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 Financial
Accounting
Reportingand
Auditing
HANDBOOK

FIRST EDITION

CENTRAL AND OPERATIONAL

ACCOUNTING DIVISION

THE WORLD BANK

January 1995
ACRONYMSANDABBREVIATIONS

ARCS - AuditReportingComplianceSystem
BP - Best Practices
CAAT - ComputerAssistedAudit Techniques
CIS - Computer Information System
COD - Country Operations Division
CPPR - CountryPortfolioPerformanceReview
EDP - Electronic Data Processing
FARAH - FinancialAccountingReporting and AuditingHandbook
IAPC - InternationalAudit Practice Committee(of IFAC)
IAS - lnternationalAccountingStandards
IASC - International Accounting Standards Committee
IBRD - InternationalBank for Reconstructionand Development
IDA - InternationalDevelopmentAssociation
IFAC - InternationalFederationof Accountants
INTOSAI - InternationalOrganizationof SupremeAudit Institutions
ISA - InternationalStandardon Auditing
GAAP - GenerallyAcceptedAccountingPrinciples
GAAS - GenerallyAcceptedAuditing Standards
OP - Operational Policy
PFS - Project Financial Statement
PSC - Public SectorCommittee(ofIFAC)
RVP - Regional Vice President
SA - Special Account
SAI - Supreme Audit Institution
SAL - Structural Adjustment Loan
SAR - Staff Appraisal Report
SECAL - Sector Adjustment Loan
SGSA - SecondGenerationSpecialAccount
SOD - Sector Operations Division
SOE - Statement of Expenditure
TM - Task Manager
TOR - Terms of Reference
VAT - Value Added Tax

ii
 TABLEOF CONTENTS

Acronyms and Abbreviations

..................... ii

Preface .................... ... v

L Introduction.1

IL Project Appraisal .3

Im Project Impmentation. .13

1V. FinancialReporting.17

V. Audit Compliance. 23

VL Country Review of Financial Accountability. 35

VI.L Annexes
Project Apprisal:
Annex I: AccountingStandards...................................................... 43
AnnexI-1 Reviewof AccountingStandards ................ ....................................... 47
Annex II: Summaryof InternationalAccountingStandards...................................................... 53
Annex m Accountingand AuditArrangementsfor AdjustmentOperations................................59
Annex IV: Reviewsof FinancialManagementand AccountingSystems
for Entities ImplementingRevenueEarning Project .61
Annex V: Reviewsof FinancialManagementand AccountingSystems
for Entities ImplementingNon-RevenueEaming Projects.71
Annex VI: Accountingfor Sectors.S e cto 75

Project Implementation:
Annex VII: TaskManager Reviewof Statementsof Expenditure.79
Annex Vm: Use of FinancialInformationto Monitor
PhysicalProjectImplementation.81
Annex IX: Form Letters:
Annual Reminderto Borrowerof Requirementto AppointAuditors.83
Reminderto the Borrowerof Requirementfor Timely Submissionof Report. 84
Noticeto Borrowerof Failureto ReceiveAudit Report. 85
Acknowledgmentof AuditReport.87
AnnexX: Guidelinesfor the Desk Reviewof AuditReport.89

iii
Financial Reporting:
Annex X1: The Elementsof FinancialStatements........................................................ 93
AnnexXII: Sampleof Parts of FinancialStatementsof a ProjectImplementing
Organization (SamplePages 1-8).95
Annex XIII: Sampleof ProjectFinancialStatementswith SOE Integrated
(SamplePages 1-5) ........................................................ 103
Annex X1V: Formatfor SpecialAccountStatement........................................................ 109

Audit Compliance:
Annex XV: International Standardson Auditing Summaryand Public SectorPerspectives....... III
Annex XVI: InternationalOrganizationof SupremeAudit Institutions- AuditingStandards....... 119
Annex XVII: Reviewof AuditFirms - Questionnaire........................................................ 123
Annex XVII: Guidelinesfor Auditors - Terms of Referenceand EngagementLetter....................... 127
Annex XIX: SampleTerms of Referencefor the Audit of ProjectFinancial Statementsand
AccompanyingStatementsof Expenditureand SpecialAccounts............................133
AnnexXX: Exampleof an AuditEngagementLetter............................................. 137
Annex XX: ModelAuditReports:
UnqualifiedOpinion- Organization.139
- ProjectFinancial Statementincluding SOE.140
- Special Account.141
Other than Unqualified.142
Annex XXI: Outlineof a ManagementLetter.143
AnnexXXII Terms of Referencefor Reviewof GovernmentAccountingand Auditing
Arrangements.145

Index.149

i~~~~~~~~i
 PREFACE

This FinancialAccounting,Reporting,and AuditingHandbook(FARAH) sets out good practicesto facili-

tate implementationof the operational policies and procedures in OP and BP 10.02 in the Bank's Operational
Manual. Its primary purpose is to provide guidance in these areas to the Bank's Task Managers. FARAHwill
also be a useful guide to borrowers in the implementationof Bank assisted projects. It provides a minimumlevel
of understanding of the role of financial managementin overall project management andthe importanceof the
various elements,from accountingsystem design, the linkageof financial informationto key indicators of project
objectives and financial reporting,to audits. In a world of scarce financial resources and complexprojects,it is
imperativethat the financial managementsystem of a project or an implementingorganizationis strong enough to
provide timely,reliable,and useful informationfor accountabilityand decisionmaking.

Accounting and auditing are fundamentalelementsof stewardship--achievingthe greatestbenefitfor the

funds invested. This implies an integration of financial and program disciplinesto manage scarce resources to
achieve commongoals. From the initial project designto project completion,all the elementsof good management
work together to contribute to good govemanceand to improve project performance and enhancethe benefits de-
rived.

The Handbook should be seen as a guide only, as it does not cover all systems, or prescribespecificsolu-
tions for particular problems. Use of the Handbookshould be accompaniedby consultationswith qualifiedBank
accountantsand consultants with respect to matters that require professionaljudgment. It will, however, provide
non-accountingprofessionalstaff with a frameworkfor an initialview of the financial managementcapacityof the
borrower, make preliminaryjudgmentsas to strengthsand weaknesses,and more importantly,recognizewhen pro-
fessional assistanceis required. This is particularly importantfor transitional economiesunfamiliarwith financial
techniquesrequired in market economies,revenueeaming projects, and other complex situations where the finan-
cial managementsystem is an issue -- or does not exist.

FARAH has been prepared by the Central and OperationalAccounting Division(ACTCO),withthe pri-
mary author being George Russell (Financial Advisor), with assistance from Margaret Bartel (Consultant). It
draws from guidelinespublishedby the InternationalAccountingStandards Committee(IASC),the International
Federationof Accountants(IFAC), and the InternationalOrganizationof Supreme Audit Institutions (INTOSAI),
whose standards on accountingand auditingare supported by the Bank. It has incorporatedguidelinespreviously
issued by Country PolicyNotes (CPN), FinancialReportingand Auditing of Projects Financed by the World Bank
for the Asian Regions, and work done by Mr. Maurice Mould on Country Assessments. It has also takeninto
considerationcomments from a wide body of Bank financialanalysts and other staff, of whom Messrs. Randolph
Andersen,Jose Collell,and Albert Kennefickwere the most involved.

ACTCO is responsiblefor policy and guidanceon accountingand auditingissues.

MichaelE. Ruddy
Director
AccountingDepartment
January1995

v
 CHAPTER I: INTRODUCTION

1: INTRODUCTION

1.01 The Bank's Articles of Agreement require 1.04 Task Managers (TMs) also require financial
that proceeds of loans' be used economically, effi- information to monitor a project's progress toward
ciently and only for the purposes for which the achieving its objectives. For both parties -- the
financing is provided as described in the loan Bank and the borrower -- reliable and timely finan-
agreements. Proper execution of this fiduciary cial information assists good decision-making to
responsibility is critical in maintaining the Bank's ensure that project objectives are achieved and the
access to the capital markets. Therefore, the Bank plans negotiated during project preparation and
(i) requires borrowers to ensure that financial man- appraisal are followed. A good financial informa-
agement and accounting systems are adequate to tion system is vital for a strong management infor-
generate timely and reliable financial information; mation system. Independent audits of financial
(ii) requires and reviews periodic financial reports statements provide faith and credibility to the Bank,
to be submitted regularly for each lending opera- its stockholders and members and to third parties
tion; and (iii) normally requires verification of such including the parliaments, chief executive, and citi-
financial reports via regular audits. zens of those national governments which are the
Bank's owners and financiers.
1.02 Accountability affects the Bank's relation-
ship with external investors and its ability to bor- 1.05 The Bank's ability to fulfill its fiduciary
row, as well as borrowing countries' credibility with responsibilities and the borrower's ability to imple-
the Bank and with internal constituencies. By ac- ment a successful project are fundamentally affected
countability, we mean: by the quality of the financial management system
used in project implementation. This quality must
* every act or action is transparent - open to law, be built in from the very beginning. Once ex-
regulation and prudent judgment; pended, financial resources can rarely be recovered.
Without strong internal controls, there can be no
all participants are responsible for their own assurance that financial resources are being used
actions; effectively and efficiently for project purposes.
Without a well-designed accounting system, the
profeverynactl actionsis subjete toudindepndent, right financial data will not be collected and aggre-
results made available to all concerned. gated to provide useful and timely information for
decision-making. Without qualified staff, transac-
1.03 Borrowers need timely and reliable financial tions may be recorded incorrectly, which could
information to serve as an early warning system for destroy the usefulness and reliability of financial
problems in project implementation, and to allow reporting. A good financial management system
corrective action to be taken to resolve difficulties will facilitate the last step of verification and estab-
before they become major problems. This enables lish the credibility of the information gained from
borrowers to better meet their own fiduciary re- the audit. On the other hand, if an audit reveals
sponsibilities to their government, taxpayers, inves- inadequate financial management, it is almost cer-
tors, beneficiaries, etc. tain that significantfinancial resources have already
been lost.
Referenceto Bank (IBRD)loans is alsoa referenceto
IDA credits throughoutthis Handbook.
2 FARAH

1.06 A good financial management system pro- 1.09 The financial management system support-
duces information/reports with certain key qualities. ing a project should reflect the characteristics of the
The information must be understandable by the project. The financial reporting for a dam con-
user, relevant to required decisions, reliable -- i.e. struction project will be different from a rural de-
free from material error and bias -- and comparable velopment project -- focusing on different costs and
with previous information. To be comparable, the producing different cost structures. Good financial
measurement and display of the financial effect of management demands a solid understanding of the
like transactions and events must be treated in a underlying "business."
consistent way throughout an entity, within an
industry, and over time. Timeliness is an important Main Features Of The Handbook
constraint on the relevance of information -- undue
delays in reporting information cause it to lose its 1.10. Chapter II -- Project Appraisal -- dis-
relevance and consequently, its utility. cusses those aspects to be addressed during the
Project preparation/appraisal cycles.
1.07 Project and financial management are
closely linked. The financial management cycle of Chapter III -- Project Implementation --
budgeting, execution, accounting, and financial discusses monitoring for performance and summa-
reporting mirrors and provides basic support to the rizes the TM's duties with respect to monitoring
project cycle of planning, implementation, recording borrowers' accountability.
results, and reporting. Financial management sup-
ports project management and helps assure that Chapter IV -- Financial Reporting -- dis-
resources go towards the successful completion of cusses the financial statements required and their
the project and are not wasted. relationshipwith each other.

1.08 A key element in the financial management Chapter V -- Audit Compliance -- dis-
system is budgeting -- the process in which the cusses the audits required and the selection of
financial implications of planned activities or pro- auditors, and provides guidance with respect to the
grams are laid out and resources allocated. Budget- audit product
ing, to be effective, must be integrated with ac-
counting. If it is not, management does not receive Chapter VI -- Country Review of Financial
the feedback necessary to adjust planned activities
to expected resources. Problems in project imple- aspects of such a review.
mentation can go undetected until it is either too 1.11 Users of this Handbook will also find useful
late, or very costly, to fix them. Similarly, if ac- Glossary of Terms Used in Financial Management
counting is not tied to planned expenditures, the of Bank Projects (GP 10.03).
financial information produced is limited in its
usefulness for project management.
 CHAPTER II PROJECT APPRAISAL 3

II: PROJECTAPPRAISAL

2.01 The Bank's operational objectives require 2.04 It is therefore extremely important that all
that a borrower should have accounting and control project appraisals include, in at least one of the rele-
systems capable of reliably recording and reporting vant missions, a competent staff member or consult-
all financial transactions. This is not only to fulfill ant to assess the capability and reliability of the fi-
the Bank's fiduciary requirements but, more impor- nancial management structures and controls of the
tantly, to provide the financial management informa- proposed project implementing organization (which
tion that the borrower requires to measure expecta- may be a separate organization or merely part of the
tions of the Project against the actual achievements. responsibilities of a government department). The
These systems should be operational when project review should cover aspects such as:
expenditures begin. The financial reporting require-
ments under the project will depend on the needs of * system of budgeting and accounting, including
the project. accounting standards used;

2.02 In view of its importance, financial manage- * internal control system and procedures,
ment should be viewed as one of the fundamental
items as each project enters the Project Cycle. As * flow of funds to support the project organization
the general accountability environment in a country and the project (including Bank funds),
will affect the financial management of all invest-
ment initiatives, it is important that the Bank has an * financial reporting arrangements, including link-
understanding of this environment, including related ages to key performance indicators, and
laws and regulations, and of the financial manage-
ment and accounting capacity of the country in ' auditingarrangements
which the Bank assistance is proposed. This infor-
mation should be obtained on a country basis and I
made available to all Bank staff as required. Coun- management structure, certain other key considera-
trywide assessments are discussed in Chapter VI of tions must be evaluated. These include the project
the Handbook. type (such as revenue or nonrevenue, industry or
activity involved), legal and regulatory environment,
2.03 It is in the background of the country envi- internal controls, and the quality of staff
ronment that the TM should, as soon as possible, 2.06 This review would be followed, as the pr
obtain a review of the financial management struc- o-
ture of the proposed implementing organization. If ect design becomes clearer, by the more specific
oth proposedpimplem thentig
thestructure oantizatin It designs of the financial management and accounting
the structure is not acceptable, then the entity must structure directly related to the proposed projet
be willing to introduce the necessary revisions to the inclurding ctai Tel a ty and quality
structure in time for project implementation. Unless auditr shalso be dtrined ath time.
this review is carried out early in the preparation
cycle, where significantdevelopment of the structure Accounting Structure
is necessary, it is likely that the project would be
appraised and processed without an adequate system 2.07 The accounting structure should be a reflec-
being in place. tion of the project itself Where the project is only
4 FARAH

concerned with expenditures and its financing is project funds can be readily matched. This seg-
earmarked for specific purposes in the Staff Ap- regation of project costs can be problematic
praisal Report (SAR), then the accounting structure when the project is part of a larger program be-
and controls would only be concerned with such ing implemented by the project organization.
expenditures and financing. This applies whether or This type of problem is common in nonrevenue
not the project is a part of a larger program or a part producing projects which are managed by the
of an operating entity with which the project has no government.
concern. Where the project is concerned with the
sustainable financial health of the project implement- 4) Interfaces with the government accounting sys-
ing organization or has an interest in its institutional tems should be transparent and the impact of
development, then the focus would also be on the government regulation determined. This is espe-
accounting structure and controls of the overall cially important when the project is partially or
implementing organization. Concern with the overall wholly incorporated into a government
structure is usual for revenue earning and other agency/department. Where there is no direct cor-
commercial type organizations. respondence between government and project
accounting categories, sub-categories under es-
2.08 Similar types of projects usually have similar tablished government accounts can be used to
accounting structures, however, projects vary widely establish a linkage. However, in some cases,
and an adequate accounting structure for one project parallel accounting will be required.
may not be adequate for another. Issues will take on
a different level of importance depending on the 5) Recurrent and investment costs should be distin-
project and therefore, care should be exercised when guished by establishing separate sub-categories.
assessing the adequacy of the accounting structure
for a particular project. There are, however, some 6) The accounting and budgeting system (see Box
key points to consider for all projects: 2.01) should be the simplest consistent with the
complexity of the project.
1) The accounting system should be fully inte-
grated, whenever possible, with all other finan- 7) Periodic financial reports produced from the
cial management systems (budget, treasury and accounting system should compare actual to
debt management) to assure that it provides a drojected/budgetedcosts for the current period
single, common database for financial informa- and the total project to date.
tion. 8) The financial data produced by the system
2) There should be a linkage between the cost cate- should be capable of providing some measure-
gories used by the accounting system and the in- ment of performance when linked with the out-
puts needed to carry out the project as reflected puts of the project. The selection of key per-
in the SAR. This linkage should be transparent. formance indicators and accompanying financial
Important costs should be segregated. Cost data must be planned for during the appraisal
groupings should be logical and key inputs ap- period, and should be incorporated into the ac-
parent. More important costs should be tracked counting and reporting system design.
at a less aggregated level. The correspondence
between actual cost and budget, as determined in 9) The accounting system should follow clearly
the SAR, should be clear, documented accounting standards. The Bank re-
quires International Accounting Standards as the
3) Project related costs and revenues should be benchmark, with all deviations clearly identified
grouped together so that the sources and uses of (paras 2. 15-16).
 CHAPTER
11 PROJECTAPPRAISAL 5

