have beenagreed:5.Financial Assurances Applicable to [XYZ]GUIDANCE: The financial assurances that are applicable to the EA—suchas 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.31.given:The following financial assurances, regarding [XYZ], have been 94 Handbook for Borrowers on the Financial Management and Analysis of ProjectsAppendix 9 Model Auditor Terms of Reference:Annual Project Accounts AuditParagraph 5.73 (page 37) refers to this appendix.[ENTITY NAME: XYZ]AUDIT OF ANNUAL PROJECT ACCOUNTSAUDITOR TERMS OF REFERENCEGUIDANCE: This template is appropriate for an APA audit. It should becompleted—by the borrower, executing agency (EA) or project preparatorytechnical assistance (PPTA) consultants—and provided to ADB forcomments before fact finding. This template can be applied to the auditof either a revenue-earning or nonrevenue-earning project.A.IntroductionGUIDANCE: Briefly describe the audit assignment. Specify whether theengagement is for one or more financial years. A longer period (e.g., 3–5years) will enable the auditor to become familiar with the entity. The actualcontract should allow for termination for inadequate performance, butnot for issuing a qualified, adverse or disclaimer opinion.32.The management of XYZ requires an auditor to carry out thefollowing audit services for the [X] years ended 31 December 20xx:• An audit of the Annual Project Accounts (APA) for each of theloan projects listed below (see Terms and Definitions).33.This letter describes the assignment scope and terms and invitesyou to submit a proposal for delivery of these services.General BackgroundGUIDANCE: Briefly describe the supervising agency and the EA. Describethe project in the context of its contribution to achievement of the EA’seconomic goals. The auditor must understand the “purpose for which thefunds are intended” in the context of the broad project objectives as wellas in terms of the specific project budget. Appendix 9 9534.…GUIDANCE: Briefly summarize relevant accounting and financialmanagement practices. Various diagnostic reports are available thatdescribe accounting and financial man-agement practices (e.g., ADBDiagnostic Studies of Accounting and Auditing, World Bank CountryFinancial Accountability Assessments). Emphasis should be placed onissues raised and risks identified in these reports.35.…Employing Authority or EntityGUIDANCE: The details of the proposed contractor of the auditor’s servicesshould be provided. If the contractor is acting on behalf of, or is part of, alarger authority or entity, this should be disclosed, to assist prospectiveauditors to determine their independence.36.The audit services will be contracted by:Delivery of Opinions and ReportsGUIDANCE: The required opinions and documents should be clearlyspecified, together with delivery time frames.37.The auditor will provide the following opinions and reports tomanagement (with copies to ADB), in accordance with the following timeframes:• Audit Opinion on the Annual Project Accounts of:– Loan xxx– Loan xxx• Management Letter on the following projects:– Loan xxx– Loan xxx38.All reports must be provided in the English language. 96 Handbook for Borrowers on the Financial Management and Analysis of ProjectsObjectivesGUIDANCE: Specify the audit’s objectives.39.The objective of the APA audit (see Terms and Definitions) is toenable the auditor to express an opinion on the financial position of eachof the loan projects listed below (see Terms and Definitions), for the yearsending 31 December 20xx, and on the funds received and expendituresfor the years then ended.GUIDANCE: This paragraph should be applied where it is referred to in theloan agreement.40.Separate opinions on the eligibility of claims made in Statementsof Expenditure (SOEs) and on the Imprest Account Statement are alsorequired.Description of Materials and Timing of DeliveryGUIDANCE: The form of the APA and supporting documentation that willbe supplied to the auditor, and on which they are to give an opinion and areport, should be specified. In practice, the form and content of APA willvary among countries and projects. For instance, the APA may comprise aStatement of Receipts and Payments only on project transactions. Otherschedules may include cumulative work-in-progress, assets andinventories, and a summarized bank reconciliation. The estimated timefor providing these documents to the auditor should be stated (e.g., onemonth after financial year-end). This schedule helps the auditee and theauditor plan for the accounts-preparation and the audit process.41.The Annual Project Accounts (APA) (see Terms and Definitions)and supporting documentation will be provided to the auditor on thefollowing estimated dates:Audit ScopeGUIDANCE: The scope of the audit should be sufficiently clear to properlydefine what is expected of the auditor, but should not restrict the auditprocedures or the tech-niques the audi-tor may wish to use to form anopinion. This section will not generally have to be customized to a particularaudit situation. The list of issues outlined in this section is not exhaustive, Appendix 9 97nor should all matters be addressed in every project. The scope and detailof an audit are likely to be unique for each project.42.Auditing Standards and Program. The audit will be carried outin accordance with the agreed auditing standards (see Terms andDefinitions), in-cluding professional or general standards, standards offieldwork and reporting standards.43.The audit program will consider the risk of materialmisstatements resulting from fraud or error. It should include proceduresthat are designed to provide reasonable assurance that materialmisstatements (if any) are detected.44.Accounting Policies and Changes. The auditor should commenton the project’s accounting policies, and confirm the extent to which theagreed project accounting policies (see Terms and Definitions) have beenapplied. In particular, the auditor should note the impact on the APA arisingfrom any material deviations from the agreed accounting standards. Theauditor should also comment on any accounting policy changes, eitherduring a financial year, or from one year to another.45.Imprest Account (or Special Account). The Imprest Accountreflects: (i) deposits and replenishment received from financiers; (ii)payments substantiated by withdrawal applications; and (iii) the remainingbalance at financial year-end. The auditor will examine whether theImprest Account has been maintained in accordance with the provisionsof the relevant financing agreements.46.The auditor must form an opinion on whether the ImprestAccount was used in compliance with required procedures (e.g., those ofADB), and the fairness of the presentation of Imprest Account activity andthe year-end balance. The auditor should examine the eligibility andcorrectness of financial transactions during the period under review,account balances at the end of the period, the operation and use of theImprest Account in accordance with the financing agreement, and theadequacy of internal controls for this particular disbursement mechanism.47.Statements of Expenditures (SOEs). The auditor will audit allSOEs used as the basis for the submission of credit withdrawal applications 98 Handbook for Borrowers on the Financial Management and Analysis of Projectsto ADB. These expenditures should be compared for project eligibility withthe relevant financing agreements (and with reference to the RRP andother project documents for guidance when considered necessary). Whereineligible expenditures are identified as having been included inwithdrawal applications and reimbursed against, these should beseparately noted by the auditor. The annual audit report should include aseparate paragraph commenting on the accuracy and propriety ofexpenditures withdrawn under SOE procedures, and the extent to whichADB can rely on those SOEs as a basis for credit disbursement. Annexedto the APA should be a schedule listing individual SOE withdrawalapplications by specific reference number and amount.48.Compliance with Financial Covenants. The auditor will confirmcompliance with each financial covenant contained in the project legaldocuments (see Terms and Definitions). Where present, the auditor shouldindicate the extent of any noncompliance by comparing required andactual performance measurements for each financial covenant for thefinancial year concerned.49.Compliance with Financial Assurances. The auditor will confirmcompliance with all financial assurances contained in the project legaldocuments (see Terms and Definitions). Where present, the auditor shouldindicate the extent of any noncompliance by comparing required andactual performance of the borrower in respect of these ADB requirementsfor the financial year concerned.50.Use of Funds for the Purpose Intended. The auditor willconfirm, or otherwise, that:• All external funds have been used in accordance with therelevant financing agreements covering each project, withdue attention to economy and efficiency, and only for thepurpose for which the financing was provided;• Counterpart funds have been provided and used inaccordance with the relevant financing arrangements andonly for the purpose for which the financing was provided;and• Goods and services financed have been procured inaccordance with the relevant financing agreements. Appendix 9 9951.Record Keeping. The auditor will pay particular attention towhether all necessary supporting documents, records, and accounts havebeen kept in respect of all project activities, with clear linkages betweenthe accounting records and the APA. This will include: (i) computationand recalculation, including checking the mathematical accuracy ofestimates, accounts or records; (ii) reconciliation, including reconcilingrelated accounts to each other, subsidiary records to primary records andinternal records to external documents; (iii) physical observation, includinginspecting or counting tangible assets, such as materials, inventory, landbuildings, property or equipment; (iv) confirmation, including directlyconfirming balances or transactions with external third parties, such ascash balances, accounts receivable or accounts payable; (v) sampling,including vouching or examining supporting documentation to determineif balances are properly stated; and (vi) tracing, including tracing journalpostings, subsidiary ledger balances, and other details to correspondinggeneral ledger accounts or trial balances.52.Internal Control Systems. The auditor will assess the adequacyof the project financial management systems, including internal controls,including whether: (i) proper authorizations are obtained and documentedbefore transactions are entered