~~ 201 ~~~~~at operationallevels such as project sites is trans-

ferred to a central location. Unless these systems
~udgtPrblems
M Iop~g Gantiies I are properlydesigned,fully integrated,and highly
computerized, delays and loss of data may result,
~ X affect prompt and accurate reporting. Con-
2{MMPwhich
it0nt tfrogh iiga Wget; -w8get Sr¢b1~i~i~ de-:: versely, decentralized systems, which permit local-
~~p~~g
r~~~~i~~te
~~~uies
t~~~~ ized financial operations, usually require more ex-
tensivecontrolsand increasedstaff

,''-''''..''',,'".'',-''',.'''.'.,'"""'''"''''''.'''0'
":.n..onim ".n erciall Gov.rnm.
.....
SXn.d h maa-mn,t fni-i; A outn ytm...............................'E
Th~iiaxtobctv ofe nerhal rente
5,.e.5.5.555,5 ;',; ', , . i -.; .':: 5 .- -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~$,*,J
t-ia- pronra i genci~ may b tS - .efnefor a nperio and to present afaiviewf

potbtY cmeciU. T orentd etities ma

--~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~OIM
- i g- r-: -. ].

performanc f
suchingtanes,
o it iscant Chnt.
:) ;~u i,n~w-errttrtw -oto
-f; fi-ca th entit. Wit a sto ou
an clearkof e~ acnt iniing
recrdsreno ii
ty as~kti*torbuge
ofallexpenditur-
caegris Te piniy
:*na-es ac*mino...tieofg
sy tes wic rnnca psvd .c.o.ntinis
drt-ia o
docume~ntation
Support
2.09 egardls qe4the
of shouldbe
tplenno maintained fo
nf oto;seottr o satw..
fffnt)f
project risfy
th.e aicO
;]ass*jji,n'--ead nailtOd .inanci .-.-:aeunt d--
I" is ellmtb:otgoenetfne mgserc
tan that the pojec
a organizationmaintaisde; t -r spplemtaaystem wo-l not e neesr.

2.09 Regardless
each ofleast
theatype
atproject year of
for after the last dis- . bU(cLaty.e..clas.iticetions,
project,'secudtor -br:tie which v
respons.:le moitoe
en thi
.. nuc
ofmh~i
buremn fundsforteproecndutil
asteod
t concepr..ts ..
.
.e-: ..... ... c aenetcpbiiis Ii fe

decentrlized
afect th finanial
ill maagemen of qured da a,.ate thn "maI Anyemabaten hnes

tanttha theproectorgaizaion
ainainadeqate proecs agap.instbugentdfigre. Althoughs:pr-i;ojec
and0clearacuting rheacordtngstuur
alxedtures
of thes.. reae:akrqieet
ac.pouting and.e r
exajened byatheraiation
Suppoteocmentin
been ishould
poetstrial for -. -t.e"ntg..y-
bemantrained or-
auditors. Og~dtoesuiiii are acutabilty.
not to . .re,
to.p..vide
aforc the pfiaci andutlila
burementr of fundswl of tol; ~
management.P9~W enerallyr,t

ganizations, governments, or large parastatals may.. ....... ....

operate centralized financial management and ac-
countingsystems,wherebyall informationgenerated
6 FARAH

AccountingStandards only when paid and not when incurred. It is very

important to understand the accounting methods
2.11 Accounting Standards are formal guidelines used in producing a particular financial report.
that specify how certain types of transactions or
events are to be recorded and what disclosures 2.14 International Accounting Standards (IAS)
should be made in the notes to the financial state- have been developed by the International Account-
ments. Standards are usually issued for the purpose ing Standards Committee (IASC) to resolve differ-
of achieving uniformity of accounting treatment and ences in accounting standards adopted by different
comparability of financial data where a wide variety countries and to harmonize accounting treatments.
of possible accounting practices exist. In individual The membership of the International Federation of
countries the body of accounting standards, policies Accountants (IFAC) and therefore of IASC is cur-
and concepts generally or widely adopted by pro- rently comprised of 110 professional accounting
fessional accountants, associations of accountants, organizations belonging to more than 80 countries.
and other authorities are referred to as Generally
Accepted Accounting Principles (GAAP). These Acceptable Accounting Standards
comprise published guidance (often in the form of
published accounting standards or guides) as well as 2.a15 In the absence of any superior national stan-
subjective, accepted practices. The government's dards, the Bank requires the use of IASs in the
role in determining accounting policies, standards, preparation of financial statements because their use
and disclosure requirements differs among countries, facilitates comparability between projects and coun-
often depending on the degree of sophistication of tries, ensures consistent presentation of financial
the country's economy. In some countries, account- statements, and facilitates their interpretation.
ing standards are set primarily by government regu- However, the Bank recognizes that local practices,
lation or simply based on tax regulations. standards, or legal requirements may not fully reflect
such standards. Government agencies serving as
2.12 An integral part of financial reporting is the implementers may be required by their own laws and
accounting standards on which it is based. Account- regulations to use an accounting methodology which
ing principles and standards provide basic guidelines does not meet IAS. Where national standards are
to determine how and when financial transactions used, the Bank requires financial statements to dis-
are recognized, calculated, classified, posted, sum- close any material departures from IAS, and the
marized, and ultimately reported. Standards can be impact of such departures on the financial statements
quite specific and may be implemented through a as presented must be stated.
variety of accounting policies and methods -- for
example, the accounting principle of matching in- - ..2.
....... ....... 3.... ...... .. .....
come with the expenses required to generate it (see ................
. . ...................... . .. ... .....
Box2.03).
2.03). i... . ...i........
:-it:i S-t:;
.....
0i-Et7 : Mat
0i0: chingt;;
;-;0::.:000-;iE-::............
-. -00-
T: titt!.:f-S
..................
i:-

2.13 The accounting method used can have a A stiml example0iTs -with invenoy Cah s is
dramatic affect on the apparent performance of the |bu:rsed~iid : incosts0 ed.to
...............................................
ldou.r.r
by ra. .......... .. -
project or organization, even doubling the amount of tpayfor lablr to produce atpr ct. Thse ...... .are.
an expenserecognized in a particularyear. In the -0notexpens,ed,bt reinted aptalized'+,
-i.e. trea0td
private sector, a difference of accounting methods l -0as:aissets--inth;isScaseinvetr. When t he:product
used can transform a loss into a profit and vice versa Tis 0soldfrlm the inventory the iite st ofpod
(see box 2.04 on Accounting for Leases). In the products w b reog e t...
.in.g.thereated
public sector, significant budget overruns can be 000tnlatch"thereveu reeie from the sale.
.........
f-E....-.......-....
hidden on a short-term basis if costs are recorded .;:.E; .EE.::;;. ::i.-E:i.;i-E.t;.;f
 CHAPTER 11 PRojEc,r APPRAisAL7
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8 FARAM

Assessing Internal Control prepared to handle more complex transactions for

which the accounting treatment is not always evident
2.17 The internal control system embodies poli- and understand the importance of audit trails and
cies and procedures adopted by the management of internal controls. Extended experience is also im-
an organization to assist in achieving management's portant, but sometimes, especially in the public sec-
objective of ensuring, as far as practicable, the or- tor, staff with experience are aware of government
derly and efficient conduct of its business, including regulations, but understand little about the "why" of
adherence to management policies, the safeguarding what they are doing. This may be adequate (though
of assets, the prevention and detection of fraud and not desirable) at the clerical level, but not at the
error, the accuracy and completeness of the account- professional level. Obviously, larger and more
ing records, and the timely preparation of reliable complicated organizations require more staff highly
financial information. There are two basic types of skilled in financial management.
intemal controls -- administrative and accounting
(Annex II, paras. 14-23 discusses some important 2.19 Related to both education and experience is
aspects of Internal Control). Administrative con- the quality of on-the-job training, in particular the
trols are broader and concerned with the control use of continuing education to ensure that staff
environment for the whole organization, including maintain their current skills and learn new ones.
the overall efficiency of the operation and adherence Staff should be encouraged to participate in profes-
to the policies and procedures of the organization. sional accounting associations and their training
Examples are personnel procedures for the hiring of programs.
staff, quality controls, or operational ratios and other
statistics such as inventory turnover. Accounting 2.20 Finally, it is important to carefully evaluate
controls deal more directly with assuring that assets the match between the complexity and responsibility
are protected and that accounting records are com- of the job and the qualifications of the person filling
plete and accurate. Examples are budget reporting, the position. An accounting unit may have good
bank reconciliation's (independent verification), and clerical support, but lack a manager who under-
safeguarding checks. A strong control environment stands the significance of the financial information
with tight budgetary controls and an effective audit being produced and is committed to timely and ac-
function complements specific accounting controls curate information. A controllership function should
and improves accountability over the use of re- have specific staff in the following areas: financial
sources. planning and budgetary control; general and cost
accounting systems; financial systems and proce-
Quality of Staff dures; and data processing and management infor-
mation systems. Staff for the treasury function
2.18 Accounting deals with a myriad of transac- should have skills in cash-flow forecasting, drawings
tions, each of which must be properly classified and from cash collection, banking relationships, and
recorded. The quality of the staff, their understand- general cash management.
ing of accounting concepts as well as government
regulations,and their accuracyis very important to ProjectTypes and Sector Characteristics
prevent material misstatements. The TM should
verifyrthat the borrower has an adequate number of 2.21 The Bank mainly supports investment and
skilled and experienced accountants and bookkeep- adjustment projects with some projects being a mix
ers at each project participating organization com- of both--termed hybrid projects. Investment proj-
patible with their accounting responsibilities. One ects may be of a revenue earning or a non-revenue
key to staff qualifications is educational background. earning nature. However, in both cases, the Bank is
Staff with an accounting education will be better concerned with the security of assets as well as the
 CHAPTERII PROJECT
APPRAISAL 9

proper and efficient use of all project related funds. identify on a timely basis the need for additional
Within each project type, there will be important revenues, serious cost leakage, or of potential cost
differences between sectors, such as financial, utili- savings. It should be able to provide signals as to
ties, industry, and the social sector, particularly in the need for tariff increases as well as the extent of
terms of the financial information required for effi- public sector subsidies. Guidelines for reviewing a
cient project management. These differences are revenue earning financial management system are
discussed below; adjustment projects are discussed given in Annex IV.
inparas 4.32-33.
Non-Revenue Earning Entities
Revenue-Earning Entities
2.24 Most non-revenue earning projects will be
2.22 Revenue earning projects are usually imple- implemented by government agencies. These proj-
mented by a commercially-oriented enterprise in the ects may come under government regulations and
private or public sector, an organization which gen- requirements. Government budgetary and account-
erates revenues either by consumer charges or forms ing systems may involve seemingly excessive bu-
of local taxation, or both. These enterprises are reaucratic prepayment authorization measures, fund
likely to be autonomous, or nearly so, with powers flow problems, and performance delays caused by
to determine financial policies. State-owned entities apparent lack of delegated responsibility. Staff are
may be required to conform to a standardized na- urged to obtain an understanding of government
tional accounting plan. It will be important to de- budgetary and accounting systems and to seek revi-
termine their legal status and the degree of auton- sions or mitigating actions where the above will
omy exercised. affect project implementation. However, it is very
important that existing checks and controls in a
1.-
.o . system are not removed without substitution of
adequate new measures and without the trained staff
forAssessing Finacial
. -- Checklt -.teto implementthem. Guidelinesfor reviewinga non-
... v:ne-a Pr:e.t revenue earning financial management system are
.:......... . given in Annex V.
r -. tt fi
..... Accounting for Sectors
. :. ety--tautoo us or. und.t o..r.--
met- contr.o 2.25 Financial management including accounting
.c n: Accontin frcesystems
tctes.-andpolciesandpracicesin
tnpo ::rcce.f....................ti and controls may vary from organization to
organization and between sectors. Each sector has
Matiagemet ar-idcontrol IvS-:-- certain key characteristics which should be reflected
'.'-,'', -Cenralzedor
"'ra'
'. of": ecentraliz
'- managemn
' ehn a:'n in the financial management system. For those sec-
a..ountin sys:tems tors of a revenue earning nature such as financial,
;.-..- .-.utilities and industry sectors, the Bank is usually
-.. : -.... .. Financial teguia.tKrns . , , .:
-. ~concerned with their financial management struc-
Fnancial mana--metnd n.
..t .: ture, including the accounting system of the overall
project implementingorganization.
2.23 In assessing a revenue earning project an
underlying concern is the current and continuing 2.26 However, it is important that TMs approach
financial viability of the organization. The financial the design of accounting procedures within the
management system should be strong enough to background of the respective implementation capac-
 10 FARAH

ity of the project organization,and examineimagi- Legal and RegulatoryEnvironment

native and innovative approaches where necessary.
Box 2.06 shows such an example; however, such an 2.27. Understanding the legal and regulatory envi-
approach requires strong accounting and control ronment in which the implementing organization
systems at the District and State levels. The specific operates is important in ensuring the best financial
financial management and accounting issues relating management for the project. The degree of auton-
to the individual sectors supported by the Bank omy exercised by the organization will determine
would each warrant their own handbook. However, how readily changes in the financial management
for this Handbook, some of the main characteristics
of selected sectors are summarized in Annex VI. system can be made. Most countries have a Com-
panies Act which sets up the legal environment in
which firms must operate. Sometimes the account-
ing structure is dictated by law. Some industries will
be more regulated than others and might have an-
::.. .0... -... ........... ... .
.... .other.et
6 . of..reg
reg.ulations in...repl.acemen of. orher
ast an
0-~~~~iProjets0- addition
00000g00to40-
the basicCmaisAt hr a
!,..... .. ...
,Et,h
..........
,e.0S,t+,,,,.to
..., ..... .. ........ . ......S-....
. ........
I.-n.t.h.e.
abv e. pr ects. .. ovrm t .ude....-a . Code establishing business law. State-run agencies
n-0X.
1... anull hough agr pa... .e ....... r ... .0 may have legally required accounting practices and

...th.ousands...fll.. age..... ools.....

that b i f... the... tion
project Awa.r
. o n.t...
i.. rv. lea:u . .. .b.licl tion
:.annoucd .t:heir: }pupose.- v --- -s th cstuci -

ha...nd ... pu..p)is

.... i. knowledge n v
committee:is th curto o: ths ud.T .pb 2.28 The Staff Appraisal Report (SAR) should
licly-tpro:v,igded .,nd,s:
f are, typically l-ess-thaniV
theSesti-i
..otth st
.mat.. m- d vl h 't i; Include a detailed explanation and assessment of the
.. E..
..-.-- .-. -E
.... -..
S.......E.E.
. -. E .... .... . -..
i.E..
.. .V.i..
. }.. . .. ..... .. ... .. ..

needned. Detailedprceurl anuasad forms' on requirements for the particular project. It should
0''the
'-s,imple-proueet a- ontn and repotin address the design of the project accounts, proce-
, a,r,e
f--pr,,cedu,re,s' d'ed'' to the:,0joint; chir
,-;0jp,rovi due eurdfo osldtngrprigfo
(h'eadmas,ter
;and-village headmn of'; the0''villag e'' various sub-projects, the use of SOEs, and any other
,cmmitteEe,,,-wh,,o repior :0to, the:,;,disrc dcto, atvte eurd oasr conaiiy hswl
,:offlceabou,t progres-s,-inludingthe sats of- f-unds---' be especially important when the project involves
reot, g,onfiind,, and; -prores is kept-in a
;-sta:tusg,Q
A: eea gnisadtemehdlg o osldt
board at the;":school- entrance' The 9|leder'w -lO*ing total project expenses is not clear. The SAR
eludessigne,
h,or thub-print,hed vcorldsof omit-o1M,should also outline the format for project reporting,

l pfirocedures
.. .E;A. ....- EASAiE0f.
0CCWEE-EE..
EE-E
 CHAPTER II PROJECT APPRAISAL 11

2.29 In the event that the financial management ability for the use of its funds. The legal agree-
system is weak, an action plan for its improvement ments, including the Agreed Minutes of Negotia-
should be negotiated with the borrower and incorpo- tion, are the authoritative source of all financial
rated into the SAR. As needed, technical assistance reporting and auditing requirements.
can be provided within the context of the project or 2.31 Loan covenants should be used to assure
even as a totally separate financial management compliance with general Bank policy. In consulta-
strengthening project. An actual plan should be tion with the legal department, the TM should en-
worked out in time to be included in the SAR, and sure that standard audit covenants are appropriate
incorporated into the loan agreement as necessary. for every project as well as any special covenants
In extreme circumstances, it may be necessary to related to financial reporting or independent reviews
contract out the accounting, but this should only be of project progress by experts. Once the Bank's
on a temporary basis and within a technical assis- requirement of basic accountability has been met,
tance plan to improve the overall financial manage- additional reporting requirements should not be
burdensome on the borrower or on future Bank staff
ment of the entity.
trying to ensure compliance with the covenants..

Provisionfor Audit

Box
......- :207 2.32 The groundwork for a timely and thorough
.0 ..... . ....... audit should be laid during the project design. The
.. Elements of FinancialManagm e.t TM will need to be aware of any legal considera-
Forlnalusion in Prject Design and SAR tions in the selection of an auditor, including
......
-. ::.::::-:
. - whether or not the project is to be audited by gov-
| Provision of p dic iten auite emment auditors and their acceptability to the Bank.
financial.statements and suggested format The TM should also be aware of the overall status of
|~ ~~ ~
:.-.:.. ~. .. .. .. ... .. ~~~~the
accounting and auditing profession. and its ad-
l.Agreementoftheprojet -financial statee nt herence to international standards relating to both
SA :proJectins. and
-:liningthe accou.ntswith ......... accounting and auditing. In consultatoon with a
.provision of informationre fson qualified accountant, the TM should determine that
.to keyperrman.e indictors . :any auditors proposed by the borrower are qualified
When.morwtha one-Imple tg to perform the audit, are independent, and have been
involved, proedures for Xo solid-ting ~*
: is provided with terms of reference satisfactory to the
.::fromindividualorgaizations---.: :: - Bank. Auditing is discussed in more detail 'n Chap-
:.,: ':: Id!'':t: .. of teHn
.. ,: ing
.:Agreemets.
. -..-.- documentation...
,. . and.
.:..,.: regaing
- . the
.. rotinin.,....
--. . : ... :. ..support-
-. . -..-.-.- tacVcofshetheretok

Accounting and Auditing Covenant in the

LegalAgreement

2.30 The Bank includes in all legal agreements

one or more accounting, financial reporting, and
auditing covenants as a means of ensuring account-
12 FARAH

NOTES
 CHAITER Im PROJEC IMPLEMENTATION 13

III: PROJECTIMPLEMENTATION

3.01 The Task Manager (TM) is charged with the 3.05 In planning the project budget it is important
physical and financial oversight of the project. By to structure the financial statements and reporting in
integrating financialmanagement techniques into the such a way as to gather appropriate data for a mean-
overall monitoring plan, the TM increases the likeli- ingful linkage between the physical and the financial
hood that project implementationwill be successful. data. The focus should be on one or two key indica-
tors rather than a myriad of combinations. In select-
Monitoringfor Performance ing the key indicators, the TM should carefully
evaluatethe impactof the measurementon the under-
3.02 Monitoring for performance is one of the key lying incentive structures for project performance.
outputs of a well-designed and constructed financial However, care must be exercised when using key
managementand accounting system. The frequency, indicators. While helpful, key indicators are not a
content, and format of reported information should replacementfor good project management and over-
closelymatch the needs of the users. Borrowers who sight.
are implementinga particular program night need
more frequent reporting and less aggregated financial
informationin order to make the necessary correc- Box3.0J
tions to project implementationand keep activitieson Ke Indicator
track. TMs might be able to use the same informa-
tion, but at less frequent intervals (perhaps quarterly A commonindicatorusedin theconstructionof roadsis the
instead of monthly or weekly), and at a more aggre- costper mile.kmof roadciompletedThis indicatorgivesa
gated level. clearindicationof whetheror no thefinancialresources will
beadequateto complete theprojectednumberof uiles,butsays
3.03 Regardless of the frequencyor level of aggre- nothingaboutthe qualityof those roads. Nonetheless, the
gation of the report, actual performance should be
combinat ion.of physical and financialdata is superior.
for
'cmiaino
monitoring lycladfrnil-atisupirfr
projectprogressto eitherof the twotakenalone.
compared to projected performance. Key perform- Suchperformance indicators
canincreasetheabilityto monitor
ance indicators, some of which combine physicaland a'projectforfinancialaccountabilityas wellas physicalcom-
financialdata, shouldbe determinedand reported on. pletio'.

3.04 Neither financialnor physicaldata by itself can

provde
inormtio
uffciet fo
provide sufficient information for theborowe
the borrower oror 3.06 The nature of the project wfll determine aa
itrlybtenfnniladpouto the
Bank to determine whether or not the project is pro-
gressing properly. The project may be achievingits Projects which closely resemble commercial enter-
physical goals, but at a rate of cost which will con- prises will lend themselves to the developmentof key
sume financialresources so rapidly that they will not indicators which are heavily "bottom-line" (or finan-
be sufficientto finish the project. Similarly,the con- cially)oriented. Comparativevalues may be available
sumption of financial resources does not imply the from the private sector. In nonrevenue earning proj-
accomplishment of physical milestones. When the ects progress toward completing the project objec-
two are linked, the TM and borrower can get a much tives may be harder to quantify, but key indicators
clearer picture of project progress and take appropri- based on throughput can have a beneficialimpact on
ate actions as needed. the overall managementof a project.
14 FARAH

3.07 One of the key tools in monitoring for per- during project implementation. In addition, AnniexIX
formance is the project financial report showing pro- provides some model Form Letters that will facilitate
jected sources and uses of funds, for the period and the monitoring for audit compliance.
for the period to date, compared to the percentage of During the Fiscal Year:
the project completed in the period and for the period
to date. Sometimes this comparison can be made on 1. Follow up with project management on the com-
the basis of financial resources consumed as a per- pleteness and timeliness of the financial records
centage of the completion of some key indicator, such and reports including periodic unaudited financial
as miles of road laid. reports and information required for monitoring
project implementation;
3.08 The key question to ask in evaluating a project
financial statement/report is whether or not the costs 2. Ensure not only the receipt, but also the re\ iew of
appear to be reasonable given the progress of the the periodic financial information that may he re-
project. For example, salary expense on a technical quested for project management. Issues idenitified
assistance project in the social services sector might should be followed up, in particular audit (uLialifi-
be expected to be fairly evenly disbursed across the cations and internal control weaknesses inCluded
life of the project. If an interim project financial re- in the audit report and management letter respec-
port showed the salary line item being disbursed in tively;
disproportion to the project life, the Project Manager 3
and the TM would focus on this exception and inves- 3 Send out reminders for audit reports (i) close to
tigate it further. There may be a perfectly reasonable the end of the entities' fiscal year. (ii) shortly be-
explanation for the variance, but by highlighting ex- fore they become due in the Bank, and (iii) each
ceptions to expected results the project financial re- 30 days thereafter;
port points to areas where problems are most likely to 4 Send a brief acknowledgment to the borrower on
be occurring. Annex VIII summarizes the Use of receipt of the reports with a statement that com-
Financial Information to Monitor Physical Project ments, if a,i beps laerentand
Implementation.~
Implementation. ~ ~ ~ ~~iec metsf
mns any, will be sent later; and
5. Ensure that adequate audit arrangements are in
place so that the audited financial statemenitswvill
3.09 There is a very clear and important linkage be available as soon as possible within the -.ra-ce
between interim financial reporting used for perform- period provided in the legal agreements. Ar-
ance monitoring and the audit. The audit of the an- rangements should include the agreemiietnt of the
nual financial statements would confirm the accuracy TOR for the audit (paras 5.39-41
and reliability of the interim financial statements. Any End of Fiscal Year:
significant difference between the audited figures for a
particular period and those reported on the interim
financial statements should be reconciled and ex- I. Ensure the receipt of the audited financial state-
plained. ments. These should be received within the unrace
period allowed in the legal covenants. The grace
Monitoring by the Bank period should be no more than six mionitlhsafter
the close of the fiscal year. The usefulness of re-
3.10 The following summarizes some guidelines for ports received much later is reduced.
the TM to monitor Financial Reporting (Chapter IV
of the Handbook) and Audit Compliance (Chapter V)
 CHAPTER m PROJECr IMPLEMENTATION 15

2. Have ail audited financial statements (including should be emphasized. The TM will follow-up
SOEs and SAs) reviewed by qualified Bank staff promptly all instances of non-compliance and all un-
within 30 days of their receipt to ensure that they satisfactory financial or audit reports submitted.
are complete, that they have been properly re-
ported upon by the auditors, and that the data 3.12 In the case of non-compliance for the receipt
provided appears reasonable. The liability to the of financial statements, the TM should, within 60 days
Bank as shown in the financial statements should of the compliance date. investigate the reasons for
be reconciled with the disbursements shown in the non-compliance and make recommendations to the
Bank records. Annex X provides Guidelines for SOD or COD chief who should notify the borrower of
the Desk Review of an Audit Report. the need for compliance, the remedial actions required
3. Obtain a report from the reviewer (when the re- to be taken by the Borrower, and the Bank's remedies
viewer is not the TM) and ensure that it is copied if such action is not taken. Where compliance is not
to the Division Chief. The letter to the borrower achieved within six months from the notice. action
with any comments relating to earlier reviews and should be taken to exercise the Banks remedies for
actions taken or proposed should be attached to that loan, unless the TM is satisfied that acceptable
the report. remedial action is in process to allow compliance
4. Notify the borrower in writing of the findings of within another six months. (For more guidance, see
the review of the financial statements immediately OD 13.40.)
after the review. Where issues are identified in the
course of the review which cannot be addressed 3.13 Where non-compliance relates to SOE proce-
through correspondence, these should be followed dures. the borrower should be notified within 30 days
up during subsequent supervision missions. Items of the due date for compliance and the remedies avail-
which would be covered in the written review able to the Bank. The borrower should be given no
should include the following, as necessary: more than three months from the date of notice to
come into compliance, after which the Bank will no
significance in the auditor's reporth longer permit disbursements against expenditures
eligible for the use of SOE procedures.
• whether all the Bank's financial reporting require- 3.14 Where Bank staff consider it necessary to
ments have been met; 31 hr aksafcnie tncsayt
allow an extension for the receipt of financial state-
. relationship between the results shown in the ments for the project implementing organization and
accounts and financial covenants; for the project (para 3.12), separate SOE and SA
audited financial statements should be required within
*aspects of financial performance and internal con-
trol including a comment on the liquidity of the the above three month period. The above timetables
implementing organization and as appropriate, on and procedures follow OD 10.60 which is currently
any other financial ratios; and under review as OP/BP 10.02. Reference should
therefore be made to OP/BP 10.02 to ascertain any
* acceptability of presentation with respect to use of changes.
Bank funds.
3.15 Where there is a loan financing several proj-
3.11 The importance of timely compliance with the ects, compliance is viewed separately for each project
Bank's financial reporting and auditing requirements (see Box 3.02). Thus the Bank may stop SOE dis-
16 FARAH

bursements for one project which is not in compli- * receipt of audit reports
ance, while continuing SOE disbursements for another
project which is in compliance under the same loan. * assessment of audit reports and follow-up

.. i. ........... * monitoring of audit compliance; and

:;A multista teloanis-m.ade.to Gvrxen lh* neig fdt n h RS

staXtegovernets ea patcptn
- Ude te lIn The TM has the primary responsibility for keeping the
I.0ff.n¢state si n-cont..ianc ;rthe Subnto$W t data in the ARCS up to date and for obtaining an
.- gauditedfiania.etatens -isbus. -endts
wou1. assessment of the reports received. Entries into the
co
.nti.
..... o te.othe. s.a.e t .
.~~~~~~~~~~~~~~
. ........ a rmdalatlnisrqurd
*Project effectiveness;
3.16 The principle outlined above may even be
extended to cover situations where, for example, the * receipt of an audit report;
same Ministry of Government has two separate proj- *ayflo-pato noedeadtrprs
ects Implemented by different departments or agen-d
cies, one in compliance, one not. However, care must and
be exercised to ensure that new departments or agen- deiinta.eeil
. cini eurd
Audit....
Reportin
...... e ysem.
cies are not created under the same Ministry for the
purpose of negating Bank actions for non-compliance Standard ARCS reports and sample report formats
by another department or agency. are provided in the ARCS User 's Guide.

3.17 Where the implementing organization is in C:ountryReview

non-compliance, no new loans to be implemented by
that organization would be made by the Bank until 3.20 Where there is pervasive non-compliance, the
compliance under the current project agreements had TM should propose an assessment of the country's
been achieved. This also applies to extensions of loan accounting and auditing capabilities, across both pri-
closing dates for ongoing projects. vate and public sectors, examining laws, standards,
training, the independence of auditors, the availability
3.18 TMs are also required to review, during mis- of skilled technicians, etc. These assessments would
sions, selected SOEs. Annex VII provides a guideline be undertaken under the umbrella of the country
for such review. ~~~~~department,
and may form the foundation for a sepa-
rate technical assistance project or a component of a
Audit Reporing Systemproject.
Complince In addition, country portfolio performance
3.19 ReprtingComplance
Te Audt ystem reviews (CPPRs) should routinely include a review of
(ARCS) is a part of the MIS and contains information the borrower's implementing organizations' account-
reatn to th adtrprseqid,aes fr thi ing and auditingcapabilities. Country AssessmentiS
submission to the Bank, details of the auditor and the discussed in Chapter VI of this Handbook.
quality of the reports received (see OD 13.10). The
ARCS should be used to monitor audit compliance on
an on-going basis. Audit reports received and their
status are required to be entered into the ARCS on a
timely basis. The ARCS cycle consists of:
 CHAPTER IV FINANCIAL REPORTING 17

IV. FINANCIALREPORTING

4.01 The financial reporting requirements will vary they are relevant to the task, but not unnecessarily
from project to project, and as embodied in the legal time consuming.
covenants of the loan. Financial statements portray
the financialeffects of transactions and other events ImplementingOrganization'sFinancial
by grouping them into broad classes according to their Statements
economic characteristics. Accounting Standards lay
out the benchmarks which the accounting and finan- 4.04 In projects where the financial viability of the
cial reporting would be expected to follow (para implementing organization is vital to the success of
2.15). the project or where one of the objectives of the proj-
ect is to improve the institutional capability of the
4.02 The Bank has always required annual financial implementing organization, particularly in financial
statements provided by the borrower showing the management, the Bank requires their full financial
project's performance for each fiscal year. More statements. These will include the balance sheet,
recently, however, a strong need is also being felt for income statement, cash flow statement (sources and
interim statements and reports, quarterly and half application of funds), and accompanying notes and
yearly, to be designed as a fundamental tool for mon- supplementary information, on the organization as a
itoring project implementation and management in whole. Annex XI summarizes the Elements of Finan-
general. These interim reports are rarely audited, but cial Statements. Most revenue earning projects fall
their accuracy can be determined by comparison with into this category.
the final audited figures for the fiscal year.
Balance Sheet
4.03 Financial reporting is based on the underlying
financial management structure and accounting sys- 4.05 The balance sheet is a financial snapshot taken
tem, which should be developed and agreed during at a particular point in time which is used to evaluate
the appraisal process. Financial reports required from the overall financial condition of the organization at
borrowers can generally be classified into categories - that date. The elements directly related to the meas-
- the implementing organization's financial statements urement of financial position in a balance sheet are
project specific financial statements including those assets, liabilities, and equity The balance sheet pro-
for adjustment operations. statements of expenditure. vides information as to what resources are currently
and special accounts. TMs frequently refer to some, available for the future performance of the organiza-
or all of the above, as Project Accounts. It is impor- tion. It also provides information regarding the fund-
tant to understand the specific role of each of the ing of those assets, such as whether they are funded
above financial statements. Each of these financial through debt or net worth.
statements should be designed so that they provide 4.06 A balance sheet normally is prepared as of the
the borrower with needed information to manage the 406 Ablnesetorayispprdasfth
project, and to provide the TM with the information close of the reporting period and should provide de-
needed to monitor project progress. Efforts should be tails of all assets (fixed, current, and other), liabilities
made to consolidate reporting requirements so that (accounts payable, short and long-term debt), and
equity (paid-in capital, accumulated earnings, or
18 FARAH

deficits). Where possible, the balance sheet should be ing treatments, and cash resources and their impact on
compiledto highlightimportant characteristicssuch as reported results.
the capital structure, the liquidity position, or the
reserves, to illustrate the nature and business of the Notes and SupplementaryInformation
organization. Presentation of comparable data from
the previous year is required by IAS. 4.10 The notes should include the main accounting
policies followed, and other important disclosures
Income Statement including risks and uncertainties affecting the organi-
zation and any resources and obligations not recog-
4.07 An income statement reports the results of nized in the financial statements. Information about
operations or performance for the period covered. geographical and industry segments and any other
The elements directly related to the measurement of information such as key indicators required for the
performance in the income statement are income and particular project would be included as supplementary
expenses. Amounts should be classified in the major information.
categories of financial informationwhich may include
but are not limited to: operating revenue by categories 4.11 Additional supplementaryschedules or reports
of sales of service; operating expenses by category; may also be required. Reporting requirements should
income other than from operations, interest and fi- be kept to the minimumneeded to ensure good proj-
nancing costs and net income. In nonrevenue earning ect monitoring and management while complyingwith
projects, financial resources may also come from IAS disclosurerequirements(see Box 4.01).
other donors or the government itself.
Treatment of the Project FinancialStatements
4.08 When budget data is utilized, along with per-
formance indicators, it is one of the best instruments 4.12 In almost all instances, the Bank-assistedproj-
for performance monitoring. It is easy to incorporate ect represents only a part of the overall activities of
budget data into an Income Statement so long as the organization. Unless separate project financial
there is a solid linkage between budget and account- statements are prepared (see para 4.13), the imple-
ing data. Budgets should be developed and account- menting organization financial statement including
ing systems improved until there is a close linkage supplementary information should clearly and sepa-
between the two. An integrated budgetinz and ac- rately show the expenditures and financing of the
counting system should be used by implementing project. However, for those projects requiring man-
agencies. agement informationand linkage to physical perform-
ance, a separate project financialstatements would be
bash Flow Statement more suitable. See Annex XII for a sample of an
Organization's Financial Statement integrating the
4.09 A cash flow statement shows the cash pro- project.
vided by and used in operating, investing and financ-
ing activities for the period covered by the income . .....
statement. An alternative "statement of sources and
applications of funds" or "statement of changes in w 0 f i
financialposition" may be prepared in some countries. statementsc. ep.inofinvstments; s .ff
A cash flow statement is important because it focuses loI:sses,
.wr.teoi-h .neoeis n caie nsa
on what happened to an organization's cash and equfl ae pxt o tedisclou r5 uie bylS
holdRers'
where It came from. By removing non-cash transac-
tions it helps to reveal the effects of different account-
 CIIAPTER IV FINANCIALREPORTING 19

Box 4.02

Centralityof Project
FinancialStatements

Schdul
o.Noes nteraed
ih|Poeiacialatmn

...--
'.'.-'l.,..,...,

ProjectFinancialStatements each project. A stand alone project usually requires

the Project Financial Statements, without the Imple-
4.13 The Bank requires annual audited financial menting Organization's Financial Statements.
statements reporting on expenditures and its financing
for each project, in order to monitor its overall finan- 4.15 The main feature of the Project Financial
cial performance, and the effective utilization of the Statement is the Source and Application of Funds for
loan. There may be more than one project to a loan, the project during the current financial year, and cu-
as in a multi-state project with separate project mulatively since the start of the project. Related com-
agreements. Separate financial reporting is required parisons of actual expenditures should be shown
to coincide with each project. In addition, many proj- against SAR original or amended projections, and
ects involve more than one implementing organiza- explanations provided for significant variations. The
tion, each subject to the Bank's requirement for ac- source of funds should be shown separately -- funds
countability. In these instances, it is strongly recoin- received from the Bank, donors, and other main re-
mended that the financial information from each im- sources. Funds provided by the Bank should be fur-
plementing organization be combined by the umbrella ther separated to show those provided a) through
project implementing organization to form a single SOE procedures. and b) through other procedures.
project financial statement.
4.16 The Bank is interested in the total project,
4.14 Project financial statements are central to irrespective of whose funds are used to undertake a
financial reporting. Regardless of type, every Bank particular activity or operation in a project for which
assisted project should submit regular periodic reports it has provided part of the funding. Application of
of receipts and expenditures against the budget for funds should be summarized to show expenditures
20 FARAH

and allocations by main project categories as laid ditional budget information and analysis, and the re-
down in the SAR (Bank funds by categories shown in ports are not audited. Reliable interim reports will
the loan agreement for disbursement purposes may facilitate good decision-making. An audit at year-end
also be shown for information.) Where project ex- provides assurance that the interim reports were reli-
penditure includes assets required for project imple- able and that future such reports are also likely to be
mentation (such as motor vehicles and other equip- reliable.
ment) these should be categorized separately and
supported by a listing of such assets to enable their 4.19 Where Statement of Expenditure (SOE) pro-
control/security. cedures are used for loan disbursement, the SOE
financial statement should be integrated to become a
4.17 Where accrual accounting is adopted, a bal- part of the Project Financial Statements (Annex XIII).
ance sheet is always required. Accrual accounting is
necessary particularly when there is an income aspect Statements of Expenditure
to the project. The summary balance sheet should
show the assets and liabilities of the project, and the 4.20 Under the SOE procedure, the borrower peri-
net fund created by the project. When liabilities are odically requests withdrawal of loan proceeds through
large, a supplementary schedule should disclose sig- submission of a statement indicating expenditures for
nificant creditors and commitments. Depending on the certain items referred to in the loan agreements. The
nature of the project, the notes to the financial state- SOE procedure simplifies and accelerates the Bank's
ments should identify the major contracts awarded loan disbursement process by eliminating the require-
and being awarded. Where applicable, a comparison ment for Bank staff to review supporting documenta-
to the previous year is desirable. Notes to the project tion for many small expenditures prior to authorizing
financial statement should include a statement of the disbursements. The SOE statements are not accom-
basis of accounting followed, and the accounting panied by supporting documentation. Implicit in the
policies under which the financial records were pre- SOE submission by the borrower is the adequacy and
pared. However, the majority of projects imple- veracity of documentation, maintained by the bor-
mented by government departments are on a cash rower, which supports the disbursements.
basis, and frequently financed as a part of the gov- 4.21 During the early stage of the project design,
enmient's own budgetary system and procedures. the TM in consultation with the Loan Department
4.18 The project accounting system provides an would have decided if SOE procedures would be
opportunity to use the management accounting dis- used for disbursements under the project. In consider-
ciplineto develop a linkage between financial account- ing the use of SOEs, the TM must also consider the
ing information and the key physical indicators re- previous record of the borrower in complying with
quired to efficiently manage and monitor project im- SOE requirements, the current timeliness and com-
plementation. Interim reports therefore are an impor- pleteness of the accounting records, a clear method-
tant aspect of the overall management by the bor- ology linking the SOE to the project financial state-
rower of the project, and for monitoring by the Bank. ments, and where more than one organization is in-
Program implementation decisions and necessary mid- volved, a means of aggregating the various organiza-
term corrections may be based on the financial and tions' SOEs into one submission without losing the
performance information provided via interim project audit trail. Satisfactory arrangements for external
accounts. The format of these reports may be very audit of the SOEs must be in place prior to authoriz-
similar to the year-end audited statements except that ing their use.
the period involved is shorter, there may be ad-
 CILAPTER
IV FINANCIAL
REPORTINC 21

4.22 Once the Bank and the borrower agree to the Special Accounts
use of SOEs for certain categories or items of ex-
penditures, SOE use is always required for these types 4.26 A Special Account (SA) mechanism may be
of expenditure. The nominated amount eligible for established to enable more effective project implemen-
disbursements against SOE procedures will vary from tation, mainly by assisting the borrower in overcoming
project to project. The TM should provide for pefi- cash flow problems. SAs are revolving account ar-
odic reconciliation between disbursements made via rangements under which the Bank advances funds into
SOEs, through direct disbursements, and Special a special bank account (at the central or at a com-
Accounts (SAs) if used, and the total disbursements mercial or depository bank). When the Bank adminis-
reflected by the Bank's records. This type of recon- ters funds provided by a co-financier, a single SA may
ciliation is essential to maintain control over project be established provided the funds are fungible.
resources. SOE procedures are fully discussed in
OP/BP 12:30, "Statement of Expenditures." 4.27 Under an SA controlled by a central agency,
sub-accounts may be established within the depository
4.23 As discussed in para 4.20, disbursements un- bank and operated by agencies that are implementing
der SOE procedure do not require the borrower to the project. Although funds are not transferred from
submit receipts and other supporting documentation the SA, the accounting records must monitor dis-
for expenditures. This poses a greater risk to the bursements against amounts allocated to each of the
Bank compared to other Bank disbursements which sub-accounts. In exceptional circumstances, the Bank
require the submission of supporting documents. To may authorize the borrower to draw funds from an
mitigate this risk, the Bank strengthened its enforce- SA and use them as an advance into a second-
ment for the receipt of SOE related audits. generation special account (SGSA).

4.24 In addition, SOEs are also subject to review 4.28 The SA is usually managed by the respective
by Bank staff during missions; Annex X provides Ministry of Finance or by the project implementing
guidelines for this review (see also para 3.18). As organization. The managers of the SA should main-
stated in para 4.19, the SOE Financial Statement tain appropriate records to control and identify the
should be integrated into the Project Financial State- movements in the SA, and are required to submit a
ment. This will, however, require the Bank to monthly statement summarizing such movements.
strengthen its enforcement for the receipt of the inte- The implementing organization must maintain proper
grated Project Financial Statement, to bring compli- books of account including all original records of
ance in line with that now required for SOEs. receipts and payments, bank statements and recon-
ciliations.
4.25 The suggested format for integration would be
to separately list, as an Annex to the Project Financial 4.29 Disbursements from SAs are made either for
Statement, the individual SOE withdrawal applica- direct project payments or to reimburse for project
tions, with the totals extended under columns show- expenditures already paid by the borrower. The Bank
ing the main project expenditure categories. The total then replenishes the special bank account on the basis
withdrawals should equal the amount shown in the of appropriate withdrawal applications submitted for
Project Financial Statement -- see Bank financing these disbursements. Interest earned on the SA be-
through SOE procedures (para 4.15). Annex XIII longs to the borrower who will need to decide how it
shows a model Project Financial Statement with an will be used -- for the project or otherwise.
Annex showing SOE withdrawals.
22 FARAH

4.30 The Special Account (SA) Financial Statement list of such items ("positive list"). Alternatively, the
(Annex XIV) is simply a summary of the Source and Bank may provide a list of goods and services against
Application of funds through the SA during the re- which the disbursement could not relate ("negative
porting period, with the Bank usually being the only list"). Accounting for such projects is merely main-
"Source" (para 4.26). Source is usually the Bank's taining a listing of the invoices and supporting cus-
initial deposit to the SA plus "replenishments." With- toms certificates applied against the loan. The listing
drawal applications are usually in the form of either should at least cover the amount of the loan dis-
direct disbursements from the SA, or reimbursements bursed. However, it is important that the borrower.
to the borrower for expenditures already paid for. retain the supporting customs or similar certificates
Other activities in the account would be interest on for at least one year after the submission of the related
outstanding balances and bank charges. The manager audit report. It should be noted that other additional-
of the SA should maintain appropriate records to procedures relating to procurement may be neces-
control and identify the movements in the account, sary. See Annex III.
and are required to submit an annual report to the
Bank summarizing such movements, also showing the Hybrid Operations
financial status of the account at the end of each re-
porting period. It is important that the SA Financial 4.34 A hybrid loan has elements of both an invest-
Sotatement be reconciled withat e Banks records, ment project and an adjustment operation. The ac-
takinginto consideration items in transit at the end of counting for each component of a hybrid loan follows
the reporting period, and also with the Bank's financ- the specified guidelines for that particular type of
ing as shown in the Project Financial Statement. operation. For example, the development of physical
infrastructure included in a hybrid loan would be sub-
4.31 In some countries where the banking system ject to the accounting and reporting requirements for
has not yet been developed (such as in the former investment projects, while the funds disbursed in re-
Soviet Union countries), project expenditures are turn for policy changes would be subject to the ac-
made using the SA as a regular bank account. In counting and reporting requirements for adjustment
these instances, the SA may be incorporated to form a operations. There would be really two parts to the
part of the Project Financial Statement. SAs are dis- reporting requirements, even when they may be con-
cussed in OP/BP 12.20, 'Special Accounts." Audit- solidated into one financial report.
ing is discussed in Chapter V of the Handbook.
EmergencyOperations
Adjustment
Operations
4.35 Accounting for emergency operations should
4.32 While most Bank loans finance investment follow the guidelines for non-revenue earning or ad-
projects, the Bank also makes Structural Adjustment justment operations discussed above, depending on
Loans (SALs) or Sector Adjustment Loans the project design. These operations may cover sev-
(SECALs). Adjustment loans generally provide funds eral different sectors, such as human resources and
to the borrower for budget support, subject to the infrastructure. One of the main differences may relate
borrower's implementation of specified economic to the several different sources of financing, some of
reforms. SALs focus primarily on broad macro- which may require specific identification for those
economic policies while SECALs focus on sector- expenditures financed by individual funds. However, it
related economic policies. is important that the control system take into account
the rapid delivery of funds required under these op-
4.33 Typically, SALs and SECALs provide quick erations.
disbursing foreign exchange which would relate to the
import of goods and services from a Bank approved
 CHAPTER V AUDIT COMPLIANCE 23

V: AUDITCOMPLIANCE

Typesof Audits and Auditors financialstatementsare unlikelyto mislead a pru-

dent user, the auditor gives an audit opinion on
their fair presentation and associates that opinion
5.01 An audit is an ex post review of the imple- with the statements.Althoughthe auditor is not an
menting organization's financialstatements,finan- insureror a guarantorof the fairness of the presen-
cial systems, records, transactions,and operations tations in the statements,there is considerablere-
performedby professionalaccountantsfor the pur- sponsibilityfor notifyingusers as to whether the
pose of providing assurance of accountability,giv- statements are properly stated. If the auditor be-
ing credibilityto the financialstatementsand other lievesthe statementsare not fairly presentedor if a
management reports, identifying weaknesses in conclusion cannot be reached because of insuffi-
internalcontrols and financialsystems,and making cient evidence or prevailing conditions, then the
appropriate recommendationsfor improvements. auditor has the responsibilityof notifyingthe users
Audits can differ considerably,dependingon their of the statementsthrough the auditor'sreport.
objectives,the activities for which the audits are
employed, and the products or reports expected 5.03 However, an unqualified opinion on the
fairness of financialstatementpresentationsshould
from the audits. In general, audits can be classified
into three basic types: financial statement audits,not be construed as an independent auditor's en-
compliance audits, and operational audits. For dorsementof an enterprise'spolicy decision,its use
financialstatementaudits, the Bank would be con- of its resources, or the adequacy of its internal
cerned with the audit of the financialstatementsof control structures. Audit conclusions about
the implementingorganizationas a wholeand of the whetherfinancialstatementsare fairlypresentedare
specificproject (see paras 4.04 and 4.13). Compli- not reached in a preciselydefinedmanner. Instead,
ance audits are discussedin para 5.18, and opera- evidence is obtained and conclusionsare reached
tional auditsin para 5.19. throughout the course of an audit. The auditor
starts with relatively little information about
Audits of Implementing Organization whether the organization's statements are fairly
FinancialStatements presented. Impressions about the integrity and
competence of management and the results of
5.02 The overall objectiveof the typical audit of previous audits are also considered. As the audit
an organization's financial statements is for the proceeds, each additional piece of evidence either
auditor to express an opinion as to whether the confirmsor contradictsthe initial impression. At
statements are fairly presented in conformitywith the completionof the audit, the auditor shouldhave
international accounting standards and generally strong beliefsabout the fairnessof the presentation,
accepted accounting principles applied on a basis whichwill leadto an opinion.
consistent with that of the preceding year. The
auditor evaluates whether the financialstatements Understandingthe Organization
are fairlypresentedby gatheringaudit evidencein a 5.04 Each audit should begin with the auditor
thorough and conscientiousmanner.When, on the obtaining an understanding of the organization
basis of adequate, sufficient,competent,and perti- being an understanding is generally
nent evidence, the conclusionis reached that the being audited This understanding is generally
' through consideration of the nature of the
~~~~~~~~~~obtained
24 FARAH

organization's activities and its background, and tended primarily to determine the extent of testing
through analyticalprocedures designed to high-light of actual transactions to be carried out in the subse-
significanttrends and relationships. In addition, the quent examination of account balances. Therefore,
auditor should be familiar with the SAR and any the auditor's report on the financial statements
agreements, including Minutes of Negotiation and should not be considered to be an endorsement of
the loan covenants, which are pertinent to financial the overall adequacy of the internal control systems.
operations.
Testing the Financial Statement Balances
Evaluation of Internal Controls

5.05 As part of an audit of financial statements, 5.08 The year- or period-end balances in the
the auditor normally examines the system of internal balance sheet and the amounts shown on the in-
accounting control for the purpose of determining come statement are verified by obtaining various
the audit tests required in order to form an opinion types of evidence. Examples include physical pres-
of the financial statements. If the auditor is con- ence at stocktaking, verification of fixed assets,
vinced that the organization has an adequate system direct written communication with third parties for
which includes controls for providing reliable data confirmation of accounts receivable, bank balances,
and for safe-guarding assets and records, the observation of actual inventory, and examination of
amount of audit evidence to be accumulated can be vendor's statements for accounts payable. Inde-
significantlyless than if the system is not adequate. pendent verification from external sources is one of
the most valuable means of verifying accounting
5.06 The degree to which an auditor will evaluate data. These tests of ending balances are essential to
an organization's internal controls is largely de- the conduct of the audit because for the most part
pendent upon the extent to which reliance will be the evidence is obtained from a source independent
placed on such controls in order to reduce the ex- of the client, and thus is considered to be of high
tent of other audit tests. When considering the quality. For example, in the course of conducting
system of controls, the auditor should first deter- an audit of a project, the auditor should contact the
mine, at least broadly, how it operates and then Bank to confirm the project balances independent
make a preliminary evaluation of whether the sys- of the implementingorganization's records.
tem has been designed effectively to accomplish the
objectives of preventing or detecting errors that 5.09 There is a close relationship between the
may be significantto the financial statements. general review of the client's circumstances, the
results of the evaluation and testing of the system of
5.07 Where the auditor has identified an effective internal control, and the direct tests of the financial
control, or a strength in the system, the auditor is statement account balances. If the auditor has ob-
entitled (but not required) to rely on this control to tained a reasonable level of confidence about the
enhance the reliability of financial information. fair presentation of the financial statements through
Hence, there is a reduction in the extent to which the general review of internal control and test of its
the accuracy of that information must be validated effectiveness, the direct tests can be significantly
through the accumulation of evidence related di- decreased. In all instances, however, some tests of
rectly to it. To justify this reliance, however, the the financial statement account balances are neces-
auditor must test the effectiveness of the controls. sary
The procedures involved in this type of testing are
commonly referred to as "tests of compliance" or
"test of transactions." It is important to recognize
that the auditor's review of internal controls is in-
 CHAPTER V AUDIT COMPLIANCE 25

Audits of Project FinancialStatements submittedto the Bank. The primaryobjectiveof is

part of the audit is to ascertain that the individual
5.10 The overall objectives of audits of Project expenditures which comprise the SOE totals are
Financial Statements are to determine whether the fully supported by documentation retained in the
statements, particularly the Sources and Applica- borrower's files, properly authorized and eligible
tions of Funds, are fairly presented for the specified under the Loan Agreement, and appropriately ac-
period, as well as cumulatively for the project; and counted for (see para 5.54). The Bank will also use
that the reported disbursements were made in ac- the results of the audit to determine whether con-
cordance with loan agreements and the SAR. The tinued use by the borrower of the SOE procedure is
audit would also look at the fair presentation of warranted, or if adjustments to disbursements on
balance sheets, with particular attention to the subsequent claims are needed to offset disallowed
treatment of assets. claims.

The AuditProcess Audits of SpecialAccounts

5.11 The process followed for auditing a project 5.14 Where Special Accounts (SAs) are estab-
specific financial statement, while generally simpler, lished, annual audits are also required. The primary
is similar in most respects to the process followed objectives of such audits are to verify that SA
for an audit of the financial statements of an execut- statements are fairly presented and that disburse-
ing organization, as outlined above. This includes ments from SAs are proper and in accordance with
an evaluation of internal controls and tests of the the respective loan agreements. Accordingly, the
underlying transactions. The auditor is, however, auditor should perform procedures to enable
expected to rely heavily on an inspection of valid him/her to conclude that the SA statement fairly
supporting documentation and to perform other reflects the activity of the SA, and that SA funds
steps, such as physical observation of significant are used solely for purposes of the project.
items purchased, where practical, to substantiate
the validity of the expenditure in accordance with 5.15 Audits of SA should, by nature, be quite
the loan agreements and the SAR. simple. SA audits consist of a review of the SA
records maintained by the nominated manager of
5.12 Where a borrower uses the SOE procedure the SA, along with the statements of the SA ac-
in claiming loan withdrawals, the expenditures re- count as provided by the central or commercial
ported in a project's statement of Sources and Ap- bank in which the SA is maintained. Movements in
plication of Funds will also include those expendi- the account will include advances and replenish-
tures under SOE procedures. ments from the Bank, and project-related disburse-
ments based on withdrawal requests. (The appro-
Audits of Statementsof Expenditure priateness of the composition of the withdrawal
requests form a part of the audit required for the
5.13 Audits of Statements of Expenditure organization/project financial statements). Special
(SOEs) should be considered a part of the overall attention will need to be given to the direct verifi-
audit of Project Specific Financial Statements. cation of balances from the Bank, and the tracking
However, a greater effort of compliance checking is of items in-transit both between the Bank and the
usually necessary as, unlike Bank disbursements for SA, and between the SA and project-implementing
project expenditures where the submission of full organizations. The audit should also cover the
documentation is required, the withdrawal requests treatment and disclosure of interest earned on the
are not supported by documentation submitted to SA.
the Bank. The primary objective of this
26 FARAH

Audit of Adjustment Loans sional accountants, since their reports ordinarily are
not intended for the use of third parties.
5.16 The audit of adjustment loans would focus
primarily on the adequacy of procedures used to Operational Audits
prepare customs or similar certificates. It would
therefore be limited to an examination of the certifi- 5.19 Operational audits are more comprehensive
cates on which the SOEs have been based, and an examinations of an organization's management,
opinion as to the reliability of the procedures ap- techniques, and performance. The objective of such
plied in verifying or issuing such certificates. Be- audits is to measure the extent to which enterprises
cause of the nature of adjustment loans there are or government operations are achieving their ob-
several issues which will require particular care: (i) jectives. The primary product of an operational
the TOR must satisfy the financial covenants of the audit is a report recommending improvements to
loan agreement, (ii) it must be clear that documen- increase the efficiency and effectiveness of opera-
tation for an adjustment loan has not also been used tions. In this sense it is the broadest type of audit in
to justify another adjustment loan, (iii) the nature of scope, and encompasses all of the major functions
the claims must be verified to ensure that items are of an organization. Operational audits are per-
correctly documented, (iv) negative list items formed by all types of auditors. However, internal
should be verified, and (v) cut-off dates considered. auditors and government audit agencies tend to be
more active in this area than independent profes-
Audits of Hybrid Loans sionalaccountants.

5.17 The audit of a hybrid loan would follow the Standards on Auditing
procedures of a normal audit of an investment proj-
ect for the investment component, and of an ad- 5.20 Audits of financial statements are governed
justment loan for the adjustment component. by the standards of auditing, and the Bank requires
adherence to the Internationai Standards on Audit-
Compliance Audits ing (ISAs) promulgated by the International Fed-
eration of Accountants (IFAC). In addition, there
5.18 Compliance audits encompass review, test- is the International Organization of Supreme Audit
ing and appraisal of controls and operating proce- Institutions (INTOSAI), which sets similar stan-
dures in an organization. In commercially-oriented dards targeted to the work of the Auditor Generals
enterprises these reviews normally involve account- of its member countries. The ISA and INTOSAI
ing, financial and other operations as a service to standards are summarizedin Annexes XV and XVI.
management. For government organizations such Important aspects of the auditors' work relate to (i)
reviews also cover compliance with regulations, their understanding of the organization and/or proj-
contracts and laws to which the organizations are ect being audited, (ii) their evaluation and advice on
subject. Compliance audits of private enterprises, the internal controls and arrangements, and (iii)
and many state-owned enterprises, normally are their testing of accounting and supporting docu-
performed by internal auditors, who are employees mentation with respect to the financial statements
of the enterprise. Compliance audits of most gov- being audited.
ernment operations are performed by government
auditors, who in a sense serve as the government's The Auditor
internal auditors. In many instances internal and
government auditors are not required to meet the 5.21 ISAs require the following of all audits and
standards prescribed for the licensing of profes- related services rendered by practicing accountants:
 CHAPTER V AUDIT COMPLIANCE 27

Personnel in the firm should adhere to the prin- tors. Annex XVII is a Preliminary Questionnaire
ciples of integrity, objectivity, independence and which will assist the TM in reviewing proposed
confidentiality. audit firms.