into; (ii) accuracy and consistency areachieved in recording, classifying, summarizing and reporting transactions;(iii) reconciliations with internal and external evidence are performed ona timely basis by the appropriate level of management; (iv) balances canbe confirmed with external parties; (v) adequate documentation and anaudit trail is retained to support transactions; (vi) transactions are allowableunder the agreements governing the project; (vii) errors and omissionsare detected and corrected by project personnel in the normal course oftheir duties, and management is informed of recurring problems orweaknesses; (viii) management does not override the normal proceduresand the internal control structure; and (ix) assets are property accountedfor, safeguarded and can be physically inspected.Management Letter53.On conclusion of the audit, the auditor will prepare aManagement Letter for each of the audited projects, detailing:• Any material weaknesses in the accounting and internalcontrol systems that were identified during the audit; 100 Handbook for Borrowers on the Financial Management and Analysis of Projects• Recommendations to rectify identified weaknesses;• The status of significant matters raised in previousmanagement letters;• Practical recommendations on the steps that could be takento become materially compliant with the agreed projectaccounting policies (see Terms and Definitions), together witha time frame for making these changes;• The degree of compliance with each of the financialcovenants in the loan agreement and recommendations forimprovement;• Matters that have come to the auditor’s attention during thecourse of the audit which have a significant impact on projectimplementation;• Any other matters that the auditor considers should bebrought to the attention of the project’s management; and• Significant matters that the auditor considers should bebrought to ADB’s attention.Statement of Access54.The auditor will have full and complete access, at all reasonabletimes, to all records and documents including books of account, legalagreements, bank records, invoices and any other information associatedwith the project and deemed necessary by the auditor.55.The auditor will be provided with full cooperation by allemployees of [XYZ] and the project-implementing units, whose activitiesinvolve, or may be reflected in, the annual financial statements. The auditorwill be assured rights of access to banks and depositories, consultants,contractors and other persons or firms hired by the employer.Independence56.The auditor will be impartial and independent from any aspects ofmanagement or financial interest in the entity under audit. In particular, theauditor should be independent of the control of the entity. The auditor shouldnot, during the period covered by the audit, be employed by, or serve as directorfor, or have any financial or close business relationship with the entity. Theauditor should not have any close personal relationships with any seniorparticipant in the management of the entity. The auditor must disclose anyissues or relationships that might compromise their independence. Appendix 9 101Auditor and Audit Staff Competence57.The auditor must be authorized to practice in the country andbe capable of applying the agreed auditing standards (see Terms andDefinitions). The auditor should have adequate staff, with appropriateprofessional qualifications and suitable experience, including experiencein auditing the accounts of entities comparable in nature, size andcomplexity to the entity whose audit they are to undertake.58.To this end, the auditor is required to provide curriculum vitae(CV) of the auditors who will provide the opinions and reports, togetherwith the CVs of managers, supervisors and key personnel likely to beinvolved in the audit work. These CVs should include details of auditscarried out by these staff, including ongoing assignments.Submission of Proposal and Work Plan59.You are invited to submit a proposal and a work plan to providethe audit services described in this letter. Proposals should address, amongother things:• the extent (if any) that you would not conform to the agreedauditing standards (see Terms and Definitions) and indicateany alternative standards to which you may (be required to)conform;• whether the audit would be conducted as a completed audit(i.e., will the auditors carry out their audit after financial yearend, when the books of account are, or are being, closed);• whether an audit carried out after financial year-end wouldbe supplemented by one or more interim audits during afinancial year. The principal purpose is to test ongoing systemsand internal controls, and to relieve pressure on the staff ofthe entity and on the auditor at year-end;• the manner in which the auditor proposes to address anystatutory requirements relating to audit (e.g., certificationsrelating to shareholders’ equity required under thecompanies’ act) or to which they may be implicitly bound bycontractual obligations of the employer (e.g., ADB auditingrequirements, Statements of Expenditure, Imprest Accounts);• procedural requirements for certain verification procedures(e.g., checking of stocks, inventories, assets, etc.); 102 Handbook for Borrowers on the Financial Management and Analysis of Projects• 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 