The audit firm (should also apply to audit body) 5.24 Supreme Audit Institutions (SAIs) are usu-
should be staffed by personnel who have at- ally acceptable for the audit of project financial
tained and maintain the skills and competence statements including SOEs and for SA audits, but it
required to enable them to fulfill their respon- is important to assure both their independence and
sibilities. their technical competence. Delays in the submis-
sion of audited financial statements of government
* Work should be assigned to personnel who have entities are sometimes encountered where the local
the degree of technical training and proficiency law first requires the presentation of an annual
required in the circumstances. report by the SAI to the parliament before final
clearance for distribution. In these circumstances
* There should be sufficient direction and super- the government should be required to submit a copy
vision of work at all levels to provide the firm of the draft-audited financial statements and report,
(audit body) reasonable assurance that the work subject to subsequent clearance by the parliament.
performed by the firm (audit body) meets ap-
propriate standards of quality. Whenever neces- 5.25 In the event of a change of auditors, the
sary consultation should be made with those borrower should notify the Bank prior to the
who have appropriate expertise. change. The appointment of the new auditor (paras
5.30-35), which should be acceptable to the Bank,
5.22 The basic auditing postulates of dNTOSAI should be expedited to allow sufficient time for the
promotes independence, competence, and due care auditor to become familiar with the project and the
Field standards are based on planning, supervision implementing organization and to complete the
and review, study and evaluation of internal con- audit by the due date. Where the Bank project
trols, compliance with applicable laws and regula- finances the auditor, there are certain special proce-
tions, audit evidence, and analysis of financial dures (paras 5.56-57).
statements.
Government Auditors
Selection of Auditors
5.26 The position of the head of a government's
5.23 Bank staff should strongly promotevte use SAI normally is established by a country's constitu-
of independent audit firms for all revenue earning tion or laws. These precepts should prescribe the
and commercial type projects in recognition of the professional qualifications and experience for the
limited experience and training that government person to be appointed, but often do not. Govern-
auditors usually have in these areas. Every effort ment auditors are frequently not professionally
should be made to select auditors who fulfill the qualified accountants -- many are political appoint-
criteria required by ISA, and whenever possible, ees, and some are public service administrators.
auditors who are members of bodies affiliated with SAIs often do not possess institutional independ-
the International Federation of Accountants ence and often are understaffed, under-financed,
(IFAC). Where the local law requires government and subject to political pressure. True independ-
auditors to audit government entities, then the gov- ence of these auditors is frequently difficult to
ernment audit institution should be encouraged to prove.
sub-contract the audit work to independent audi-
28 FARAH

5.27 Where public sector auditors appear to be Private Sector Auditors

the best option, their level of independence should
be carefully assessed. The level of independence of 5.30 A frequent problem in developing countries
a government auditor may be acceptable if the is the wide range in the quality of private audit
auditor does not report to the operational manage- firms. The firms with direct links to foreign major
ment of the implementing organization, nor engages audit firms or which maintain full membership in
in any approval process for transactions, nor is international professional auditing organizations can
otherwise involved in the internal control or finan- usually be relied upon to provide an acceptable
cial management systems of the organization. The level of performance. Firms which are merely as-
degree of independence can be enhanced to a level sociated by name with international firms and not
of acceptability by a form of external supervision subject to their quality controls may not conform to
such as an audit board, audit examiners, or a similar acceptable standards.
specialized group. 5.31 In order to ascertain satisfactory perform-
5.28 The lack of professional expertise and audit ance, qualified Bank staff should carry out periodic
experience of senior government auditors hinders reviews of the work papers of selected auditors in
effective development of the public sector auditing each country in order to develop a list of acceptable
profession in many countries. This is further aggra- auditors.
vated by the relatively low salaries in many public
sectors in the developing countries, when compared 01
.B.o........
..................
.... .. : ...
:-.-:.-:. . -
to the salary levels of similar audit professionals in -O -T: 0.--. ; i
the private sector. This lack of experiencedleader- p,1y.te Setr AuItos-- :.
ship often affects the morale of the few experienced
t-t.t---;.t;i; . t - .i. | i ..i
and skilled auditors, and results in disillusioned ---
The quait .Wpdvate etraiiosi eed
managers, and poor staff recruitment and training. Ott 0

5.29 Country reviews of financialaccountability the:.. c the :fcornd

..*---..q.uality
(I) . t....
(see Chapter VI) by technically qualified staff laws and00 reg.ulatios.swhi.h.
Xpeci1t ac nt..
should be used to make decisions as to the contin- and;.auditing requirementsand the.r..or.of
ued acceptability of government auditors. In those th!e rmonitorn
!-irfi !n nbree
countries where the competence of the public : -t.: :iC: :C-.- -;Sit0 -- -t..
auditor is an issue, the Bank should promote the mo.ralstrength.f the contin. -.-
(2.).0th--*e.0
iolve of prvate auditor whileseeking olv...of partiv.are
aitors whilei.-. . to
.se
.ei.n. t- ft.....
upgrade the professional quality of government ...--....i;.-....- fi.mn cod~...
.
auditors. Bank staff should in these circumstances - - 0t0tt0--00g00l0 g0
seek to develop either free-standing technical assis- (3 heqalt of t.e pr.-si.-- d.m. hg
trang .. a
tance projects or components of other projects, fy| -yqUXvt-.t.rgtntng.it t-i....
dedicated to the development of the SM and, . t.;-;.-g0-.-rigorou-Iy
appld continuing ... eu.
where necessary, the accounting professions in .-!0 0i -
general. Government audit work should be equal
in quality to that of private independent auditing
firms and should be subject to the same type of
review of working papers as private firms.
 CHAPTERV AUDIT COMPLIANCE 29

Appointing the auditor 5.34 In those cases where an auditor is already

appointed, including a government auditor, the TM
5.32 The auditor should be appointed well before should be satisfied that the auditor will continue to
the beginning of each fiscal year to allow the audi- be acceptable.
tor to become familiar with the objectives of the
systems and operations of the implementingorgani- 5.35 For the appointment of auditors, the bor-
zation and of the project, and to make whatever rower should provide draft Terms of Reference
arrangements are necessary for interim work and (paras 5.39-41) which have been approved by the
for year-end verifications. Bank, to the auditor. The auditor may also provide
an Engagement letter (para 5.42-43). In determin-
5.33 It is the responsibilitv of the borrower to ing the Bank's approval, consideration should be
advise the Bank of the proposed auditors for a given to the past experience and references of the
lending operation, even when the government selected auditors as a basis for judging the accept-
auditor is the statutory auditor. It is thereafter the ability of the firms concerned. If the Bank has ob-
responsibility of the TM, backed up by qualified iections, these should be explicitly stated to enable
professional advice, to determine the acceptability the borrower to understand the Bank's concerns.
of that auditor. Acceptability is best determined by
having a professionally qualified member of staff or Independence of Auditors/Conflict of Interest
a consultant meet with the auditor, at which time
they would review working papers of prior audits in 5.36 Auditors should be impartial and independ-
connection with projects financed by the Bank and ent of the control of the institution and persons
discuss among others, the following points: appointing them. In particular, no auditor should
be employed by, or serve as a director of, or have
* evidence of independence; any financial or close business relationship with the
institution when engaged as an independent profes-
• qualifications and experience of the partner-in- sional auditor. Audit fees should not be contingent
charge, the proposed audit manager and pro- on a given income of the audited organization or
posed key audit staff, established in such a way that the auditor's inde-

• experience of the auditor in conducting audits pendence is impaired.

of a similar size and scope; 5.37 Auditors should not be appointed to carry
out any duties that may be construed to be those of
estimerequirements for the audit in terms of employees or of management for the institution for
elapsed time and personnel inputs; which they are appointed auditor. The overriding
... back-up
availabletothefipoint
facilities is that auditors should play no part in deci-
evaku fhatspcialteseavahiable
torteq firmeid sion making and management. IFAC's Ethics for
Professional Accountants permits audit firms to
* experience in auditing Bank-financed lending carry out non-audit work, provided that this does
operations; not impair the auditor's objectivity and independ-
ence. Norrnally, auditors should not be appointed
* experience in the type of operations to be as management consultants responsible for design-
audited; and ing accounting and control systems on which they
would be required, as auditors, to comment. This
* peer review, quality control, and professional increases the risk that internal control and account-
continuing education policies of the firm. ing failures will not be reported by the auditor since
they may be indicative of short-comings in the sys-
30 FARAH

tem design or other consulting work provided by give an opinion on the specified financial state-
the firm. This risk increases to the degree the work ments. If the auditor will be in a position to obtain
performed represents a significant portion of the a view of much of the workings of the institution,
firm's business. management should take advantage of this inde-
pendent view and ask for a Management Letter
5.38 Auditors should respect the confidentiality (para 5.55). This letter should not be confused with
of information acquired during the course of their the audit report in which the auditor is required to
work and should not disclose any such information express an opinion.
to a third party without specific authority, or unless
there is a legal or professional duty to disclose. Contract or Engagement Letter of an
Auditor
Terms of Reference
5.42 Where a formal contract is used, it is nor-
5.39 For different types of audits, the scope of mally prepared by the client institution or its legal
the audit will vary according to the nature of the counsel; often a simple engagement letter is used
implementing organization and the type of opera- which is essentially prepared by the auditors. In
tion being audited. See Annex XVIII for Guide- either case the contract or letter sets out the re-
lines for a TOR and Annex XIX for a model TOR. sponsibilities of the auditor, and in effect, consti-
For example, the Terms of Reference (TOR) for the tutes the contract between the auditor and the cli-
audit of a financial intermediary will require the ent. Where it is not submitted by the auditor, the
auditor to pay particular attention to the loan port- client should provide the letter to the auditor. See
folio, while the area of greatest emphasis may be Annex (XIX) for sample.
different for the auditing of a public utility.
5.43 The contract or engagement letter should
5.40 ISA and the standards of most countries' include, but not be limited to:
professional auditing organizations suggest that the
auditor normally determines the scope of the audit . confirmation of acceptance of the appointment
of financial statements in accordance with require- including reference to the TOR;
ments of legislation, regulations, and generally
accepted auditing standards (GAAS). Therefore, * the client's responsibilities, particularly the
the TORs must not restrict the auditor's obligations preparation of financial information, i.e. the fi-
with respect to such requirements. In other words, nancial statements;
the auditor should not be allowed to claim in the
event of poor performance that the TORs prevented * access to whatever premises, records, documen-
him/her from performing to statutory, regulatory or tation and other information the auditor may re-
professional requirements. quest in connection with the audit;

5.41 However, the TOR provides the opportu- * the form of audit reports;
nity for drawing special attention to areas of con- .
cern that may not be covered or emphasized under *arngmtseadighenvlmnto
cern
not that
bemcoveredoremphasizeduninternal
,- auditors and of any other external
a normal audit, such as compliance with loan cove- auditors (such as government auditors);
nants; for example, the special review of procure-
ment documents. When in doubt, the TOR should . the expected date of issuance of the audit re-
specificallyrelate to aspects of the operation and its port, etc.; and
accounts that require special review. The scope of
the audit should always include the requirement to
 CHAPTER V AUDIT COMPLIANCE 31

the basis on which fees are computed, and any following matters, in accordance with the auditor's
billing arrangements. TOR:

Auditors' Opinions . the financial information has been prepared

using acceptable accounting policies, which
5.44 The audit report should contain a clearly have been consistently applied;
written expression of opinion on the financial in-
formation. An unqualified opinion indicates the . the financial information complies with relevant
auditor's satisfaction in all material respects with the regulations and statutory requirements;
matters dealt with in the paragraph above. When a
qualified opinion, adverse opinion, or a disclaimer . the view presented by the financial information
of opinion is given, the audit report should state in a as a whole is consistent with the auditor's
clear and informative manner all of the reasons for knowledge of the business of the entity/agency;
such an opinion. . there is adequate disclosure of all material mat-
5.45 ISA provide guidance to auditors on the ters relevant to the proper presentation of the
form and content of the auditor's report issued in financial information; and
connection with the independent audit of the finan-
cial statements of any organization. Much of the * additional requirements that may have been
guidance provided can be adapted to audit reports requested in the TOR have been met.
on financial information other than financial state- 5.50 A qualified opinion is issued when the
ments.55 ulfe pnini sudwe h
auditor concludes that an unqualified opinion can-
5.46 The Bank requires the preparation of re- not be issued, but that the effect of any disagree-
ports in accordance with ISA. ISA specifies that all ment, uncertainty or limitation of scope of the audit
audit reports should include: title, addressee, iden- is not so material as to require an adverse opinion
or a disclaimer of opinion. The subject of the
tification of the financial information audited, a qualification and its financial effect must be clearly
reference to auditing standards or practices fol- stated in the auditor's report.
lowed, and expression or disclaimer of opinion on
the financial inforrnation, signature, the auditor's 5.51 An adverse opinion is issued when the effect
address and the date of the report. of a disagreement is so pervasive and material to
the financial statements that the auditor concludes
5.47 Samples of audit reports which the Bank that a qualification of the report is not adequate to
expects to receive in satisfaction of its audit re- disclose the misleading or incomplete nature of the
quirements are included in Annex XXI. Note that financial statements.
the examples are indicative of clean or unqualified 5.52 A disclaimer of opinion is issued when the
opinions, and should be appropriately altered when possible effect of a limitation on the scope of the
the qualifications or modifications, such as the pe- audit or of an uncertainty is so significant that the
riod under audit, are appropriate. auditor is unable to express an opinion on the fi-
nancial statements.
5.48 An auditor's opinion may be: unqualified;
qualified; adverse; or disclaimer of opinion. 5.53 Some government auditors try to avoid
giving a clear-cut, specific opinion, preferring in-
5.49 An unqualified opinion indicates the audi- stead to provide a report covering all the mistakes,
tor's satisfaction in all material respects with the misfeasances and malfeasances found by the audi-
32 FARAH

tor, but without confirming their materiality and inclusion in the costs of the project and financed
impact on the financial statements. The TM should from the Bank loan. This could apply particularly if
be sure that the government auditors understand audit costs are incremental because of the project
that while the detailed comments will be welcome, nature (if they would not have been incurred oth-
an opinion on the accounts in accordance with the erwise to the same extent, if at all, such as when
above is required for it to be acceptable to the private audit firms are required), or in cases of
Bank. countries with limited foreign-exchange resources
that have to engage foreign auditors. The costs of
5.54 In addition, where SOE procedures are audits performed by government audit institutions
used, the auditor's opinion to the Project Financial should not be financed by the Bank except in very
Statements is required to include a paragraph certi- unusual circumstances.
fying to the eligibilityof those expenditures against
which SOE disbursements were made. Any excep- 5.57 Where an auditor's services are to be in-
tions or disallowed expenses should be referred to. cluded in a project's costs and are to be partly or
wholly financed from a Bank loan, the borrower
Management Letter would be expected to use the Bank's selection
procedures. The borrower should seek proposals
5.55 In the case of the implementing organiza- from a short list of firms based on their ability to
tion, the scope of the engagement as set out in the audit the lending operation, including the imple-
TOR should require the auditor to provide a Man- menting organization, where necessary. For further
agement Letter. This is a report on the internal information, see 'Guidelines for the Use of Con-
controls and operating procedures of the institution, sultants." It is expected that those to be included
covering all aspects included during the normal on the shortlist should be acceptable to the Bank;
course of the audit. This is not a substitute for the price would then carry a larger weighting than for
short form audit report which is always required. the engagement of consultants.
Because an auditor is unlikely to cover all activities
of a clientduring an annualaudit, the Management Timingof Submissionof Audit Reports
Letter may address only those specific activities
which came to the attention of the auditor during 5.58 During project preparation, the Bank and
the review. The management and the auditor may the borrower agree on the required timing for sub-
agree at the commencement of the audit on particu- mission of financial statements and audit reports.
lar subjects to be addressed in the Management Where required, all audited financial statements
Letter, but it should still be the prerogative of the should normally be submitted within six months
auditor to address any matter not agreed upon, but following the fiscal year-end of the project imple-
which, in the auditor's opinion, should be drawn to menting organization. In general, longer allow-
the management's attention. (See Annex XXI for ances for submission of audited financial reports
sample.) should be considered only for borrowers who are
undertaking a time bound program to overcome
Financing deficiencies in accounting and auditing capabilities,
after which the normal timetable should apply
5.56 The Bank normally does not finance the (paras 3.11-15).
costs of auditing services where these represent an
ongoing part of the operating expenditures of a 5.59 It is the responsibility of the TM to ensure
borrower, exceptions must be approved by the that the audited financial statements are adequately
RVP. There may be circumstances, however, when reviewed as they are submitted (see para 3.10).
the costs of auditing services may be considered for Where questions arise or the project is high risk, the
 CHAPTER V AUDIT COMPLIANCE 33

TM should seek the assistance of a professional FinancialIntermediary Operations

accountant.
5.61 For projects that are conducted through
Subsidiary Audits financial intermediaries for onlending to sub-
borrowers, there may be a requirement for the audit
5.60 Where there are several implementing of the subprojects. In these instances, it would be
agencies under one project, several separate audits the responsibility of the financial institution to ob-
may be necessary. In these circumstances, the um- tain the subproject audit reports and to review them
brella implementing agency of the project should for acceptance. The main auditor would examine
collect these audited financial statements and con- these reviews to the extent considered necessary,
solidate them into one set of financial statements, taking this into consideration when giving an opin-
which would be reviewed and subject to one audit ion on the overall financial statements of the inter-
report. This umbrella report would often need to mediary, including its loan portfolio. Also, a sepa-
rely on other auditors and where considered neces- rate comment may be necessary, if required by the
sary, the main auditor would review the working legal covenants.
papers and procedures of the subsidiary auditors.
34 FARAH

NOTES
 CHAPTER VI COUNTRY REVIEWOF FINANCIALACCOUNTABILITY 35

VI: COUNTRYREVIEWOF FINANCIALACCOUNTABILITY

Overview Country Operations Divisions should ascertain that

a satisfactory mechanism is in place in the con-
6.01 Lending operations in each country, cerned Regional Department to:
whether conducted in the public or the private sec-
tor, are dependent on the capability and capacity of . identify within a country the authority(ies) re-
the country's financial services. Therefore, econ- sponsible for the development and administra-
omy and efficiency in Bank operations demand that tion of the financial services and, in the absence
there should be a continuing review of the efficacy of clearly identifiable responsible authorities, to
of these services, with experience from ongoing agree with the government concerned on
projects available to TMs and other Bank staff mechanisms to provide the government and the
concemed with understanding and using the per- Bank with satisfactory evidence of financial ac-
formance of these services in a country. countability with respect to each lending opera-
tion in the country;
6.02 The implementing agencies are made re-
sponsible by the government concerned for re- . maintain a dialogue with the above authorities
sponding to Bank requirements to provide timely to prepare and implement, where necessary, a
and adequate and audited financial statements for development plan for effective financial service
projects. Lending operations in a country range within the country;
over multiple sectors and usually a central unit
(often in a Ministry of Economic Affairs, or in the * ensure that Bank staff, when requiring borrow-
Treasury of a Ministry of Finance) acts as a coun- ers to use the financial services available:
terpart to the Bank for identifyingand managing the
logistics of lending operations. It is left to Bank (i) are frlly informed as to the levels of effi-
staff to ensure that the accountability arrangements ciency of financial accountability likely to be
agreed to by the borrower are, in practice, dis- available; and
charged in accordance with loan agreements. (ii) institute changes or upgrading of the serv-
ices anste
pharte ofrprposedmlnig oph eratio
6.03 It is in the borrowers' interests to ensure ices as part of a proposed lending operation
that their resources (including Bank funds) are which are in conformity with the national
effectively managed. Many do not appear to do so, development plan outlined above.
nor to have any mechanism for providing the neces- 6.05 The levels of efficiency of the financial
sary assurances. Bank staff need to emphasize the services in a country are likely to comprise two
importance of efficient financial and project infor- distinct categories, namely the performances of the
mation in the management and monitoring of proj- public and private sectors respectively. Proficiency
ect implementation. levels may vary extensively between these two
6.04 To ensure that each government meets its sectors, as described below. With each sector pro-
responsibilities for financial accountability with ficiency levels may be relatively uniform; and there
regard to its legal agreements with the Bank, may be discrepancies in skill levels between inter-
national and local private sector firms.
36 FARAH

6.06 Country Operations Divisions with the assis- the point of entry into the government accounting
tance of qualified financial staff or consultants, system, which may not be obvious in some coun-
should establish an information system on the gen- tries; an example might be the question of which
eral proficiency of the financial services in the pub- government agency makes the decisions on ac-
lic and private sectors of each country through counting rules and systems and the necessity for
Country Financial Accountability Assessments to: further approvals.

* advise Bank staff on prospects for, and steps 6.10 The review should determine any laws
likely to be necessary to achieve financial ac- which specifically form part of public sector ac-
countability; counting. Specific laws relating to sectors and
activities (e.g. power sector, municipalities and
* identify or approve inputs of technical assis- urban authorities, water and sanitation authorities,
tance, or other means, by the Bank and other railways) may identify accounting and auditing
lenders and donors, to upgrade the services to requirements. Each authority responsible for de-
efficient levels; and signing, administering and monitoring accounting
systems in government should be determined.
* identify those sectors and key institutions where These details should be obtained for all the primary
it will be to the advantage of the government
and the Bank to include the costs of auditing systems which are in place, including:
services for lending operations as part of ex- . budgeting and budgetary control of expendi-
penditures to be financed from the proceeds of tures for routine and development (project) op-
the loan. erations;

PublicSector AccountingServices . budgeting for revenues (income taxes, VAT,

customs and excise, etc.);
6.07 The responsibility for accounting services in
public sectors is frequently difficult to identify. In a debt management;
some countries, even the concept of a public sector
accounting service is not readily recognized, nor . accounting and financial reporting;
appreciated. Instead it may be a budgetary control
operation under a Director of Budget, with the sole * foreign exchange control and management;
objective of reporting expenditures against budgets,
while revenues are separately "controlled" outside * public sector enterpises in the various sectors;
the budgetary system. These systems rarely provide and
meaningful forms of financial accountability. . consolidated reporting from other levels of
6.08 Each country should be the subject of an government.
ongoing analysis in order to enable Bank staff, 6.11 The review should provide a brief descrip-
when preparing and appraising lending operations,
tion of each form of accounting system, the ac-
to determine the current status and performance of counting standards in use, and who established and
the services, and to recommend the most appropri- updates these (see Annex XXII for model TOR).
ate means of achieving the accountability require Linkages between different systems should be
ments for a particular lending operation. identified, with the manner of operation and reasons
6.09 Assistance from the government's counter- clearly explained. In particular, the ability of man-
part to Bank staff may be necessary to determine agers at all levels to make useful changes to a sys-
 CHAPTERVI COUNTRYREVIEWOFFINANCIAL
ACCOUNTABILITY 37

tem should be established, with brief descriptions of Public Sector Auditing

any mechanisms available to achieve modifications.
6.16 Unlike accounting services, public sector
6.12 The assessment should offer judgment on auditing in most developing countries has an es-
the efficiency of each system, and provide recom- tablished identity, usually in the form of a Supreme
mendations for possible improvements, together Audit Institution (Auditor-General, Comptroller-
with the means by which they could be achieved, General, an Audit Commission, or a Court of Ac-
including estimates of time and cost requirements. counts). Many SAIs belong to INTOSAI, which
Such recommendations may need to include propos- with United Nations and donor support, has pro-
ing a detailed study of the governmental system in vided considerable assistance to its members to
order to provide the government and the Bank with upgrade their operations, particularly by developing
a detailed picture of system deficiencies and long- auditing standards and other guidelines.
term solutions.
6.17 The review should establish the legal
6.13 It is important that a review should record authority for government auditing activities, includ-
whether existing accounting systems generate ing the role of internal auditors who provide audit
meaningful management information with financial services to ministries, departments and agencies and
accountability. If they do so, the ways in which support the work of SAI. The review should indi-
these are achieved should be detailed in the final cate the principal controlling authority(ies) for
report. Failure to generate such information should auditing. In most countries, this is likely to be one
be reported with recommendations for improve- authority, but there are countries which have mul-
ments. tiple authorities, of which the majority are forms of
internal auditors. Their responsibilities should be
6.14 An assessment should be made of the ca- defined and their independence, ability, and willing-
pability and capacity of accounting managers and ness to provide unbiased reports specifically de-
staff responsible for designing, operating and termined. In larger countries it will be necessary to
monitoring the systems, including the methods of obtain an audit organization structure chart to as-
recruitment, and adequacy of compensation. An certain how the various states or provinces of a
identification of training needs is required including country are covered, and to determine how the
approaches to training, methods, facilities and central management monitors the effectiveness of
budget adequacy. In addition, an assessment the organization to plan and offer adequate audit
should be made of the overall perception by ac- cover.
counting managers of their role in financial ac-
countability. 6.18 The auditing standards which the auditor
applies should be determined together with the
6.15 Financial reporting should be evaluated at manner in which the audit management ensures
the organization level, as well as the national level, their application. In the absence of meaningful
including timeliness, usefulness, and reliability of audit standards, the principles and methods adopted
the nation's annual financial report. The review by the audit management to control the quality and
should aim to provide as complete a picture as nature of audit activities should be explained.
possible of a government's efforts to achieve finan-
cial accountability, not only for Bank lending op- 6.19 A number of government auditors partici-
erations but for national resources. The need for pate in the expenditure approval process by con-
improvement and possible means of achieving these ducting priori reviews and approvals. This effec-
should be detailed in the final report. tively precludes them from providing independent
38 FARAH

opinions, because they are using their staff to per- auditors in professional accountancy organizations
form functions on which they later offer an opinion. should be evaluated.
It is difficult for such auditors to be unbiased.
Therefore the existence of such practices should be 6.24 Among other things, the country review of
fuilly researched, and the impact on the auditor's public sector accounting and auditing should ad-
independence commented upon. dress the responsibility of the government in fulfill-
ing its role as a borrower, i.e. ensuring that Bank
6.20 The budgetary allowances of government loans are used for the purposes intended. The re-
auditors frequently may be a constraint. It is port should identify whether any government de-
therefore necessary to estimate the extent to which partment or organization is required to take any
the auditor is able to conduct meaningful annual responsibilityfor ensuring that information provided
audits of all government services (priori reviews to the Bank under legal agreements is satisfactory
should be excluded). This will require identifying and timely. If these features are not present, rec-
the number and qualifications of audit staff, and the ommendations should be included to address mat-
availabilityof non-accounting skills to provide other ters.
forms of professional expertise. In particular, the
extent of any performance, or "comprehensive"
audits should be establishedby examiningsamples PrivateSectorAccounting
and Auditing
of performance reports.