anymatters arising from the audit, and with whom thesediscussions would be held; and• the timetable for provision of opinions and reports.Terms and Definitions60.This section defines the terms used in this document.Annual Project AccountsGUIDANCE: The Annual Project Accounts (APA) may comprise a Statementof Receipts and Payments (Cash flow statement). This template is specificallyintended for audits of these types of APA. Other schedules of value orcumulative work-in-progress, assets and inventories and a summarizedreconciled bank statement are to be attached. Project reporting requirementswill usually be specified in the RRP and in the loan agreement. Thecomponent parts of the APA should be specified in this section.61.The Annual Project Accounts (APA) comprises:[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, andOther 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,Statement of Uses of Funds by Project Activity,Notes to the Financial Statements, andOther Information (specify). Appendix 9 103GUIDANCE: The APA should include: (a) a summary of funds receivedshowing ADB funds, any cofinancing and counterpart funds separately;(b) a summary of expenditures shown under the main project componentsand by main categories of expenditures (as referenced in loan and appraisaldocumentation) for the year ending 31 December 20xx and cumulativeexpenditures on the project to date; and (c) statement of fund balance asof 31 December 20xx.Loan ProjectsGUIDANCE: List the loan projects that will be audited. Provide brief detailsand attach relevant documents.62.Annual Project Accounts (APA) and supporting documentationwill be provided for the following loan projects financed by the AsianDevelopment Bank (ADB) [and IDA, EBRD, etc]:• Loan xxxx,• Loan xxxx, and• Loan xxxx.Agreed Project Accounting PoliciesGUIDANCE: The project accounting policies that govern APA preparationwill normally be agreed and documented in the RRP and/or loanagreement. Choose the appropriate option.63.“Agreed project accounting policies” with regard to preparationof Annual Project Accounts, means• [Option A: Cash-based International Public Sector AccountingStandards] the cash-based International Public SectorAccounting Standard (IPSA S) promulgated by theInternational Federation of Accountants (IFAC).• [Option B: Accrual-based International Public SectorAccounting Standards] the accrual-based International PublicSector Accounting Standards (IPSAS) promulgated by theInternational Federation of Accountants (IFAC).• [Option C: International Accounting Standards] theInternational Financial Reporting Standards (IFRS) issued bythe International Accounting Standards Board (IASB) (alsoknown as international accounting standards). 104 Handbook for Borrowers on the Financial Management and Analysis of Projects• [Option D: National Accounting Standards] the accountingstandards issued by [national authority].• [Option E: Modified National Accounting Standards] theaccounting standards issued by [national authority], with thefollowing modifications and/or additional disclosures:• [Option F: Specific Government Accounting Standards]describe these standards.Agreed Auditing StandardsGUIDANCE: The agreed auditing standards will normally be documentedin the RRP and/or loan agreement. Choose the appropriate option.64.“Agreed auditing standards” means• [Option A: International Standards on Auditing] theInternational Standards on Auditing (ISA) promulgated by theInternational Auditing and Assurance Standards Board (IAASB).• [Option B: INTOSAI Auditing Standards] the auditingstandards promulgated by the International Organization ofSupreme Audit Institutions (INTOSAI).• [Option C: National Auditing Standards] the auditingstandards promulgated by [national authority].Financial Covenants Applicable to ProjectsGUIDANCE: The financial covenants that are applicable to projects will beincluded in loan agreements. This section should list, describe and fullyreference all applicable financial covenants.65.The following financial covenants have been agreed for thefollowing projects:Financial Assurances Applicable to ProjectsGUIDANCE: The financial assurances that are applicable to the EA—suchas 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.66.The following financial assurances, regarding the followingprojects, have been given: Appendix 10 105Appendix 10 Model Auditor Opinion for aNonrevenue-Earning ProjectParagraph 5.84 (page 41) refers to this appendix.To: Borrower (or designated agency)We have audited the accompanying financial statements(pages _____ to _____) of the _______________ Project financed under theAsian Development Bank Loan No. _____as of 31 December, 20____, andfor the year then ended.These financial statements are the responsibility of themanagement of [the EA]. Our responsibility is to express an opinion onthe accompanying statements based on our audit.We conducted our examination in accordance with InternationalStandards on Auditing. Those standards require that we plan and performthe audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. Our audit includesexamining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. Our audit also includes assessingthe accounting principles and significant estimates made by management,as well as evaluating the overall statement presentation. We believe thatour audit provides