6.21 The activities of internal auditors who pro- 6.25 The objective of a country review of private
vide reports to ministries, departments and agencies sector accounting and auditing services should be
should be described, including the standards used, to:
justification for their role, and its possible effective-
ness. The nature, form and typical timing of report- . evaluate corporate accounting, financial report-
ing by government auditors should be defined, ing and auditing requirements, capacity and ca-
particularly the facility--if any--to provide reports pabilitoes and recommend steps to be under-
directly to management of governmental agencies taken to achveve short, medium and long te;a
(rather than initiallyto a legislature). improvements; and

6.22 An appraisal should be made of the profes- provide the Country Operations Division con-
sional capability and capacity of audit managers and cerned with an information system to enable it
staff responsible for designing, operating and to advise and guide Bank staff in making ac-
monitoring the audit programs and systems, includ- countability arrangements for ongoing and fu-
ing the methods of recruitment, and adequacy of ture investments in the private, and where ap-
compensation. An identification of training needs is propriate, the public sector of the country.
required including approaches to training methods, 6.26 A country review of private sector financial
facilities and budget adequacy. In addition, an services should address certain key conerns, in-
assessment should be made of the overall percep- cluding appropriate legislation, regulations and
tion by audit managers of their role in financial management of the accounting profession and cor-
accountability. porate practices. Each professional accounting
6.23 Finally, it is necessary to determine the organization should be assessed as to its ability to
SAI's attitude towards financial accountability, as promote a truly professional approach to account-
well as the extent to which it is organized and pro- ing and auditing and the service it provides to its
fessionally qualified. Participation by government members.
 CHAPTER VI COUNTRY REVIEW OF FINANCIAL ACCOUNTABILITY 39

6.27 The review should ascertain the ability of 6.29 The following are matters which should be
the profession to provide the requisite high quality addressed as part of the review:
services at fee rates which provide an equitable
return to the firms and which can give reasonable * establishment and regulation of the accounting
assurances of independence and impartiality. It profession
should evaluate the adequacy of corporate legisla-
tion, including national accounting standards and * a commercial code or corporate law requiring
principles and regulation of accountants, to encour- appropriate accounting, financial reporting and
age investment and to provide investor protection auditing
by encouraging the use of accounting services un-
der appropriate regulatory approaches. It should
appraise the complete range of training facilities and Structure and Strength of the
standards accessible to those who would enter the AccountingProfession
profession and to those who continue in the profes-
sion, to ensure their continuing professional educa- . Numbers of members in profession
tion. Finally, it should address any technical assis-
tance requirements to achieve the necessary stan- a Classification of profession by financial account-
dards of performance by the accounting profession ing, management/cost accounting, taxation,
and the government, as its regulator. auditing, management consultancy, etc. and re-
lated numbers
6.28 The review should provide a complete pic-
ture of the private sector accounting profession of a . Nature and locations of pre-entry training for
country, together with the nature and adequacy of accountancy, taxation, auditing, etc.
the services which are provided. It should identify
the degree of independence achieved from govern- . Acceptability and quality of professional exami-
ment and impartiality from client interference in nations
providing opinions and reports. The extent to
which foreign links assist, or are allowed to do so, . Licensing
should be ascertained. Linkages with the public
sector from basic education, through regulation, to * Nature of accounting standards and their obser-
the provision of services should be identified. The vance
objective should be to determine whether the pro-
fession is competent, independent and thriving, or . Nature of auditing guidelines and their enforce-
otherwi.whether it is in need of support, and if eti continuingprofessional
otherwise; naI educationmneaOIspprt
so, the nature of, and likely sources required to give
such support; and a possible role for the Bank in Existence and enforcement of a code of ethics
future development of private sector accounting in and other disciplinarymeasures
the country. Selected accounting firms should be
interviewed and classified according to strengths, . Requirements for third party liability insurance
specialties, degree of professionalism, quality con-
trols, and staff training programs. . Existence and quality of peer reviews

* Fee structures
40 FARAH

Quality of Accounting Firms 6.31 Staff or consultants engaged as country

and Individual Practitioners reviewers are encouraged to be explicit about rec-
ommended changes. In doing so, they should spec-
• Type of affiliation and degree of support from ify the nature of any local or foreign technical assis-
intemational accounting firms tance which may be required to achieve the desired
modifications and improvements.
* Local facilities to provide back-up support for
researches and training 6.32 Technical assistance toward strengthening
the financial management in both the public and
*Independence and impartiality piaescosmyicue
private sectors may include:
* Work availability from private sector and public
sectors . drafting new or revised legislation and regula-
tions for all primary purposes, systems reviews,
* Availability (admissibility to country) of expa- design of modified or new accounting, financial
triates reporting, and auditing systems

* Oversupply or undersupply of accountants development of accounting standards and

auditing guidelines

Bank Experience of Working . design of new or modified educational programs

withFirms and Practitioners at secondaryschools, university, qualifyingor
post-qualifying levels

, Possible legislative requirements to improve training of trainers at all levels

independence and performances 6.33 Recommendations in a final report on a
• Possible technical assistance requirements country review for technical assistance should in-
clude, wherever possible, the nature and form of
Technical Assistance required inputs, the reasons for their inclusion,
estimates of time requirements and cost, and gov-
6.30 he
evie
Cuntyand ssesment iill ernmental reactions to any such proposals. In some
identify steps which may be needed to support
improvements and changes to financial services in cases it may not be possible to estimate the final
the public and private sectors. These steps may costs, particularly in those cases where further in-
range from simple organizational and management depth investigations are recommended. In such
changes in institutions and firms to major investiga- cases, an estimate of the investigatory costs only
tions and the construction of completely new sys- should be included.
tems.
 FARAHs
ANNEXES 41

ANNEXES
42 FARAH ANNEXES

NOTES
 ANNEXI 43

ACCOUNTINGSTANDARDS

1. Accountingstandards address issues such 5. Underthe Cash Basis systemreceipts and

as accrualand cost basis accounting;qualitiesof good payments(as differentiatedfrom incomeand expense)
financialinformation;balanceand reasonableness;and are recognizedonly when cash is receivedor paid.
internalcontrol. The cash basis of accounting is often used in the
preparation of financial statements for government
fundedentities. This is becausethe primaryobjective
Accrualvs. Cash Basis of governmentaccountingis to identifythe objectsand
2. One of the most basic aspectsof account- purposesfor which fundshave been receivedand paid
ing which must be understood in order to properly out during a particularperiodand to maintainbudget-
evaluatefinancialinformationis the timing of the rec- ary controlover suchactivity. Cash basis is also used
ognition of revenue and expenses. Under Accrual when the accountingsystem lacks enoughsophistica-
Basis accounting,the financialeffects of transactions tion to implementaccrual accountingand benefitsof
and eventsare recognizedin the periods in which they major changes do not justify the cost. However,in
occur, irrespectiveof whether or not cash has been both of these cases, if trade credit is used in any sig-
receivedor paid. This allows transactionsto be re- nificantway, a cash basis treatmentcan resultin seri-
corded in the accountingrecords and reported in the ous off-budget/bookliabilitiesbeing incurredbut not
financialstatementsof the period in which the service recordedagainst the current budget becausepayment
was received(expense)or rendered(revenue). There is delayed.
occurs a matching of the revenue and the expenses 6. Under some circumstances,especiallyin
requiredto generatethat revenue. central governmentoperationsand municipalities,the
3. Financial statementsprepared on the ac- most appropriate method of recording transactions
crual basis inform users not only of past transactions may be a combinationof the cash and accrual basis.
involvingpayment and receipt of cash, but also of Under this ModifiedAccrual Basis, revenue is re-
obligations to pay cash in the future and of resources
that represent cash to be received in the future. Budget ManagementUnder the Cash Basis
Hence,theyprovidethe type of informationabout past
Many govemnmentsoperate under a cash basis of
transactions and other events that is most useful to
. . ~~~~~~accounting--record-
cash receipts and expenses as
users in making econoniic decisions.
they are receivedor disbursed. Bills are accounted
4. Accrual accountingis generallythe most for whenthey are paid. So long as bills are paid as
acceptedmethodfor recogrizingincomeand expense they are received, such a system can effectively
in the private sector. It is increasinglyseen and en- monitorcosts. In countrieswhere there is a strong
couraged in the public sector, but remains relatively encumbrancesystem, i.e. charges are made against
rare. Occasionally,a cash basis is used where the budgetswhenpurchaseordersare issued,this system
recordingof cash receiptsand paymentsis the primary works fairly well in keepingthe organizationwithin
interest or wherethere is a legal requirement. Many its budget. However, where countries are under
associationswhich fund-raise for a specific purpose severe budget constraints, where the encurnbrance
operate on a cash basis. They may be requiredto system is weak or non-existentand budgets often
distributeall the fundsraised withina specifiedperiod unrealistic,a commonoccurrenceis for paymentson
of time. Another exampleof a cash basis system is bills to be delayedoften from one budget period to
tax systemswhichallowcash basis accountingto help another. As a result, budget controlsbreak down
ensure that taxpayers have adequateliquidityto pay and unpaidbills accumulate,sometimesin excess of
the taxes involvedin the period. next year's budgetallocation for the same sub-head
or lineitem.
44 ANNEx I

cordedonly whencash is received,whileexpensesand 8. To be useful, financial reports must be

related liabilities are recorded when incurred, irre- both relevantand reliable. The relevancyof financial
spective of the time of cash disbursements. The reports will be largely dependenton the degree to
modifiedaccrual basis generallyis followedin cases which the underlyingaccountingsystem reflects the
where revenues cannot be measured until they are demandsof implementingthe project, i.e. the way in
actuallyreceived(e.g. certaintypes of taxes, fines and which it segregates,classifies,and aggregatesaccount-
fees), or where the timingand amountsto be collected ing data.
on customeraccountsreceivablemay be highlyuncer- Peraing any accountingsystem are cer-
tain. tain elementswhich affect the quality and quantity of
Md-fiedi accrual Basis information produced by an accounting system.
IModified.Acc rua Basis
Timeliness is a key element of any financial report. If
lA modifiedaccrual basis can sometimesbe a more there is unduedelay in the reportingof informationit
conservativeapproachto financial.statementpresenta-- may lose its relevance.
ftion.
l. .. Thisis itrue: inthe recognitionof interestincome
i.i.. ...... Balanceand Reasonableness
Iforlendingorganizatons. In somecountnesiterest is
accrued forallperformiing loansas it is due from the 10. Balance is a very important concept to
borrower. Only: when .a loan is classifiedias non- bear in mind in analyzingthe adequacyof a financial
performing(uually paymentsin arrears for 90 to 120 managementsystem for full accountabilityand man-
days);is interettincomerecordedon a cash basis. All agementusefulness. For example,managementmay
expensesare accruedas incurred. needto balancethe relativemerits of timelyreporting
Some countries use a modified cash basis in w : Ech and the provision of reliable information. The
;:one: coun tres. use .a modified cash~basis 'm whkch
achievement of total accuracy and absolute control
pcexpnses:are accrued: as -mourred butimterest incme is
expensesarecaccrued
e d als incaurred
but interestinacmeis mightdelaythe releaseof the informationso long as to
recoredThi
a recived
caues sme msmathing make it irrelevantfor decision-miaking.The fiancial
of income-andexpense. However,the resultis a more
ctservative income statementbecause the iabilityto; losses of poor managementmay outweigh the re-
collect
any intere,t income recognized is absolutEly sources conserved via accuracy and micro controls.
:coledtatiy etees:incomeirVecogtuod~IS: asltely
However, failure to establish an adequate control envi-
assura.fbecause:
asue b.alE
its.:ealreidy:ee
iEs
b o1ce.
collEcted.
ne
.been Une a ronment may result in a high rate of leakage of finan-
full:accrual method,interestincome couldbe Vaccrued cial resourcesand may renderthe informationso inac-
that would never be collectedand would have.to be
curate as to also make it irrelevant for decision-
wiftten :off.at. a later date when the loan was: declared
.d .at a e e E s making. In achieving a balance between relevance and
non-performing.Wi :t;;i; E;;f: the
;iR overriding ; ;;; ;;reliability,
;> :S: ;; fconsideration is how best to

Oualitiesof GoodFinancialInformation satisfy the economicdecision-makingneeds of users

who need to make the best use of the financial re-
7. Qualitative characteristics of a financial sourcesavailable.
management system require that the informationit II. Reasonablenessis another key concept in
provides be useful for decision-makers. For Bank asbess a an ot kem andept in
projects, this means useful to the Project Manager assessinga financialmanagementsystemand its data.
(borrower)and the TM (Bank). The purpose of a There must be a reasonablerelationshipbetweenthe
Bank projectis to bring a concretebenefitto the proj- cost of obtaining accounting information and the
ect beneficiariesand to the countryin general. Finan- benefit obtained. The benefits of a basic accounting
cial informationgeneratedfor project implementation system which controls and reports on costs can be
must supportthe projectpurpose. To knowhowmuch enormousand the outlay relativelylow. The level of
has been spent is of limiteduse unless one also knows aggregationof data in an accountingsystemwillaffect
how muchof the project has beencompletedand what the cost of gatheringand reportingit, as willthe num-
additionalresources it will take to achievethe project ber and type of cost classifications. Both the level of
aditonals aggregationand the numberof cost classificationsand
goals. centersshouldbe carefullydesignedto focus on areas
where costs are significantlycontrollable,material in
 ANNEX I 45

their impacton the project, and useful in both planning * Degree of independenceof the civil service from
and monitoringproject performance. A systemwhich politics;
is too complexfor an organizationor projectwill rap * Positionof the accountingand auditingprofession
idly incur costs with little marginalbenefit. Its com- within the and
plexity may result in a total break-downof the system withinthe culture;and
because of inadequate personnel and materials to * Technical developmentof the accounting and
maintainit. auditingprofessionin the country.
12. Reasonablenessalso affects the design of 15. Organizational Risk There are some
intemal controls. These controls should be designed basic characteristics of a good control environment
so there is a reasonable expectation that material withinan organization. Of primary importanceis the
losses of financial resources will not occur either presenceof honest and capable employees. This can
through error or theft and that the accountingrecords be assessed by consideringcompensation,education,
reflectin all material aspects a true and fair presenta- and experiencelevels.Where compensationis inade-
tion of the financial transactions which transpired. quate theremay be strongincentivesfor the misappro-
The controlsrequiredto achieveabsoluteassuranceof priation of funds; this diversion. may be relatively
the abovemay hamperif not preventthe implementa- minor, such as the use of an officialcar for personal
tion of the project. businessor may involvemore serious losses such as
13. Hence a balancing,or trade-off, between the diversionof cash, the loss of other tangibleassets,
qualitative characteristicsis often necessary.Gener- or the sale of patronagefor goodsand services.
ally the aim is to achieve an appropriate balance 16. The education and experience levels of
among the characteristicsin order to meet the objec- staff will have a major impact on the accuracy and
tive of financialstatements.The relativeimportanceof completenessof the accountingrecords. Both should
the characteristicsin differentcases is a matter for the be stronglyrepresentedon the staff. Educationwith-
professionaljudgmentof a qualifiedaccountant. out experience may result in confusion especially
Internal Controls when dealing with unusual transactions. An experi-
encedperson mayhave no problemwith routinetrans-
14. Country Risk Country risk deals with actions, but be unable to think through the correct
the overall environment for internal controls and accountingtreatmentfor unusual transactionsor new
auditingwithinthe country. Factors affectingcountry circumstances.
risk are:
17. Another fundamentalaspect of organiza-
• Supportof sound financialmanagementand inter- tional control is clear delegationand segregationof
nal controlsat the highestlevelof government; duties. No one person should have control over the
* Salary structure within the public sector and be- entireprocessingof any giventransaction(segregation
tweenthe public and private sectors. Public sec- of responsibilities).Authorizinga particular transac-
tor salarieswhichare belowa reasonablestandard tion, such as the procurementof a fixed asset, should
of livingfor the countryoftencontributeto the ac- be kept separatefrom recordingthe transaction,which
ceptance of corrupt practicesas a means of sup- in turn should be kept separate from maintaining
plementingincome. Additionally,wide discrep- physicalcustodyof the asset. If all threefunctionsare
ancies between private and public sector salary fulfilledby three separate individualsthen the diver-
scales contributesto a migrationof trained and sion of financialresources requirescollusionbetween
qualifiedstaff to the privatesector; two or more persons--makingit more unlikely and
riskier. However,executiveoverrideand/or collusion
* Historical and cultural support for a strong civil can circumventeven the strongest internal control.
serviceethic; This is why internaland independentaudit is impor-
tant.
46 ANNExI

is one of the best and simplestinternalcontrolmecha-

nisms.
.Sampk.Internal C:ontrolstit;: t ti;ti:0000000;21. Physical control over assets is another
Authoriation of Epenses: Expense should
1be basic interal control principle. A limi,tednumberof
tauthoized
by:-a*desiated
tdepartment-
peron in:aa personsshouldhave access to the assets, and respon-
generallythe hiad of the department. :Accounting sibilityfor their protectionshouldbe clearlyindicated.
personnel:should not authonrze expense except for Most funds should be in a bank account but some
accountilg, operatingcash may be kept in a lockedsafe. In both
fPre-numberedf lDocuients.$ 0Pre-nbe:ring-Xcon*oli cases a minimumnumberof persons shouldbe able to
document. (especially.checks,.purchase : . sign checks and have access to the safe. Inventory
cash; receipts)and helps;:-assure that unau.ized should be securedunder the custody of one person at
transactionsdo not take place.t;ForXexamtple, by:usingt any giventime. Blank checksshouldbe lockedsafely
pre-ered.cash receipts and by informingthe pub-00 away. All of thesetechniquesare designedto protect
lic that they should;geta treceipt,it makes it harderbfor the organization'sassets againstunauthorizeduse.
a cashierto pocketmoney;receivedfrom customers. 22. Independentverificationis the final prin-
.. EE ciple
EEV:.of good internal control. This means that the
person charged with reconcilingthe monthly bank
18. Financial regulations setting authority statementshouldbe someonewho is not involvedwith
limits, and clear procedures for the processing of the receiptof disbursementof cash. By reconcilingthe
transactions are other important aspects of a good accountingrecords to the bank's records any discrep-
internalcontrolenvironment.Documentedprocedures ancy can be investigated. Because the person has no
help assure a consistencyin recordingand classifying access to cash it is doubtful that there will be any
the financialtransactions. A Chart of Accountsis the incentiveto cover up any discrepancieswhich might
primary tool for achieving consistency in account be evidenceof theft. In regardto fixedassets, periodic
classification. Written procedural manuals help as- physicalcountingof assets on hand and then compar-
sure that new employeesfollowthe same guidelines. ing the resultswith the accountingrecordsprovidesan
Manuals should not be unduly detailed nor cumber- independentverification. Again the person doing the
some or they will be ignored. Many computer-based inventorycannot also be responsible for either the
accountingsystemsalso enhanceconsistentaccounting physicalcustody of the inventoryor recordinginven-
treatrnent. tory transactionsin the accountingrecords.
19. Accounting documents filed in logical 23. One of the key indicatorsof a good inter-
sequencewhich support financial reports help estab- nal control environmentis accountingrecords which
lish a clear audit trail and providefeedbackfrom other areboth accurateand up-to-date. Whereaccountingis
partiesregardingthe accuracy of the financialreports. in arrears, internal controls are often weak if only
because there is no feedback on the utilizationof fi-
20. A key conceptin financialreportingis that nancial resources through financial reporting. Addi-
of responsibilityreporting,where a manager can be tionally,under pressureto catch up, internalcontrols
calleduponto explaina particularcost and attest to its may be cast aside or circumvented. A summaryma-
validity and relate it to physical performance. A trix of some importantareas to be consideredwhen
budgetreport comparingactual to projectedexpenses, reviewing Accounting Standards is shown as
reviewedby the manager in charge (as wellas others) AnnexI -1.
 ANNEXI-1 47

REVIEWOF ACCOUNTING
STANDARDS
WHAT HOW TOASSESS ISSUES

AccountingStandards

Guidelineswhichspecifythe account- 1. Determinestandards used, par- 1. Standards used by govem-

ing treatment for particular financial ticularlyin regardsto important ment or quasi-government
transactions Used to ensure compa- costs or financialareas. entities may be dictated by
rability, consistency,and complete- 2. ComparetoIASCstandards. law. Needed changes for
nessfor the financialrecords. 2 good management of the
3. Deternine the impact of differ- project may requirechanges
enceson project reporting. in the law which can be a
lengthyprocess.
2. Deviations from L4SC
Standardsmust be disclosed
in project financial reports
and/oraudits.

Qualityof FinancialInformation

Good financialinformationis timely, Determineif financial information 1. If part of larger agency, it

relevant,and reliable. currently producedby organization maybe difficultto segregate
is timely(Whenwere the last finan- the financial information
cial reports issued?), relevant (Do pertainingto the implement-
the Accounts correspondto budget ing organization.
accounts? Does the information 2. Entity accounts may have
providedrelateto project activities?) very littlecorrespondenceto
and reliable (Has informationbeen the cost structure of the
independentlyaudited,and what was project and hence financial
the result?). infornation would have lit-
tle value.
3. Centralizedaccountingmay
causedelays in financialre-
porting and informnation to
be less relevant.
48 ANNEX
I-1

REVIEWOF ACCOUNTINGSTANDARDS

WJL4T HOW TO ASSESS ISSUES

InternalControl
Internal control helps ensure Determinecontrolsystems. Micro-controls focused on
the resourcesare safeguarded Who doesfance f . r to? form and not substanee can
and financial informationis lead to loss of control be-
completeand accurate. * Is that person independentof manage- cause agencyhas insufficient
ment or is there other means of inde- resources to maintain the
pendentverificationof records such as system and those resources
an audit? used do not focus on the
* What steps are required to process reasonability of the costs,
payment? onlytheir allowability.
* Is one person in charge of generating
the invoice,recordingit, and payingit?
CountryRisk Reviewcountryassessmentif available. Problems associated with
. What is reputation of civil service country risk will probably
withincountry? Are salariessufficient? require longer-termsolutions
which probably cannot be
* Contact professional groups. How addressedwithinthe scope of
strong is accounting/auditing
profession the project. Project-specific
withincountry? controlssuch as specialunits
and outside consultantsmay
be required to ensure ade-
quate controlover resources.
 ANNEX I-1 49

REVIEWOF ACCOUNTINGSTANDARDS

WHAT HOW TO ASSESS ISSUES

Organizational Risk 1) Review staffing levels, filled and unfilled posi- Restrictions on civil
-- Honest and capa- tions. service compensation,
ble employees I t at least one ma . d enough recruitment, and firing
. .. . , . . . ~~~~may
adversely affect staff
credentials and experience in accounting to make quality.
good judgments on the production of financial in-
formation?
* Are there skilled staff for each of the primary
functions of the financial management system?
2) Review staff retention, recruitment, and training
opportunities.
* What is the staff turnover rate?
* Does the recruitment process attract and screen
for qualified applications?
* What are the training opportunities and how
frequently are staff trained?
* Is there an adequate performnancereview proc-
ess?
50 ANNEXI-1

REVIEWOF ACCOUNTINGSTANDARDS

WHAT HOW TO ASSESS ISSUES

Organizational * Reviewfinancialprocedures. Organizationswhich are small

Risk - Segrega- may not have sufficient em-
tion and delegation a Wouldcollusionbe requiredbetweentwo or ployees to provide for ade-
of duties more employees for theft to occur unde- quate segregationof duties.
tected?
* Are duties rotated either because of vaca-
tions or as a part of a general staffingpat-
tem?

Organizational Reviewwrittenprocedures. Procedureswithingovernment

Risk -- Clear pro- organizationsare often out-of-
ceduTes * Are there writtcedures and do they date with modem financial
matchactualprocedures? management. However,their
* Do the prescribed account classifications replacement may not be as
provide adequatecontrol over expenses es- practical within the scope of
peciallyin relationto theproject? the project. Damageto inter-
nal controls can occur if old
procedures are discarded be-
fore new ones are thought out
and developed.