a reasonable basis for our opinion._______ [The EA’s] policy is to prepare the accompanyingstatements in the format agreed between the Asian Development Bankand the Government of _______ as noted in the Minutes of Negotiations forthe Loan [on a cash receipts and disbursements basis in which cash isrecognized when received and expenses are recognized when paid, ratherthan when incurred]/[on an accruals basis in which expenses arerecognized when incurred and revenue is reported when income is due].In our opinion, (A) the aforementioned financial statements andappended notes that were also the subject of the audit, fairly present in allmaterial 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 theprevious year; (B) the [Borrower] [EA] has utilized all proceeds of theloan withdrawn from the Asian Development Bank only for purposes ofthe Project as agreed between the Asian Development Bank and [the 106 Handbook for Borrowers on the Financial Management and Analysis of ProjectsBorrower] in accordance with the loan agreement; and no proceeds ofthe 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 ofaudit with all financial covenants of the loan agreement.In addition:(i)(ii)(a) With respect to Statements of Expenditures, adequate supportingdocumentation has been maintained to support claims to the AsianDevelopment Bank for reimbursements of expenditures incurred;and (b) which expenditures are eligible for financing under LoanAgreement No. _____.(a) The Imprest Accounts (page ___) give a true and fair view of thereceipts collected and payments made during the year ending______; and (b) these receipts and payments support ImprestAccount liquidations/replenishments during the year.[(i) and (ii) above are to be provided where the loan agreement requiresseparate Imprest Account and statement of expenditures audits and auditopinions.] Appendix 11 107Appendix 11 Model Auditor Opinion for a Revenue-Earning AgencyParagraph 5.84 (page 41) refers to this appendix.To: Borrower (or designated agency)“We have examined the Balance Sheet of ___________as of________ 20__ , and the Income Statement, Cash Flow Statement andrelated statements and Notes (see pages____ to ____ of our Report) of the_________________ Project financed under the Asian Development BankLoan No.________________ as of 31 December, 20___, and for the year thenended.We conducted our examination in accordance with InternationalStandards on Auditing [auditing standards of the country of ______]. Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of misstatement.Our audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements. Our audit alsoincludes assessing the accounting principles and significant estimatesmade by the Management, as well as evaluating the overall statementpresentation. We believe that our audit provides a reasonable basis forour opinion.In our opinion, (A) the aforementioned financial statements andappended notes that were also the subject of the audit, fairly presentseparately (i) the financial position of the ___________ Project and (ii) theoverall operations of the __________________ [name of EA] asat__________20___and the separate results of the project operations andthe EA’s operations for the year ended _________ 20__, in conformity withInternational Accounting Standards [accounting standards of the countryof___________], applied on a basis consistent in all material respects withthat of the previous year; (B) the [Borrower] [EA] has utilized all proceedsof the loan withdrawn from the Asian Development Bank (ADB) only forpurposes of the Project as agreed between the Asian Development Bankand [the Borrower] in accordance with the loan agreement; and noproceeds 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 ofthe year of audit with all financial covenants of the loan agreement. 108 Handbook for Borrowers on the Financial Management and Analysis of ProjectsIn addition:(i)(ii)(a) With respect to statements of expenditures, adequate supportingdocumentation has been maintained to support claims to the AsianDevelopment Bank for reimbursements of expenditures incurred;and (b) which expenditures are eligible for financing under loanagreement No. ___________________. (Required where an SOE auditis required under the loan agreement.)The Imprest Accounts (page ____) gives a true and fair view of thereceipts collected and payments made during the year ending_________________.[(i) and (ii) above to be provided where a separate Imprest Account auditis required under the Loan Agreement.] Appendix 12 109Appendix 12 Useful Reference MaterialsUsers of this Handbook may find the following reference materials useful.They are available from Asian Development Bank (ADB) in hard copy orcan be freely downloaded from www.adb.org.Selected ADB GuidelinesGuidelines for the Economic Analysis of Projects (1997)Guidelines for the Economic Analysis of Telecommunications Projects(1997)Guidelines for the Economic Analysis of Water Supply Projects (1998)Guidelines for the Financial Governance and Management of InvestmentProjects financed by ADB (2002)Guidelines on the Use of Consultants by Asian Development Bank andIts Borrowers (2002)Selected ADB HandbooksHandbook for Integrating Poverty Impact Assessment in the EconomicAnalysis of Projects (2001)Handbook for Integrating Risk Analysis in the Economic Analysis of Projects(2002)Handbook for the Economic Analysis of Health Sector Projects (2000)Handbook for the Economic Analysis of Water Supply Projects (1999)Handbook for Users of Consulting Services: Procedures and Practices –Volume I, Fifth Edition (2002)Loan Disbursement Handbook (2001)Other Recommended ReadingAnticorruption Policy: Description and Answers to Frequently AskedQuestions (2000)Economic Analysis of Subregional Projects (1999)Economic Evaluation of Environmental Impacts: A Workbook (1996)Framework for the Economic and Financial Appraisal of UrbanDevelopment Sector Projects (1994) [...]... financial management policies and requirements 1.11 The provisions of this Handbook apply to investment projects and project EAs and implementing agencies (IAs) For the purposes of this Handbook, investment projects include ADB- Mainbody.pmd 3 08/11/2006, 1:46 PM 4 Handbook for Borrowers on the Financial Management and Analysis of Projects loan-financed projects and the identifiable investment components of. .. assets and resources [4.2.1] … and operate within an effective control environment 4.04 ADB assesses the financial policies and the capacity of the financial systems practiced or proposed by the borrower/EA to support project We assess the effectiveness of these systems 17 08/11/2006, 1:46 PM 18 Handbook for Borrowers on the Financial Management and Analysis of Projects implementation and operation The. .. auditing arrangements and agree relevant covenants Accounting Standards and Policies Introduction 5.03 ADB is concerned about the accurate interpretation of the financial position and performance of its borrowers and EAs However, the preparation and reporting of accounting information vary widely among countries and contributes to a substantial lack of transparency and consistency in financial reporting... and identifies proposed funding sources the proposed ADB loan, other loans, equity or capital contributions, subsidies for operations, and internally-generated cash [3.4.6.6] 13 08/11/2006, 1:46 PM 14 Handbook for Borrowers on the Financial Management and Analysis of Projects Financial Cost-Benefit Analyses ADB- financed projects must be financially and economically viable … 3.18 ADB requires that financial. .. revenues … 3.03 These forecasts should, ideally, be prepared by the borrower’s agencies However, where ADB staff or PPTA consultants prepare forecasts, it is essential that the borrower’s agencies … are the borrower’s responsibility 9 08/11/2006, 1:46 PM 10 Handbook for Borrowers on the Financial Management and Analysis of Projects own these forecasts because they are ultimately responsible for their accuracy...Introduction 3 1.08 ADB s integrity is one of its strongest assets ADB affirms a zero tolerance policy when credible evidence of fraud and corruption exists among ADBfinanced projects or its staff You may report allegations of fraud and corruption by contacting the Anticorruption Unit of the Office of the General Auditor (OGAU) by e-mail, telephone or facsimile Communication sent by these methods... Because financial reporting practices vary widely among DMCs … 5.04 ADB, together with other MDFIs, encourages borrowers and EAs to adopt uniform standards of accounting and financial reporting In this respect, ADB recommends that: Mainbody.pmd 27 08/11/2006, 1:46 PM 28 Handbook for Borrowers on the Financial Management and Analysis of Projects • Revenue-earning EAs comply with national accounting standards... Preparing and Appraising Investment Projects 11 However, ADB financing of these is subject to the requirements as laid out in the Cost Sharing and Eligibility of Expenditures for ADB Financing, Staff Instructions paper, 15 March 2006 Local and Foreign Costs 3.07 There is no longer a distinction between local and foreign currency costs for purposes of ADB financing and disbursement However, for the purpose of. .. 6 ADB Avenue Mandaluyong City 1550 Metro Manila, Philippines Mailing Address : P.O Box 789, 0980 Manila Philippines This Handbook 1.10 This Handbook reflects progress on MDFI harmonization, explains ADB financial management policies and procedures, and is aimed at borrowers and their EAs These policies and procedures are fully consistent with our anticorruption approach This Handbook explains our financial. .. related and long term—that should be addressed either as a project component or by TA; and (iii) confirm that the financial management system is sustainable [4.1.3] Assessment Scope and General Approach While the assessment’s exact scope will depend on our involvement with the EA … 4.06 The scope of the financial management assessment will depend upon the extent and type of dealings ADB has with the EA concerned, ... 08/11/2006, 1:46 PM Handbook for Borrowers on the Financial Management and Analysis of Projects MDFI Harmonization Efforts … and are working hard to harmonize these policies with other MDFIs to reduce... project We assess the effectiveness of these systems 17 08/11/2006, 1:46 PM 18 Handbook for Borrowers on the Financial Management and Analysis of Projects implementation and operation The EA should... interpretation of the financial position and performance of its borrowers and EAs However, the preparation and reporting of accounting information vary widely among countries and contributes to
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