Organizational Reviewphysicalcontrol.
Risk -- Physical * Is an annual inventory conducted of equip-
control mentand otherphysicalassets?
* Who has access to cash, equipmentand
otherassets?
 ANNEX I-1 51

REVIEWOF ACCOUNTINGSTANDARDS

WHAT HOW TO ASSESS ISSUES

Organizational Risk 1) Reviewprior audits,externalor internal. 1) When accountingrecords are
-- Independent veri- . . . . . behind, independent verifica-
fication * Was thea uie tion is oftenpushed aside and
any way adverse? eitherdonelate or not at all.
2) Reviewinternaldocumentssuch as bank 2) Statements from outside or-
statements,inventories,etc. ganizations can also be late,
* Does a separate entity (bank or government especially if they originate
agency) report on cash transactions inde- froma centralizedagency.
pendentof the recordsof the organization?
* Are these reports reconciledto the entity's
records by a staff person not directlyasso-
ciatedwiththe transactions?
ProjectTypes
There are three basic 1) Revenueearningprojects: 1) The implementingorganiza-
project types, reve- Dte . viability . tion may have non-revenue
nue earming, non- oanalyvia .le ofpndeproa mandateswhich interferewith
revenueearming,and aewhol through anal o s d financial decisions and may
adjustment opera- lack sufficientautonomyfrom
tions. * Determineindependenceof entityvia exami- the public sector to tailor fi-
nationof legal documentsand enquiries. nancialsystemsto its needs.
2) Non-revenueearningprojects: 2) In transitional economies, it
* Determine how financial management of may be difficultto determine
project will fit into the overall management boundariesof enterprise.
of theimplementingagency. 3) Sector differences will affect
emphasis of financial man-
3) Adjustmentoperations- SeeAnnexIII. emntassessment.
agement assessment.
* Determinemeans by which borrower will
ensure that disbursementsare made only for
items on the positivelist or conversely,that
no disbursementsare made for items on the
negative.
52 ANNEX 1-1

REVIEWOF ACCOUNTINGSTANDARDS

WHA T HOW TO ASSESS ISSUES

Availability and Quality of

Auditors

Audits are required for Bank Groundwork for selection of I) Auditing expertise may
compliance with regulations auditors should be done prior to be scarce and require
and also provide independ- project implementation. significant resources to
ent verification of reason- find satisfactory solution.
ableness of interim financial
2) Public sector auditors
reports. may have jurisdiction.
may lack expertise.
 ANNEX II 53

SUMMARYOF INTERNATIONAL ACCOUNTINGSTANDARDS

OF IASC

L4S I - Disclosure ofAccounting Policies value, the profit or loss for the period should be
All significantaccounting policies which have been chargedwith the difference.Disclosureis requiredfor
adoptedin the preparationand presentationof finan- the main categoriesof inventories.
cial statements need to be disclosed as an integral part LAS 3 - Consolidated Financial Statements
of the finacial statements. Supersededby IAS 27 and IAS 28.
Exception: following fundamental accounting as- S 4- DepreciationAccounting
sumptionsof going concern,consistency,and accrual
neednot be disclosed,but if a fundamentalaccounting The depreciableamount of a depreciableasset should
assumptionis not followed,the fact should be dis- be allocatedby usinga systematicdepreciationmethod
closed,togetherwith reasons. to each accountingperiod during the useful life of the
Changes in accountingpolicy which have a material asset. The depreciationmethodselectedshouldnot be
changedfrom periodto period. If depreciationmethod
shouldbe disclosed,togetherwith reasons. changed,the reason and quantifiedeffect of the change
should be disclosed in the period of adoption of
LAS2 - Valuation and Presentation of Inventories in change. Factors to be considered for estimating the
the context of the Historical Cost System useful life of period are expected physical wear and
Inventoriesshouldbe valued at the lower of historical tear, obsolescence,and legal or other limits on use of
cost and net realizablevalue. Suchvaluationshouldbe the assets. Useful life estimates for each asset or
done iternby itemor by groupof similaritems. group of assets should be periodicallyreviewed,and
any sigrificant change should be disclosed.For each
GenerallyFIFO or weightedcost approach shouldbe class of assetsthe depreciationmethod,the useful lives
used to ascertain historicalcosts of inventories.Ex- or the depreciationrates, the total depreciationalloca-
ception: tion for the period, the gross amount of depreciable
1) Inventorieswhich are specificallyidentifiableor asset, and accumulateddepreciation should be dis-
not ordinarily interchangeablemay be valued by closed.
specific identification of individual costs, and L4S 5 - Information to be Disclosed in the Financial
2) LIFO may be used, providedthat the difference Statements
betweensuchvaluationand Minimumdisclosurerequirementsset out. Dividedinto
(a) the lowerof FIFO (or weightedcost approach)and generaland specificdisclosuresas follows:
net realizablevalue, or * all materialinformation,and
(b) the lowerof currentcosts and net realizablevalue, * correspondingfiguresfor precedingperiod.
is disclosed.
Major categories of specificdisclosuresfor Balance
Estimatesof net realizablevalue should be based on Sheet are:
general market prices rather than on temporary fluc-
tuationsin prices. Exception: Net realizablevalue of * Long Term Assets,: Separate disclosurerequired
firmnsales shouldbe based on contract value. When for property, plant, and equipment,and other long-
inventoriesare written down to their net realizable term assets.
54 ANNEXII

* Current Assets: Separate disclosurerequiredfor Flow Statementis detailedin the statement. The main
cash, marketable securities and other short term in- categoriesunder whichmovementsof cash needs to be
vestments,receivables,and inventories. shownare cash flow from:
* Long-Term Liabilities (net of portion repayable * OperatingActivities
within one year) : Separate disclosure required for n a F
secured loans, unsecuredloans, intercompanyloans, * Investmgand FmancmgActivities,
and loans from associatedcompanies. * ForeignCurrency,
* Current Liabilities: Separate disclosurerequired * Extraordinaryitems,
for Bank loans & overdrafts,current portion of long- Interestand Dividends,
.
term liabilities, payables, and other liabilities and
provisions. * Taxeson Income,
* Shareholders' Interest : Separate disclosure re- * Acquisitionsand Disposal of Subsidiaries and
quiredfor Share Capitaland otherequity. Otherbusinessunits, and
Disclosures should also be made for restriction on * Non-cashtransactions.
asset titles, security given against liabilities,method Further components of cash and cash equivalents
for provisionfor pension and other liabilities,contin- ute opnnso ahadcs qiaet
gent assets and liabilities,and amountscommittedfor should be disclosedand reconciliationpresented be-
futures cap expenditue. tween the amounts in the cash flow statement and
equivalentitemsreportedin the balancesheet.
Major categoriesof specificdisclosuresfor Income AS 8 - Unusual and Prior Period Items and
Statementare : Changes in Accounting Policies
Salesor otheroperatingrevenue, Any prior perioditemsand adjustmentsresultingfrom
* depreciation, changes in accountingpolicies should either be re-
income,
interest ported by adjustingthe opening balance of retained
inmterest
mcome,earnings in the financialstatements(and amendingthe
* incomefrom investments, comparativeprior year informationpresented)or ad-
justed againstcurrent incomewith separate disclosure.
- interest expense,GCorrections resultingout of a changein the accounting
* taxes on income, estimateshould be adjusted against current incomeas
an ordinaryitem in the period of change and in future
* unusual charges, periods if the change effectsthose periods. Any mate-
* unusualcredits, rial effect should be quantified and disclosed sepa-
* significantintercompanytransactions,and rately.
uS 9 - Accounting for Research and Development
* net income. Costs

Guidancegiven on identifyingResearchand Develop-

LAS 6 - Accounting Responses to Changing Prices mentcosts incurredin houseor contractedfrom others.
Research and Developmentcosts should be expensed
Supersededby IAS 15. unless all of the followingcriteria are satisfied, then
theyshouldbe deferred:
uAS7- Cash Flow Statements * the product or process is clearly defined and the
Requirespreparationof Cash Flow Statementfor all associatedcosts are clearlyidentifiable,
enterprisesand including it as part of the financial * the technical feasibilityof the product or process
statements. Procedure for preparation of the Cash has beendemonstrated,
 ANNEXII 55

* the enterprise will produce and market or use the MS 13 - Presentation of Current Assets and Cur-
product or process, rent Liabilities
* clear indication exists of the future market poten- If an enterprise presents current assets and current
tial or usefulness to the enterprise, and liabilities separately from other assets and liabilities,
then the standard is applicable. The standard sets out
* resources available to complete the project. items to be considered as current assets and current
Allocation of deferred Research and Development liabilities, and sets out presentation and disclosure
costs to future periods should be done on a systematic requirements for such assets and liabilities.
basis. The total Research and Development costs, MS 14 - Reporting Financial Information by Seg-
including any movement, along with amortization of ment
the costs should be disclosed together with the basis of
allocation. This standard requires segment information disclosure
for publicly traded enterprises and economically sig-
4S 10 - Contingencies and Events Occurring after nificant industries, including subsidiaries. Disclosures
the Balance Sheet Date required include bifurcation by industry and geo-
Guidance given to identify contingencies and events graphical segments.
occurring after the Balance Sheet date. MS 15 - Information Reflecting the Effects of
The existence of contingent loss should be disclosed in Changing Prices
the financial statements unless it is remote; contingent The statement applies to enterprises whose revenues,
gains should be disclosed if it is probable that gain will profits, assets or employment are significant in the
be realized. The value of assets and liabilities should economic environment in which they operate. The
be adjusted for events after balance sheet date that standards detail two acceptable methods, viz., General
effect the values as of the balance sheet date. Other Purchasing Power and Current Cost Approach. The
events after balance sheet date that are significant disclosures required should be as a supplemental in-
should be disclosed for the user to make proper formation to the financial statements.
evaluations. The nature of the event or contingency
with its estimated financial effect should be disclosed. MS 16 - Accounting for Property, Plant and
For contingencies the uncertain factors should also be Equipment
disclosed. The definition of property, plant and equipment has
MS 11 - Accountingfor Construction Contracts been set out under the standard. The purchase price,
any improvement costs, and any costs directly attrib-
The percentage of completion method or the completed utable to bringing the costs to its working condition,
contract method should be used in accounting for con- but excluding any general repair and maintenance
struction contracts. The standard gives guidelines for costs, should be included in the cost of the asset. Costs
(i) usage of both the methods and (ii) disclosures re- of self-constructed property, plant and equipment
quired for such contracts. should include specific costs directly related to the
MS 12 - Accountingfor Taxes on Income specific asset and should not include any cost ineffi-
ciencies. Property, plant and equipment acquired on
The expense on tax should be determined by tax effect exchange should be priced at book value of similar
accounting, using either deferral or liability methods. assets, or at fair value, when similar assets is not
Tax effect accounting considers taxes as an expense to owned by the enterprise. If their is a permanent im-
accrue income, and thus taxes should be accrued mithe pairment to any item or group of items, so that the
same period as the revenue and expenses to which they recoverable amount falls below the net carrying value,
relate to. The standard has laid down disclosure re- then the net carrying value should be reduced to the net
quirements for tax accounting. recoverable amount.
56 ANNEXII

For revalued property, plant and equipment, any up- IAS 21 - Accounting for the Effects of Changes in
ward revaluationshould be credited to shareholders ForeignExchange Rates
interestdirectlyand not creditedto incomestatement. Transactionsin foreigncurrenciesshould be recorded
Any decrease due to downwardrevaluationof prop- at the reportingcurrencyof the enterprise,and reval-
erty, plant and equipment,should be charged to - ued at the closingexchangerate for reportingpurposes
come, except the amount of downward revaluation (exceptionbeing forward exchange contracts, where
relatedto any earlierrevaluationshould be chargedto special accountingtreatment is given). Exchangedif-
shareholdersinterest. ferencesarising out of such treatment should be rec-
Disclosurerequired over and above LAS4 & 5 are ognizedin the incomefor the period (exceptionbeing
methodsused for determininggross value of property, in case of certain long-termitems, exchange differ-
plant and equipment,and revaluationmethodused for ences can be recognizedto incomeof current and fu-
any revaluations. ture periods on a systematicbasis).Procedureshave
S 17 - Accountingfor Leases been laid out for translationof financialstatementsof
a foreignentity and for financialstatementsof foreign
The standarddiscuseslease accountingundertwo sub operations of an enterprise. Disclosure requirements
categories: financeleases and operationalleases,and has beenspecified.
included are discussions on sale and leaseback trans- AS 22 - Accountingfor Business Combinations
actions. Disclosurerequirementshave been set out
for both the lessorand lessee. Businesscombinationsshouldgenerallybe accounted
rS 18- RevenueRecognition for under the purchasemethod,exceptionin rare cases
being the pooling of interests method. Both these
Revenueshouldbe recognizedif it meets certainstan- methods are discussed in the standard. Disclosure
dards of transfer of ownership,uncertainty,collecti- requirementshavealso beenset out.
bility, and measurabilitycriterions, as set out in the
standard. Disclosurerequirementsincludedisclosures
as to any postponement of any revenue recognition. IAS 23 - Capitalization of Borrowing Costs
L4S 19 - Accounting for Retirement Benefits in the Circumstances when borrowing costs can be capital-
FinancialStatementsof Employers ized when they meet certain criteria, has been dis-
The standard sets accountingrequirementsfor retire- cussed. Generally,during the time an asset is being
. > > . - . . . .
ment benefits for defined benefit plans and defined ~~~made ready
y for use or sale, any
y borrowingg costs in-
contributionplans. Minimumdisclosurerequirements curredcan be capitalized. Borrowingcosts capitalized
havealso beenset out. shouldbe disclosed.
I4S 20 - Accounting for Government Grants and lS 24-Related Party Disclosures
Disclosures of Government Assistance Disclosure required for related party transactions if
Governmentgrants related to assets, including fair they meet certain criteria. Related party transactions
value of non monetarygrants, should be disclosedin have beendefined.
the financialstatementseither as a deductionfrom the LMS25 - Accountingfor Investments
carryingvalue of the assets, or, as a deferredincome. Investmentscan either be accountedfor as short-term
Other goverment grants related to assets, including (current)or long-term.For short-terminvestments,the
fair value of non monetary grants, should be recog-
nizedover the periodsin whichthe relatedcosts occur carr vl sheor
market value. For long-term rvest-
and are accountedin the income statementof the en- ments,the carryingvalue shouldeither be cost, reval-
terprise. Disclosures required for accounting policy, ued amounts,or, in case of marketableequity securi-
nature and extent of grant, and any unfulfilledcondi- ties the lowerof costs or market value.
tions for the grant.
 ANNEXII 57

Investmentproperties can either be accounted for in IAS 29 - Financial Reporting in Hyperinflation

accordance with IAS 16, with depreciation, in accor- Economies
dance with IAS 4, being charged to the income state- The financial statements should be restated at measur-
ment, or, investmnent properties can be accounted forI
aent, or, investmentm ing unuts as applicable on the balance sheet date. The
resulting gain and loss in the net monetary position
Accounting for changes in carrying value of invest- should be included in net income and separately dis-
ments, transfers and disposals has been discussed. closed. Disclosures are required for restatement of the
Disclosure requirements has been set out in the stan- financial statement figures, the basis of measuring
dard. applied to the financial statements, and the identity of
L4S 26 - Accounting and Reporting by Retirement the current measuring unit or price index.
Benefit Plans lAS 30 - Disclosures in the Financial Statements of
This standard sets out reporting requirements for the Banks and Similar Financial Institutions
plans, and should be distinguished from LAS 19, which The disclosure requirements set out in this standard
discusses reporting requirements in the financial are in addition to those set out in other standards. Re-
statements of employers having such plans. quired disclosure has been discussed under (i) Income
U4S 27 - Consolidated Financial Statements and Statement, (ii) Balance Sheet, (iii) Contingencies and
Accountingfor Investments in Subsidiaries Commitments including Off Balance Sheet Items, (iv)
Maturities of Assets and Liabilities, (v) Concentra-
Preparation and presentation of consolidated financial tions of Assets and Liabilities, (vi) Losses on Loans
statements for a group of enterprises under the control and Advances, (vii) General Banking Risks, and (viii)
of a parent is discussed in the standard. Assets Pledged as Security.
MAS28- Accountingfor Investments in Associates IAS 31 - Financial Reporting of Interest in Joint
Investment in associated companies should be ac- Ventures
counted for by using the equity method; exceptions are Disclosure requirements for interest in joint ventures
noted in the standard. Disclosure requirements have has been discussed separately for jointly controlled
also been set out. operations, and jointly controlled assets. Reporting
requirements for an enterprise have also been dis-
cussed as a venturer and as an investor.
58 ANNEXII

NOTES
 ANN1XIII 59

ACCOUNTINGAND AUDIT ARRANGEMENTSFOR

ADJUSTMENTOPERATIONS

ArrangementsRequired
1. Ensurethat the Borrowerintroducesarrangementsto recordthe CustomsCertificates,relat-
ing to the underlyingimportdocuments,to be used to supportBank disbursementsunderthe loan. (The
CustomsCertificatewill includethe suppliername, supplyingcountry,value, descriptionof goods,the
importerand the dateof importation.)
2. The arrangementsshouldensurethat:

a. the goodsare eligiblebased on a positiveor negativelist.

b. the goods are suppliedby a membercountry.
c. the date of importationis availableto determineeligibility.

3. Ensure that arrangementsare in place to retain, with easy access,the CustomsCertificates

for at least one year after the submissionof the relatedaudit report.

Audit Requiredand Opinion

1. Ascertainthe adequacyof theproceduresused to preparecustomsor similarcertificates.
2. Examinethe customscertificateson whichthe Bank's disbursementshave beenused.
3. Issue an opinionas to the reliabilityof the proceduresapplyingin verifyingor issuingthe
customscertificatesin supportof the Bank's disbursements.
60 ANNEXIII

NOTES
 ANNEXIV 61

REVIEWSOF FINANCIALMANAGEMENTAND
ACCOUNTINGSYSTEMSFOR ENTITIESIMPLEMENTING
REVENUEEARNINGPROJECTS
1. Most revenue earning entities are autono- * Financial staff: management, competence and
mous,or have a high degreeof autonomy,with powers training
to determinefinancialpolicies and the design and op- The extent of the reviewrequiredfor each of the above
eration of financial managementand accountingsys- is discussedin the followingparagraphs. In general,
tems. Somestate-ownedenterprises,on the otherband, staff should ensurethat each review is adequate to
may be required to confomi to a national accounting advise the Bank prior to negotiations for a loan on the
plan. The followingis a checklistof itemsto be con- adequacy of financial management and accounting
sideredwhen reviewingthese arrangements. The re-
viewsshouldtake place early as possiblein the project iformation.
cycle of identification,preparation, preappraisal or
appraisal. Statutory or General Legal Requirements

2. Laws, governmentregulationsand/or rules

* Statutory requirementsfor accountingand finan- under which an entity operates should be examined,
cial reporting and the entity's observanceor nonobservanceof them
should be identified,so as to determineany possible
enSt o ntity effectsonthe projectearly in the projectcycle, because
erinmentcontrol ..introducingnew legislationor amendingany existing
• Accountingpoliciesand practicesin force laws may require considerabletime. Legal Depart-
ment's advice shouldbe sought if it appearsthat legis-
- Managementand controlsystemslaiecngsmybrqued lative changes may be required.
* Centralizedor decentralizedmanagementand ac-
countingsystems
3. Statutory powers or requirements may
* Financialregulations relatedirectlyto the entity's operations(e.g., power to
* Financialmanagementand accounting fix tariffs and levy chargesfor productsor services)or
they may define criteria within which an entity may
(i) Managementaccounting operate (e.g., banking laws which define borrow-
(ii) Corporateplanning,budgetingand budget- ing/lendinglimits). Detailed financial or accounting
ary control requirementsmay not be part of specific legislation
...i) F.Mancialaccounting relatingto the entity or in the entity's "charter"but
may be addressed in general laws to which the
(iv) Cost accounting "charter"may refer. Particular attention should be
paid to concessionagreements,which are generally
found in utilities in some French-speakingcountries.
(vi) Data processing Under this system, which requires special accounting
treatment,a governmentmay give an entity the right,
62 ANNExIV

for a fixed term, to operate, manage and develop the Accounting Policies and Practices in Force in the
service and to recover its investments at the end of the Entity
concession. If existing statutory requirements may The acceptability of the accounting poli-
inhibit normal reporting of project performance, this cies, including standards of financial reporting and
should be discussed with the government and the bor- general accounting practices in force in the project
rower, so as either to obtain changes in the statutes or entity, should be examined against the background of
to redesign the project's reporting requirements. the related chapter in the handbook on financial report-
mg and budgeting compliance. If the policies do not
Status of an Entity conforn to accepted international or national standards
and practices, the borrower should be informed of any
4. In order to determine a borrower's author- required modifications and the latest date for their in-
ity and ability to formulate and implement financial troduction, e.g., before project implementation com-
policy, and to design and install financial management mences, or by a date to be specified in a covenant. On
systems, and thereby indirectly to determine how much the other hand, if only minor items are in dispute (e.g.,
time may be needed for making changes, it may be methods of apportionment of overheads or valuation of
necessary to establish the extent of its autonomy and/or inventories), as long as these variances are revealed in
control by higher authorities. The following questions the annual financial statements and the auditor's re-
should be resolved: port, their continued use may be acceptable.

(a) Is it fully autonomous (for example, can it legally Management and Control
exist in its own right by the laws of the country 6. To judge the effectiveness of an organiza-
without government control)? tional structure, the following should be reviewed to
(b) Can it contract, and sue and be sued in its own judge their suitability to support project implementa-
name? tion and operation and the extent of their observance in
(c) Can it determine its own financial policies? practice:
(d) Is it government-controlled? If so, what is the
extent of that control and influence on financial * By-laws of the entity
policies and accounting requirements? * Executive orders (if any)
(e) Is there a specified code or chart of accounts?
-- Statements of objectives and policies
(f) Is it a government agency? If so, does the entity's
management have any powers to decide financial * Organizational structure, including the reporting
policy and accounting systems, or are these pre- level of the chief financial officer
scribed by government? For example, there could * Intemal control and internal auditing
be separate accounting rules for parastatals.
* The need to furnish financial information on an
(g) Is the project to be executed by a part only of an entity's performance to concemed parties within,
entity? and external to, the entity, and the extent of the
(h) Is it necessary or desirable to require a separation achievement of such dissemination.
of accounts and/or funds for that part only, and
would such a step be feasible?
 ANNEXIV 63

7. The impact of management and control systemswith regard to the efficiencyof centralizedor
systemson the operationof the financialmanagement decentralizedoperations. Key factorsto be considered
and accountingsystemsshouldbe examinedby seeking are the competenceof management,security, commu-
answersto the following: nications,and the availabilityof trained staff.
(a) What is the backgroundand experienceof those
who representthe financefunctionon the Boardof FinancialRegulations
Management?
9. These regulationsare usually designed to
(b) Who in management reports on financial perform- 9. Ths reuain ar sal eindt
ie m
(b) eWho eenti' rneportso definethe objectivesof, and responsibilitieswithin,a
financialmanagementand accountingsystem. They
(c) Who reports on financeto the management?What may form part of StandingOrdersor OperatingRules
is the status of this official? or be a prefaceor annexto a Manualof Accounting,or
(d) In what form and how frequentlydoesmanagement they may be restrictedto limiteddefinitionsof budget-
require and receive information about financial ary, accounting or interal auditing responsibility
performance-- type of reports and distributionof within an entity. They may range from statutory
such to various levels of management? Is it ade- regulationsto financialmanagers' informalrules with
quate? no legal status, and shouldfacilitatethe examinationof
the financial managementsystems by defining their
(e) What are the controlsystemsand linkagesbetween structure and subsystems,and by designatingrespon-
top managementand financial management,and sibilities. Regulations,if any, shouldbe reviewedfor
betweenother managersand the financialmanag- their form and context,and for their observance.Nor-
ers? mally, at the time of appraisal, the extent to which
(f) Do the answersto questions(a) through (e) above FinancialRegulationssatisfactorilyaddressthe follow-
add up to a system acceptableto the Bank for ing shouldbe examined:
project implementation? If not, can they be (a) Basic financialpolicy with regardto revenuesand
amended in a timely manner to achieve project expenses
implementation? (b) Appropriationof surpluses/treatmentof deficits
(c) Programming and budgeting, including me-
Centralized and Decentralized Accounting Systems diumtlong-term investment planning
8. Large industrial and commercialorganiza- (d) Budgetarycontrol
tions, governments,or large parastatals may operate
centralizedfinancialmanagementand accountingsys-
tems, wherebyall informationgeneratedat operational (f) Recordingof assets and inventories
levels (e.g., project sites) is transferred to a central
location for making payment to contractors,etc.; for
data processing; and for compilation of accounting (h) Depreciationrules
records. Delays and loss of data may result, which (i) Debt management
affect, interalia, promptand accuratereporting. Con-
versely,decentralizedsystems, which permit local fi- (j) Billingand collection
nancial operations, usually require more extensive (k) Write-offs
controlsand morestaff. Therefore,beforerecommend-
ing changesto a borroweron project (and, where ap- (1) Biddingprocedures
plicable, project entity) financial management and (m) Paymentprocedures
accountingsystems,it wouldbe prudentto examinethe
advantagesand disadvantagesof existingand proposed (n) Form and timingof financialstatementsand bal-
ance sheets
64 ANNExIV

(o) Internalchecksand controls Financialaccounting

(p) Internalaudit Payments
(q) Externalaudit Costing,etc.
Bankingoperations
10. Regulationsshouldalso clearlydefinewho Billing
is responsiblefor their implementation.The provision Debt management
of new regulations or the improvementof existing
regulations should preferably be sought before loan Inventories
negotiations.Technicalassistanceto help introduceor Finally,it shouldshow establishedposts/salarylevels,
improve regulations and systems should be encour- and posts occupiedand vacant.
aged, where necessary, through the use of a free
standingprojector a projectcomponent.
13. The borrowershouldbe notifiedof any
concernsaboutinadequacies,or changesrequiredin
the management accounting system to achieve satisfac-
ManagementAccounting System tory to project implementation.
11. A managementaccounting system should
collectand promptlyreportfinancialand relatedstatis- CorporatePlanning,Budgetingand Budgetary
tical informationabout an entity's operationsto the C
various managementlevels, supplyingeach level with ontrol
the necessary details at the appropriate times. It 14. Long-, medium- and short-term planning
should incorporateprocedures for budgeting and fi- shouldbe primaryelementsin financialmanagement.
nancialplanning,record-keepingand reports, and cost Long- and medium-termplans are usually referredto
accounting(includingcost control and analysis) for as corporate planning and require different planning
recordingcosts. Such a system, which is often best approaches,often characterizedby "irollingprogram"
illustratedin chart form, should also provide for ade- techniques,or 'indicativeplanning"only, comparedto
quate internal checks, controls and, if appropriate, the short-termbudgetingand budgetarycontrolproce-
internalauditing. dures, which are normallybased on annual plans. In
addition, examination of corporate planning and
budgetingsystems adopted by an entity should focus
12. In the absenceof a chart of a management on the emphasisplaced on profit maximizationcom-
accountingsystem,an organizationchart of the entity's paredto routineexpenditureand revenuecontrol. An-
structureshouldbe obtainedor drawn up. It shouldbe swersto the followinggroupsof questionsmay provide
suitablyamendedto illustratethe areas of management an adequate overviewof the corporate planning and
served,or to be served,by the managementaccounting budgetarysystems:
system. The chart shouldshow, inter alia, the linkages
betweenthe system and the managementcenters of the
entity, and to a central organization,if the entity or (a) Characteristicsof Planning
system is a decentralizedunit. The chart shouldalso (i) is there overallcorporateplanning?
showthe main and subordinateactivityareas,e.g.:
(ii) what is the time span of corporateplans?
Controllershipfunction
(iii) howare corporateplans expressed?
Treasuryfunction
(iv) are corporateplans summarizedin financial
Programmingand budgeting terms (pro formaannualfinancialstatements
Cash collection and balancesheets)?
 ANNEXIV 65

(v) are overall financialplans supportedby ap- (ii) how does the accountingsystem serve con-
propriate subsidiarybudgets (revenuesand trol in (i)?
operatingexpenditures,capital expenditures, (iii) who prepares fiancial reports relating to
debt-equityproposals)? performance, corporate plans and annual
(vi) what are the critical monitoringindicatorsin budgets?
corporateplans? (iv) does the reportingsystem allow controland
variation of corporate plan execution by
(b) Responsibilitvfor Planning functionalmanagers? On a timely basis?
With adequateinformation?
(i) who prepares and approves corporateplans (v) are adequatecorrectionsmade to corporate
and annual budgets? ()aeaeut orcln aet oprt
plans and annualbudgets on a timelybasis?
(ii) is there a review system for tariffs, prices By whom?
and changingmechanisms? (vi) what controlsexistover contingencies?
(iii) is there a reviewsystemfor capital expendi-
tures?
(iv) do the corporate plans and annual budgets (e) Structureand Contentsof Budgets
identify specific managerial responsibilities (i) what is the analyticalstructureand degreeof
for implementationand review? detailof the annualbudget?
(ii) is there a physicalbudgetin additionto a fi-
(c) Timetablesfor Planningand Budgets nancialbudget?
(i) what is the timetablefor preparationand ap- (iii) what identificationand form of presentation
proval of corporateplans and annual budg- of capital and recurrent expenditures and
ets? revenuesare in use?
(ii) does the timetableallow sufficienttime for (iv) are line-item classifications objective or
generationof all inputs and managementre- subjective?
.
viewsof corporateplans and annualbudgets (v) is a cash or accrual accounting system in
(consider the extent of centraliza- use?
tion/decentralization
of the entity)? (vi) what period(s) of forecasting (month,year,
multiyear)are in use?
(iii) whopreparesand controlsthesetimetables?
(iv) are there sufficienttime allowancesand ar- (f) Bases for Forecasting
rangementsfor preparation and incorpora- (i) what controlsexistover contingencies?
tion of revisionsin corporateplans and an-
nual budgets? (ii) are analytical supporting data used
(statisticalanalysis,financialratios)?

(d) Controlof Plans. Budgetsand Performance 3 Objectiveclassification

is analysisby operationalunits
(i) what is the system of control of actual per- or by output (e.g., for a power utility, generation,
formancevis-a-vis corporate plans and an- transmission, distribution, etc.). Subjectiveclassifica-
foralncudetvis?~-vs corporate plans and an-tion is analysis by basic inputs (e.g., salaries, wages,
nualbudgets? fuel,supplies).
66 ANNExIV

(iii) are correspondingresults or data for previ- mine the effectivenessof the accountingsystem with
ous and currentyears available? regard to (a) sound design and ability to respond to
(g) CashFlowBudget project, and, where applicable,entity requirementsand
(b) the extent of compliance in practice with the
(i) howis the cash flowbudgetoperated? manuals and codes. Updatingof manuals or redevel-
(ii) whoapprovesand executesit? opmentof an ill-structuredcodesystemmay needto be
addressedbeforeor duringprojectimplementation.
(iii) how frequentlyis it prepared(daily,weekly,
monthly,annually)?
(iv) who relates forecaststo actual positionand 17. A financialaccountingsystem should con-
howregularly? sist of at leastthe following:
(v) can the cash flow budget overridethe main
budget(s)(e.g., by stopping paymentsor by (a) a system of records or accounts of individual
stoppingexcessiveshort-termborrowing)? transactions, sometimes referred to as books of
"primeentry,"e.g., cash books;
15. The foregoing review should be used to (b) a self-balancingsystem of '"ontrol and total ac-
judge the effectivenessof corporate planning and counts"derivedfrom the totals of accounts in the
budgetaryprocesses,and the degreeto which changes booksof prime entry,sometimesreferredto as the
should be soughtto improvetheir efficiency. In par- "generalledger;"
ticular, it shouldbe used to determinethe borrower's (c) a system for making transfers and adjustments
ability to achieve controlled implementationof the between accounts, sometimes referred to as the
project and covenantedfinancial performance (e.g., "joumal."
levyingof taxes and charges),after taking account of
any constraints which may be imposed by superior
authorities. Where possible, the borrower should be The individualtransactionsmay be grouped into sepa-
asked to remedy any deficienciesbefore the project rate accounts (or account books) for each category,
begins. If extensivemodificationsare required,agree- such as cash, salaries and wages, purchases, loans
ment should be soughtduring negotiations,on what is received,etc. The generalledgershould be the princi-
to be done, the timetablefor implementation,external pal source of informationfor financialstatementsand
assistancerequirements,and whetherthe improvements financial reporting. The foregoingis oversimplified,
shouldform a project component(for example,a new but a preparationor appraisal mission should satisfy
budgetingsystem). itselfthat in an existingentitythese recordsat least can
be traced in some form. Many systems will use data
processingwith possible difficultiesin tracingthe flow
FinancialAccounting of entries. Reviewsmay requirethe use of specialists;
16. A borrower may use an AccountingMan- alternativelyit maybe sufficientto discussthe systems
ual or a Procedures Manual, or both to prescribe flowwith the internaland/or externalauditors. On the
regulations and responsibilityfor operating the ac- basis ofthese discussions,it should be possibleto de-
countingsystem. The systemflow,recordkeepingand ternine the suitabilityand qualityof the system.
authorizationproceduresfor making amendmentsor
correctionsare normallydescribedin the lattermanual, 18. The principleby which accountingentries
togetherwith machineaccountingor computingproce- 18. she princinedb ich thebooks
dures,whereapplicable. A systemmaybe based either are made should be determined. Ideally,the booksbe
of
an autonomous revenue earnig entity should
on an internally constructed coding system or on a a n a ordance with entry ahcul
nationalChart or Code of Accounts. Such a chart, or mamtained in accordancewith double-entyaccrual
internal coding system, and the manuals mentioned principles. A governmententity's accountingsystem
above, where available, should be reviewedto deter- that operates on a double-entrycash basis may be ac-
 ANNEX IV 67
4~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

cepted, however, as long as the entity maintains sub- operations both in determining costs of services as well
sidiary records that make it possible to determine as costs of products, by providing early and measur-
capital and current expenditure transactions, a cash able comparisons of performance against determined
flow and an analysis of commitments and receivables standards. It is preferable if the cost accounting is an
where necessary, at the beginning and end of each fis- integral part of the financial accounting system so that
cal year. all inputs each system are mutually consistent. Costing
systems separate from the accounting system may ex-
ist; in such cases, however, confirmation should be
19. In the absence of confirmatory evidence, obtained that adequate controls are used in each system
e.g., auditors' reports, limited checks should be made to reconcile the data.
to establish that accounting records are kept up-to-
date, with regular balancing (monthly, quarterly) and
provision of financial reports on predetermined dates, 21. A costing process may require a consider-
by requesting and examining trial balances,5 the dates able degree of analysis to enable managers to control
on which they are taken, and the period covered by the all inputs to a production process. Staff should ensure
transactions. As a guide, a trial balance taken later that: (a) the entity is using its costing system to pro-
than one month after the close of an accounting period6 vide valuable management information, (b) costs and
may be unsatisfactory. Selected items may be traced benefits are evaluated before recommending such a
from the annual financial statements through the ap- system and (c) the entity is capable of operation a
propriate books of account (e.g., fixed assets to the costing system.
assets register) (a) to confirm the statement entries and
(b) to understand the information assembly and low in
the system. Internal Control and Internal Auditing
22. One of management's more important
Cost Accounting functions is the design and maintenance of internal
controls to achieve accountability at all levels in an
20. Cost accounting systems may not be avail- entity. Typical elements of internal control should
able or necessary in many project entities. Specialized include:
costing systems may, however, offer substantial bene-
fits to some projects or specified parts of some entities'
(a) enabling legislation

4 Simply defined, cash accounting records transactions (b) by-laws, standing orders
only as cash is paid or received;in accrual accounting, (c) policies, objectives
transactions are recorded at the time expenses are in- (d) systemsand procedures
curredor income earned.
In this context, a trial balance is a listing of all debit (e) organization structures providing for segregation
and credit balances in a ledger system, used as an ini- of duties
tial test only to determine if a double entry system is (f) job descriptions
in balance. It is not a verification,becauseit cannot
revealcertain types of errors. (g) planning and budgeting
6 An accounting period in this context is a period (one (h) accounting
week, one month, three months, etc.) chosen to allow (i) financial and physical performance reports
regular accounting control. It should not be confused
with a fiscal year, which is usually a legal accounting (j) internal auditing
period.
68 ANNEXIV

23. Sound managementand effective internal (d) methods of remedyingweak controls or creating
controlrequire the organizationalindependenceof the themwherethere are none;
operating,custodialand accountingdepartments. Op (e) verificationof assets and liabilities.
erating departmentsshouldnot have any principalac-
countingor custodial functions,even thoughthey may
be responsiblefor producingand recordinginitial or 26. An interal auditor should work within a
basic data. Initiationand authorizationof a transac- well-definedframework of programs and reporting
tion, its recording and custody of the resultingasset requirements.If there Is a data processinginstallation,
should be separated.Thus, receipts and disbursement t
of fundsshouldbe divorcedfrom accounting. A mate- computerpror change aamedmensare con-
rials departmentshouldnot have accessto the principal sisten monret preventiregularits. Toe -
accounting records used for checking storekeeping in tent and effectvene internal eand
integrityand a productiondepartmentshouldnot com- cnt their associatedicosts maybecreiewd
pute its own costs. Normally,dutiesand responsibili- aanttose the extea audt; wto te rer,
ties should be so segregatedthat no one person will a the exteamay be overlytepen on-
hadl a trnato copetl frmbgnin.oed the external system may be overly expensive; con-
handle
a trnato.opeeyfo einn oed verselythe costsof an internalauditby permanentstaff
If that divisionis not feasible, other protectiveprac- maybe ch he at teoal audit or.
tices mustticesbbe devisd.
ust
devised. Thse nea
These internal hcshls help es-
checks maybe muchhigherthat those of an extemalauditor.
tablish the reliability and integrityof the accounting
recordsand information. Data Processing Systems
27. Two main features of the systems may
24. While small entitieshaveto rely on internal requireexamination:
checksand controls,larger organizationsshould have (a) the effectivenessand security of existing systems
some form of internalaudit. Internalauditing's unique and relatedequipment;and
role consists of assessing how well the other control
elementswork and the extentto whichthev are relevant (b) any proposalsby a borrowerto install new equip-
to the systems. In most entities,the internalauditoris ment and/orsystemsas part of a project. Complex
also expectedto propose remedialaction when called systems,may require the advice of a specialist.
for. An internal audit unit consists of a person or a The first feature will require examinationfor the
group reportingto the management-- if possible,inde- compatibilityof the data processing system with
pendentlyof the financialmanagers. Ideally,the inter- other elementsof the financialaccountingprocess,
nal auditor shouldhave as much freedomto decide on and any directlyrelatedactivitiesof the borrower,
his role and operationsas the externalauditor; other- e.g., inventory and experiencedmanagerial, su-
wise, his position may become untenable and be of pervisory accounting, bookkeeping,clerical and
littleuse for assuringaccountability. data processingstaff. Well-runorganizationshave
professionalswho specializein staff selectionand
training arrangements.In a revenueearningentity,
25. Typicalmatterswhich intemalaudit should there shouldbe at least one senior managerin the
appraiseand reporton to managementinclude: systemwith financialexperienceand an accounting
backgroundsufficientto enable him to make ade-
quatejudgmentsabout staffingmatters in the ac-
erationalcontrols,and any needs
s
for revision;
> c
~~~~~~~~~~counting/finance
department(s).
(b) the extent of compliancewith prescribedpolicies,
plans and procedures;
.c theofaccountingsystems,dataan28.
reliability Appraisalshould include a review of staff
(c)itheeiabliy
r of numbersand qualityto ensure that these are appropri-
financialreports; ate for the kinds of activity and output required. For
example: cash management(i.e.,the treasuryfunction)
 ANNEXIV 69

shouldhave staff who specializein cash-flowforecast- review to judge whether employees are performing
ing, drawings from cash collection,bank deposit ar- satisfactorily. These programs may involve formal
rangementsand general cash stewardship. A control- traininggivenbeforethe positionis occupiedor on-the-
lershipfunction shouldhave specific staff to address, job training or some combinationof both. it may also
inter alia, financial planning and budgetary control be necessaryto examine the quality of internal and
general and cost accounting' financial systems and external training programs to advise the borrower
procedures;and data processing and managementin- and/or the entity on the need for improvementor ex-
formnation systems. pansion. Judgmentson the effectivenessof hiringpro-
29. Recruitmentprocedures should be exam- cedures,the quality of existingstaff, and on the quality
inedfor their suitability. There should be an adequate of trainingprograms shouldbe reflectedin a mission's
employee training program and periodic personnel reporton the financialmanagementsystem.
70 ANNEXIV

NOTES
 ANNEXV 71

REVIEWSOF FINANCIALMANAGEMENTAND
ACCOUNTINGSYSTEMSFOR ENTITIESIMPLEMENTING
NON-REVENUEEARNINGPROJECTS
1. Most non-revenue earning projects will be ary and accounting only when they, and the govern-
implemented by government agencies. The following ment, are fully satisfied that the new procedures will at
checklist is therefore designed mainly to promote ex- least maintain and, wherever possible, improve ac-
amination of typical government budgeting, accounting countability and facilitate project implementation.
and internal control systems, and should be read in Dismantling existing checks and controls in systems,
conjunction with Annex IV, which contains detailed without substituting adequate new measures and with-
recommendations for reviews which are common to out the trained staff to irnplement them, can have seri-
both revenue earning and non-revenue earning projects. ous consequences.

* Government accounting 3. Governments undertake a wide range of

• Status of entity services, often as the largest collectors and users of
funds in a country. This requires sound financial sys-
- Financial regulations tems within government, with mandated methods of
budgeting and accounting. These are usually estab-
* Financial management and accounting: lished on a "cash" basis, however, in contrast to the
accruals system usually adopted in commercial prac-
tice. When a project entity forms part of a government
administration; a government's financial management
(ii) Financial systems and procedures and accounting practices would normally apply to it,
(ill) Financial accounting and costing unless agreement can be reached on specialized ac-
counting arrangements for a project, and, where appli-
(iv) Internal control cable, the project entity.

Basic systems to establish and maintain accountabil- 4. The location of responsibility of govem-
ity ment accounting services varies among countries. In
Government Accounting some, an accountant-general or comptroller may be
responsible; in others, the Ministry of Finance may
2. Many non-revenue earning projects will be assume jurisdiction; in others, it may be difficult to
executed by entities that are part of a government, identify responsibility -- the systems having been es-
government-controlled, or government-sponsored. A tablished under earlier regimes, with no continuity of
full understanding of the principles and operation of responsibility. Determination of this responsibility
each budgetary and accounting system involved in such may be necessary if accounting changes are required to
cases should be obtained before a project is imple- implement a project, or to improve a project entity's
mented. Government budgetary and accounting sys- operations.
tems may include seemingly excessive bureaucratic
pre-payment measures, repetitive bookkeeping main-
tained at different level or locations. performance de- 5. The senior financial staff of a recognized
lays caused by apparent lack of delegated responsibil- government accounting service may hold responsible
ity, and "old-fashioned" rules and regulations. Staff roles (e.g., accountants-general), from which they can
are urged to seek improvements in government budget- influence the development and maintenance of sound
72 ANNEXV

accountingpractices. The existenceof these services FinancialRegulations

cannot, however,be taken to imply that government 8. Any existingregulationson the operationof
practices are automaticallysound and acceptable for financialmanagementand accountingsystems (Annex
prospective project entities. Prescribed government IV, para 9) should be reviewedto ensure their com-
practices may have been unofficiallymodifiedat the . ,
locallevelbecausethey are too detailed,misunderstood pati th thBns requireme Any amend-
oror,
ilsprie.'
ill-supervised.I mentsto regulationsshouldbe madeonly to strengthen
an entity's internal systems,in additionto supporting
the project.
6. Staff shouldfamiliarizethemselveswith the
precise roles which responsible officials play in con- Financial Management and Accounting
trollingand monitoringthe performanceof accounting
in governmentbefore seekingtheir assistance on spe-
cific project matters. The term "accountant" in gov- Budgetingand BudgetaryControl
emmnent oftenhas a very differentmeaningor interpre-
tation from "public accountant" in the private sector. 9. The reviewsrelatingto annualbudgets and
An accountant-generalmay be a designationfor an budgetarycontrol recommendedin Annex IV are also
officialpost, whose incumbentmay have little or no appropriate as far as they apply to a non-revenue
knowledgeof financeand accounting. earningproject. Experiencewith these projects,how-
ever, emphasizesthe importance of determiningthe
budgetary system that will apply during the project
Status of the Entity period. At appraisal,staff shouldbe satisfiedthat they
fullyunderstandthe systemand that they haveobtained
7. The status of an entity should be estab- (o ca obana.eoitos gemn n
lishedto detenmine,in particular,its abilityto:
(a) budget for and obtain budget approvals for re-
quiredfunds; (a) The budgetproceduresto be used by an entity and
by controllinginstitutionsgiving higher level ap-
(b) furnish funds promptlyfor project implementation provals which ill ensure timely and adequate
and operationand maintenance; pprojectc implementation;
l a
(c) institute, operate or amend financial accounting (b) the timing of all budget framingand approvalop-
systemsto respondto Bank requirements; erationsto ensure annual allocationand release of
(d) providethe necessary staff, with requisite skills, funds; and
for project implementation; (c) the timing of releaseof counterpartfundsprovided
(e) institutesatisfactoryinternaland externalcontrols in budgets.
and audit arrangements.
To the extent that any of the above requirementsis 10. If a borrower's fiscal year in which the
outsidethe entity's jurisdiction, staff should conduct project is due to begin starts before the date of loan
the examinationwith the responsibleinstitution(s)to effectiveness,it is essential to ensure that the budget
ensureeither their agreementto fulfill the requirements for projectstart-up(includingthe costs of operatingthe
promptly or to delegate to the entity the right(s) to projectentity and its accountingsystem,and of engag-
implementthemduringthe projectperiod. ing auditors)is availablefor the initialfiscal year. The
availabilityof such funds should be mentionedin the
SAR. If there are no budget provisions the SAR
shoulddescribehow the project willbe fundedpending
budgetauthorization.
 ANNEXV 73

FinancialAccountingand Costing
(c) the basis for all types of claims for disbursement
I1. It is preferable that an entity maintain at of loans.
least the recordsspecifiedin AnnexIV, para. 16,but in Item (a) is particularly importantin governmentac-
some accountingsystems (particularlythose of gov- counting, where asset records covering a period of
ermnents) many such records -- particularly control years are not oftenmaintained.
accounts - may not be maintained. Typical govern-
ment accountsmay reflectonly budgetheads for serv-
ices. A project or project componentmay utilizeonly 14. The Bankmay agreeto financeincremental
one line in an expenditure"block," or it may even be recurrentexpenditures,i.e., expendituresabove a par-
containedwith other items in a one-lineentry. Unless ticular level establishedat an agreed time with a bor-
staff make early requests for more detailed reporting, rower. Governmentaccountingsystemsmay not dis-
project subcomponentexpendituresmay be impossible tinguish betweenbase and incrementalexpenditures,
to controlwhenthe project starts. particularlyin the case of salaries, wages and related
overheads. It is therefore necessaryto agree with a
borroweron adequatemeans of identifyingboth budg-
12. When a government budgetary and ac- etary provisionsand accountingdata that can provide
countingsystemis to be used, it is usefulto decidethe for and report on these expenditures. The following
detailsof projectexpendituresfor whichregularreport- steps couldbe taken: establishingappropriateaccount-
ing will be required, and whetherthese can be intro- ing for specialheads of expenditure,subcodes,subsys-
duced into the accountingor costing system without tems and special reports; agreeing on accountingfor
difficulty.If they cannot,then the borrowerand/orthe only the main heads of expenditureconcernedand de-
entityshouldbe askedto establisha subsystemto meet veloping a formula for periodic application to total
the Bank's accountingand financialreportingrequire- expendituresunder those budgetheads to obtaina rea-
ments. An entity shouldbe encouragedto use the re- sonable apportionmentof incremental expenditures;
sultanttotals of a subsystemto supportor reconcilethe and continuouslyrevisingbase and incrementalcosts.
data in the standardsystem;i.e. the subsystemshould
becomean integralcostingsystemof the main account-
ing system. InternalControl
15. Any system to support a project should
includethe basic controlmeasuresmentionedin Annex
13.leo chevr systie ans nyuses ' t ms e IV. If the intemal checksand control systemsare not
satisfactory,and the effectivenessof the externalaudit
(a) project costs by componentsagreed on between is not established,then the project should not be al-
staff and the entityfor eachproject; lowedto proceeduntil the borrowerand/or entity has
(b) operating costs by budget heads analyzed in agreedto strengthenthe internalcontrolsystems.
enough detail to provide control of incremental
current expenditures; and
74 ANNX V

NOTES
 ANNEXVI 75

ACCOUNTINGFORSECTORS

1. The followingare somekey featuresaffect- non-loansources of income such as a direct sub-

ing the accountingfor selectedsectors. sidy paymentfor operatingexpenses;
* Separate categories for each major source of
FinancialSector funding. Many DFIs receive subsidiesvia below
market interest rates. To calculate the subsidy,
2. The success of a financialsector program concessionalloans funds must be segregatedin the
depends on the preservationof capital and the intro- books.
duction of control and tracking mechanismswhich
monitorthe quality of the portfolio and the financial * Ability to generate key performnanceindicators
returns accruing to it. Many Bank projects will be such as returnon equity,averageinterestincometo
involvedwith DevelopmentFinanceInstitutions(DFI) the portfolio,operating expenses to income,loan
whosecredit activitiesand financialhealth are required lossesto income,arrears to amountcollectible,av-
to be self-sustainable. To be self-sustainable,it is erage cost of funds, average returnon equity;per-
importantthat the financialinstitutionearns sufficient cent performingloans,portfolioat-risk,etc.
net income to maintain its equity in real economic
terms ( i.e. after allowingfor inflation).To achievethis
position,interest income which will be influencedby Infrastructure
the market rates shouldbe sufficientto coverthe costs 3. Infrastructureactivitiesrelate to almost all
of financing, operating expenses and any reasonable sectors, for example, the construction of irrigation
loss on its portfolio. However,in some instancesthe dams, schools, roads, etc. These are usually large
governmentmay wishto financean elementof subsidy investmentsover a period of time that require careful
to coverabnormal operatingcosts and portfoliolosses monitoringfor implementationagainst the plan. Some
arisingfrom lendingto targetedgroupsand areas. It is specificaspectsrequiringattentioninclude:
importantthat revenuesand costs are properly segre- a
gatedto providethe informationneededto calculatethe * the managementof large contracts wlth possible
subsidynecessaryto cover the impact of the targeted cost overrunscomparedto orginal plans, including
operation,and the performanceindicatorsused in the estimationof coststo completion;
finance sector to measure efficiency. Some key con- * the effectsof foreign exchangemovementsin local
cerns whichshouldbe addressedin evaluatinga finan- currency on costs of importedequipmentand for-
cial managementsystemin this sectorare: eigndenominatedaspectsof contracts;
* Degree of independenceof the finance institution * capitalizationof constructioncosts; and
from governmentpoliciesand interventions.
* delayscausedby a delay of early securingof land
* Conservativeprinciples regarding the recognition and other rights; the need for a large amount of
of interestincome; counterpartfinancingwhich may pose a problem
* Clear accountingpolicies on the classificationof for borrowers.
performingand non-performingloans and provi-
sion for bad debts; Utilityand TransportationSectors
* Separate income categories for interest, non- The utility sector is usually comprisedof
interest chargesassociatedwith the loan,and other energy, water, and telecommunicationsprojects. The
transportationsectorincludesports, railwaysand pub-
76 ANNEXVI

lic road transportation. Associatedissues could in- * Degreeof independence( wherecontrolledby gov-
clude: ernments)on price setting.
* Managementof large contracts with possible cost HumanResourceand AgricultureSectors
overus comparedto originalplan; 6. For those sectorsof a non-revenueearning
* Foreign exchange movements in local currency nature, such as human resources which covers health,
whichcouldhave a significantimpacton indebted- education, population, etc.; and agriculture, which
ness, and on operatingcosts (fueland spare parts); coversresearch,farmers'technicalassistanceincluding
extension;and irrigation--theprojects are usually im-
. Hyperinltonio neurnheplemented by the governmentthrough one of its de-
tionfofnassets; partmentsor agencies. These projects are, therefore,
heavilyaffected by the conditionand sophisticationof
* Projectsusuallyrequirea largeamountof counter- the government'sfinancial managementstructure of
part financing which may pose a problem on li- whichthey maybecomea part. On occasion,theymay
quidity; be accountedfor entirelyseparatelyfrom the govern-
ment accounts. For these projects, the Bank would
tig,food monncialinformageatnd tarliff,forrates- usually be concernedwith the structure and controls
tion, for month ori age andib g for affectingthe project. Becausethe governmentdoes not
tosanotepromnets; measure performance via profitability, performance
* Separationof productionand costs of key monitor- indicatorshave to be carefullyconstructedusing both
able areas such as powergeneration,transmission, physicaland financialdata. Some commonitemsto be
and distributionin the energy sectors and similar consideredin providingfor the financialaccountability
process functionsin the watersector. of the aboveprojectsare:
* Clear segregationof project expenditureswithin
Industryand Agri-BusinessSectors the governmentaccountingsystem;
5. These sectors would include many of the * Establishmentof linkagesbetweenprojectexpendi-
featuresof the utilitysector;associatedissuesinclude: tures and thegovernment'saccountingsystem;
• Foreignexchange movements in local currency * Identificationand linkageof projects expenditures
which could have significanteffect on indebted- and physical
r nforsation requiredfor perfo;mance
ness, and on operating costs for raw materials, indicators;
fuel, spare parts, and other inputs, and on export * Clear identificationof how the projects are fi-
pricesparticularlyfor the agri-businesssector. nanced whether through governmentbudget and
* Hyper inflationenvironmentrequiringthe revalua- expendituresystemor whetherseparatelyfinanced,
tion of assets which affect operatingcosts, and on includingthe identificationof counterpartand/or
export oriented activities which would affect in- donorfinancing;
come; * The consolidationof sub-project accounts where
* Separationof manufacturingand other production there are severalsub-implementingagencies;
costs fromoverheadcosts,and of fixedassets from * Accountingtreatmentof assets utilizedby the proj-
productionassets. ect:
The recordingand valuationof inventoriestaking * The requirementsof co-financingand /or donors,
into considerationnet realizablevalue of invento- whereapplicable;
ries (perishabilityin agri-business);
ries (prihailtyinagiusn* The segregationof recurringcost from investment
* The productioncycle, particularlyin agri-business cost;and
e.g. tree faruming.
 ANNExVI 77

* Any other additional issues which relate to the projects would have similar characteristics to those
specificsectors. discussedunder the financial sector. Some specific
characteristicsof agricultureare:

Agriculture * A long operating or productioncycle. Operating

cycles may range from a low of 6 months (where
7. The agriculturalsectoris composedof both there are two growing seasonsa year) to 6 years
revenueand nonrevenueearning entities.The revenue and more in the case of tree fiuming(citrusfruits,
earningentitiesare coveredin the discussionon Indus- for example).
try and Agri-Business(para 5). Amongnonrevenue
projects, such as research, technical assistance and * Agriculturalprojects use net realizableworth or
extensionprojects, accountingrequirementswould be lowerof cost to value agriculturalproducts.
similar to those discussedabove. Agriculturalcredit * Seasonalaspects and perishabilityof production.
78 ANNEXVI

NOTES
 ANNEXVII 79

TM REVIEWOF STATEMENTS
OF EXPENDITURE

T.heTM shoulduse the followingas a guideand may 4. Foreachexpenditure,performthefollowing:

omnitsome procedures he/she considers unnecessary (a) Evaluatethe adequacyof the supportingdocumen-
after consultationwith an Accountig and Auditmg tation wich should normallyiclude one or more
Professional. of the following:

1. Through
1. discussion
iscusion with
Though wth borrower staff, ob-
borowerstaff ob- * procurement docurnents (bid documents, invitation,
tain an understandmgand document(or update pervi- eapro n ado
ous documentationof) the processand relatedcontrols evaluation,award
by which expendituresare committed,reviewed,ap- * purchaseconract
proved,paid, and identifiedfor inclusionin loan with- a purchaseorder
drawalapplications.
* Ietterof credit

2. Considerthe effectivenessof the following * supplier's invoiceand certificateof origin

controls and document any instances where controls * shippingor import documentsand inspectioncer-
are lackingor are consideredin needof strengthening: tificates
* Appropriatelevels of review and approval are in * contractor'sinvoicesor certificates
place and are followedfor each stage of the ex-
penditureprocess. * other evidenceof receiptof goodsor services
* Proceduresand responsibiliticsare clearly defined * force accountrecords
and are adequatelydocumented. * recurrentcost records
* Adequatesegregationof duties exists betweenthe * authorizationfor payment
initiation,authorization,disbursement,and record-
ing functions. * evidenceof payment/bankstatements
* Authorizationand approval is obtained prior to * accounting records of approvals, disbursements,
incurringof the expenditure. and balances available
* Documentationis maintainedfor an adequatepe- * evidencethat refundshave beenmnadeby suppliers
riod of time for purposes of fulfillingaudit ro and correspondingadjustmentsmadein subsequent
quirementsas wellas reviewby Bank staff. applicationsin instances where goods have been
returned.
* Commitmnents are made after applicable proce-
dures havebeenfollowed.
(b) Ascertain that the expenditure was properly
authorizedand approved.
3. Obtaina listingof all SOEs submittedduring
the period under reviewand for selectedSOEs from
this listing, and have borrower staff retrievethe sup- (c) Verify that the expenditureis eligible for Bank
portingdocumentationfor the expenditures. disbursementunder the loan agreements. Ineligi-
ble expenditureswouldinclude:
80 ANNExVII

* duplicateinvoices; paymentsfor itemson the negativelist or not

*paymentsmade in advance of receipt of good or on the positivelist (for adjustmentoperation
delivery of services, unless these payments are lending).
consistentwith contract provisionsand are estab-
lishedcommercialpractice; (d) Verifythe mathematicalaccuracyof the SOE.
* paymentsthat should have been made under nor- (e) Agreethe percentageused to determinethe Bank's
mal disbursementprocedureswith full documenta- share of the total disbursements to the loan
tion (eg paymentsagainst contracts subject to the agreements.Verify that the proper amount was
Bank's prior review,or paymentsagainstcontracts requestedfor reimbursement.
with valuesexceedingdefinedSOE limuts;and
(f) Summarizethe results of the workperformedon a
* paymentsfor itemsthat are not procuredin accor- summaryform.
dancewith the legalagreements,such as:
(g) Notify borrowerof all instancesof negativefind-
0 paymentsfor items from countriesthat are ings
not eligible under the Bank's Procurement
Guidelines;
0 paymentsfor itemsnot specifiedin the pro- 5. Where appropriate and practical, consider
curement; physicallyobservingsignificantitems purchasedon a
test basis to confirm their existence.
0 paymentsmade prior to loan signingor be-
fore the eligible date specified for retroactive
financing;
 ANNEX
VIII 81

USEOF FINANCIALINFORMATION
TO MONITORPHYSICAL
PROJECTIMPLEMENTATION

Need for FinancialInformation Major methods to monitor project performance

Project Managers need to have accurate, timely and * Key Factormonitoring
reliablefinancialinformationnot only to evaluateper- Vanc
. Analysis
formancebut more importantlyto help dynamicprob-
lem solving by anticipatingthe latent problems and * FinancialAnalysisand Projection
risks at differentsteps of project implementationin a Key FactorAnalysis
dynamicsocial,economic,and financialenvironment.
Financial informationon project implementationbe- Key Factoranalysisis an inexpensiveway of providing
comes of prime importancewhen there exists an en- a simpleindicatorof projecthealthand of potentialand
demic inadequacyof managerialinformationsystems actual problems. The majorityof projectshave a few
in the borrowingdevelopingcountry factorswhoseperformanceis a very sensitiveindicator
of overall project performance. Such factors are des-
Use Financialinformationto: ignated as key factors. Key factor variance ranges
Ongoingprojects may be set up for eachproject for everystep of project
implementationand at the time of commitmentto the
* Evaluateproject implementationstatus project; and key factor varianceanalysis is regularly
* Analyze the variance of projects costs against carried out by the project managerto monitorproject
budgetand by sector implementationperformance. Any major variance
from key factor tolerancelimits is an indicatorof ac-
• Identifyend-useof resourcesused tual or potentialproblemsand shouldbe investigated.
* Identifyand anticipateproblemsand risks If major varianceis a reason for unavoidablecircum-
stances, and cannot be corrected, key factor variance
* Decidenecessarymodificationsto projectdesign tolerancelimitfor futureproject implementationstages
- Reassessproject objectivesin light of experience shouldbe changedaccordingly.
and new developments Examnplesof Kea Factors
* Reallocateresources At theproject implementationstage:
Ex-post * In the EnergySector,key factorsmay be - for an
* Analyzeproject objectivesvariance hydro-electricproject - percentageof completion
per dollar of resourceinput, which may vary ac-
* Identifyproject features that should be replicated cordingto the stageof completionof the project.
and pitfallsto be avoided
* In the AgriculturalSector - for an irrigationproj-
* Identifypotential for improvementthrough hind- ect - S cost incurredper canal milemay be the key
sight factor.
* In the EducationSector - for a primaryeducation
project - cost incurredper 1,000pupils at educa-
tion facilitymay be the key indicator.
82 ANNEXVIII

At theex-postperformanceevaluation: * electricalsystems
In the EnergySector,key factorsmay be: * soil analysis
* kilowatt-hourper dollar of resourceinput, where * dredgingexpenses
resourceinputcan be;
*educationof farmers
* replacementprice of a non-renewableresource
(likecrudeoil); * relocationcost of displacedfarmers
* socio-economiccost of displacementof people;
and/or FinancialAnalysisand Projection
* environmentaldamage resulting from the con- This is the most extensiveand forward-lookingmethod
structionof a hydro-electricalgenerationstation in monitoringprojects, and should be used as a com-
VarianceAnalysi-s plementto the other methods. The aim is to analyze
the currentperformancedata of project implementation
Variance analysiswith plan is the most widelyused and forecast the expectednext steps to completethe
methodof using financialinformationto measureproj- project. Potentialproblemsbecomemore evident,and
ect implementationand ex-postproject performance;it optionalsolutionssurface.
requiresa more extensivemonitoringsystem than the Sourcesof FinancialInformation
key factor analysis method. Actual expenseand per-
formanceis comparedwith the plan, to identifyactual * cost accountingdata of the project
and potential problems by expense category. Any * balance sheet, incomestatement,and sources and
varianceis investigated,and if it is justified, the plan is useshet indsstatement,and sources ata
revised to take the variance into account for future
analysis. * financial analysis carried out during project
For an irrigation project, for example, the expense analysisat the time of commitment
categoriesmay be: * social, financialand economicdate from the bor-
* canal building rower/country
* instllation of pump sets
 ANNEXIX 83

FORMLETTER

Annual Reminderto Borrower of Requirementto Appoint Auditors

(for audits by prvate firmsonly)

Send before end of each year

re: Loan/Credit

Dear

This is to remindyou that the Bank's Guidelinesregardingindependentaudits

recommendthat the auditor be appointedbeforethe beginningof eachyear.

Please notify us of the name of the firm and whether the same firm,
, has been appointed to perform the annual audit for
If not, please furnishnames of firmsbeing consideredand the other informationset out in
Guidelines, paragraphs , so that this may be reviewed and communication made
to you regardingacceptabilityin timeto appointthe auditorbefore the start of the new year.

Sincerelyyours,
84 ANNEXIX

FORM LETTER

Reminder to the Borrower of Requirementfor Timely Submission of Report

Send before end of each year

re: Loan/Credit

Dear :

Thisis to remindyou that the annualauditof pur-

suantto the aboveindicatedLoanAgreementis requiredto be submittedto the Bank no
laterthan accordingto Section of the Loan/CreditAgree-
ment.

We appreciateverymuchyourremindingthe auditorsof theirneedto beginthe

planninginterimand year-endauditworkin sucha wayas to ensurecompliance with this
requirement.Pleaseadviseus directlyif youcontemplateanydifficulty
in compliance.

Thankyou foryourcooperation,

Sincerelyyours,
 ANNEX IX 85

Noticeto Borrowerof Failureto ReceiveAuditReport

Send 1st day after deadline has passed

AUDIT REPORT REQUIRED BY SECTION

LOAN/CREDIT AGREEMENT NO HAS NOT BEEN
RECEIVED AS AT . PLEASE ADVISE STATUS
BY RETURN TELEX. REGARDS

(Note: If not answered or answered unsatisfactorilysubsequent telex should be more

forcefuland shouldbe sent at least every15days.)
86 ANNEX IX

NOTES
 ANNEX IX 87

Acknowledgment of Audit Report

Send to the borrowerimmediatelyupon receipt of auditedfinancial statements

re: Loan/Credit_
Dear

We acknowledge the receipt of the audited financial statements of

as required under the above indicated
Loan/CreditAgreement.

We will review it within the next few days and if we have any commentsor
questions,we willcommunicateaccordingly.

Thankyou for your cooperation.

Sincerelyyours,

or

Dear

We acknowledge the receipt of the audited financial statements of

for the fiscal year end December, l9xx.

We will review it and if we have any comments,we will communicatewith

you accordinglyas soon as possible.
Sincerelyyours,
88 ANNEX IX

NOTES
 ANNEXX 89

GUIDELINESFORTHE DESKREVIEWOF
AUDITREPORT

1. The followingGuidelinesare for the DeskReviewof theaudit report (financialstatementsand audit

opinion)receivedby the Bank. However,it is importantto understandthat theseguidelineswill not cover
all the scenariosand that the TM shouldseekthe assistanceof a professionalaccountantwheneverconsid-
ered necessary. For example,the reviewof the financialstatementsof a revenueearning organizationis
muchmoreinvolvedthan the reviewof a simpleprojectfinancialstatementinvolvingthe Receiptand Ex-
penditureof fundsonly.

Background

2. Obtainfrom LOALAthe Loan balanceof the project as at the report date, with a printoutof dis-
bursernentsa monthbeforeand afterthe reportdate of the financialstatements(e.g December31 for the
year endedon that date).

3. Note dateof the receiptof the reportand ensurethat an acknowledgmentis sent to the borrower.

4. Comparethe nameof the auditorwith that agreedby the Bank. The acceptabilityof the auditorin-
cludingqualifications,independenceand competenceshouldhave been agreedfrom the time of appoint-
ment.

5. Ascertainthat the reportreceivedcompareswith that requiredby the Loan covenantsi.e organiza-

tion (entity)financialstatements;project financialstatements;separateSOE financialstatements;special
accountfinancialstatements.

6. Ascertin from the Loan Agreementand the Terms of Reference(TOR), which shouldhave been
givento the auditor,those financialcovenantsthat shouldbe coveredunder the audit, and any special re-
quirementsuchas those that may requireverificationfor compliance.
90 ANNEx X

Review of The Audit

7. The audit opinionshouldbe signedby the auditorand dated on the letter head of the audit firm or
on papershowingthe nameand addressof the auditor.

8. The audit reportshouldbe addressedto the borrower(implementingagency).

9. Ascertainif the audit opinionis unqualified,qualified,adverseor is a disclaimer(seeAnnexXX).

10. The audit opinionshouldshow what accountingprincipleshavebeen appliedin the presentationof

the financialstatements(usuallygenerallyacceptedaccountingprinciplesor it may say internationalac-
countingstandards). The Bank's CountryDepartmentshouldhave already been aware of what are the
generallyacceptedaccountingprinciplesof the borrowerand their acceptabilityto the Bank.

11. The auditopinionshouldshowthe auditingstandardsapplied(the Bank requiresinternationalstan-

dardson auditingor its equivalent).

12. Ensurethat thereis a definiteopiniongivenby the auditor. In manyaudit reports (particularlygov-

ernmentaudits),there is a long discussionof issueswithouta clear conclusionor opinionon the financial
statements. Recommendthe use of a managementletter(representationletter)for issuesthat are not suf-
ficientlyimportantto affect the true and fair view of the fls.

13. Reviewthe notes to the financialstatementsand the managementletter (whereavailable)to ascer-

tain that there are no importantissuesthat wouldrequirea changein the opiniongiven. For example,the
notes and the managementlettermay indicatecircumstancesthat wouldrequirethat an unqualifiedopinion
be changedto that of a qualifiedopinion.

14. Where SOE proceduresare used, the opinionshouldhave a separate referenceto the use of SOEs
(see AnnexXX).

15. Where SpecialAccountsare integratedin the Projectf/s, the opinionshouldhave a separate refer-
enceto the use of the SpecialAccount.

16. Wherethe TOR requiredcompliancetesting, ensurethat the audit has addressedthese in the opin-
ion, possiblythrougha separatereferenceto the verificationrequested.

17. Generally,concludewhetheror not the auditorhas performedreasonable.

 ANNEX X 91

Review of The Financial Statements

18. The auditormayhave donea goodjob but the reportdoes not havean unqualifiedopinion. In these
instancesit is importantto identifythe main reasons for the qualifications,adverseor disclaimeropinion
and to requireexplanationsand followup action,as necessary,fromthe borrower.

19. In reviewingthe reportthe Reviewershould:

* ensurethat the audit reportwas presentedboundwith all its sectionsidentified(opinion,balancesheet,

incomestatement,cash flow statement,notes to financialstatements).
* identifythe projectwherethe projectfls are an integratedpart of the entity fls.
* identifythe SOEBank withdrawalswherethe SOEfls is integratedin the project fls (as recommended
by the guidelines).
- identifythe linkagewith the SpecialAccountfls (usuallya separateaudit reportbut may be integrated
in the projectaccount).

20. Reconcilethe Bank's financingwith the audit report (usingthe Bank's printouts (from LOALA)
and the movementsthroughthe special accountwhere applicable).The cash flow statement(sourcesand
applicationof fund statement)willbe useful in this review.

21. Where interimunauditedfls were received- comparethe report to identifyany significantdiffer-

encesin trends betweenthe unauditedand auditedreportsand requestfromthe borroweran explanationof
significantchanges.

22. Reviewthe contentsof the financialstatementin total to ascertainthe performanceof the organiza-
tion and/or the projectand compareit withthe SAR or budgetfor the periodunder review. The notes and
managementletterusuallyprovidesa wealthof information.Theborrowershouldbe asked to explainany
significantvariationsto the resultsexpected.

23. The receipt of the report and the results of the review should be entered into the ARCS.
92 ANNEx X

NOTES
 ANNX XI 93

THE ELEMENTSOF FINANCIAL STATEMENTS

(Summarizedfrom IASC'sFrameworkfor the Preparation
and Presentationof FinancialStatements)

Financial statements portray the financial * current liabilitiesmight include bank loans and
effects of transactions and other events by grouping overdrafts,the short-termportion of long-termli-
them into broad classes according to their economic abilities,and payables
characteristics. These broad classes are termed the
elements offinancial statements. The presentation of
these elements in the balance sheet and the income * long-term liabilitiesmight include the long-term
statement involves a process of sub-classification. portion of loans, provisions, deferredtaxes, and
Elements may be classified by their nature or function deferredincome
in the business of the enterprise in order to display i ht include the various classes of share
information in the manner most useful to users for a equity pid inncapt revalaions
clsps, o re-
purposes ofmaking economic decisions. capital, paid in capital, revaluation surplus, re-
serves,and retainedearnings.
Cash Flow Statement
FinancialPosition--TheBalanceSheet Information about the cash flows of an
The elementsdirectly relatedto the meas- enterprise is useful in providing users of financial
urements of financial positions are assets, liabilities, statementswith a basis to assesthe abilityof the enter-
and equity. Theseare definedas follows: prise to generate cash and cash equivalentsand the
* An asset is a resourcecontrolledby the enterprise needs of the enterpriseto utilize those cash flows. It
as a result of past events and from which future also enhances the comparabilityof the reporting of
economicbenefits are expectedto flow to the en- operatingperformanceby differententerprisesbecause
terprise. it eliminatesthe effects of using different accounting
treatmentsfor the sametransactionsand events.
* A liability is a presentobligationof the enterprise The cash flow statementshouldreport cash
arisingfrompast events,the settlementof which is flowsduring the period classifiedby operatinginvest-
expectedto result in an outflowfrom the enterprise ing and financing activities. Further discussionof
of resourcesembodyingeconomicbenefits. each of these classesof cash flowsappearsbelow:
* Equity is the residualinterest in the assets of the
enterpriseafter deductingall its liabilities.
Classificationof items in the balance sheet 1. Operating Activities The amount of cash flows
shouldbe made in such a way as to be meaningfulto ansing from operating activities is a key indicatorof
the users of the financial statements. The following the extent to which the operations of the enterprise
represent some typical items which should be consid- have generatedsufficient cash flows to repay loans,
ered for separatedisclosurein the balancesheet: maintainthe operatingcapabilityof the enterprise,pay
dividendsand make new investmentswithoutrecourse
* segregationof current assets and current liabilities to extemal sources of financing. Examples of cash
from long-termassets and long-termliabilities flowsfrom operatingactivitiesare:
* current assets might include cash, marketablese- * cash receiptsfromthe saleof goodsand the render-
curities,receivable,and inventories ing of services
94 ANNEXXI

* cash receipts from royalties, fees, commissions, * cash proceeds from issuing debentures, loans,
and other revenuescash paymentsto suppliers for notes, bonds, mortgages,or other short or long-
goodsand services term borrowing
* cash paymentsto and on behalfof employees * cash repaymentsof amountsborrowed
* cash receipts and cash paymentsof an insurance * cash paymentsby a lesseefor the reductionof the
enterprisefor premiumsand claims, annuities,and outstandingliabilityrelatingto a financelease
otherpolicybenefits Financial Performance-Tlhe Income Statement
* cash payments or refunds of income taxes unless Profit is frequently used as a measure of
they can be specificallyidentifiedwith financing perforrnanceor as a basis for other measures,such as
and investing activities return on investmentor earning per share. The ele-
* cash receiptsand paymentsfrom contract held for ments directlyrelatedto the measurementof profit are
dealingor tradingpurposes incomeand expenses:theseare definedas follows:
2. InvestingActivities The separate disclosureof * Incomeis increasesin economicbenefitsduringthe
cash flowsarisingfrom investingactivitiesis important accountingperiod in the form of inflows or en-
because the cash flow representsthe extent to which hancementsof assets or decreasesof liabilitiesthat
expenditureshave been madefor resourcesintendedto result in increasesin equity,otherthan those relat-
generatefuture income and cash flows. Examplesof ing to contributionsfromequityparticipants.
cash flowsarisingfrom investingactivitiesare: Expensesare decreasesin economicbenefits dur-
* cash paymentsto acquire and cash receipts from ing the accountingperiod in the form of outflows
sales of property,plant and equipment,intangibles, or depletionof assets or incurrencesof liabilities
and otherlong-termassets that result in decreasesin equity, other than those
* cash paymentsto acquire and cash receipts from relatingto distributionto equityparticipants.
sales of equity or debt instrumentsof other enter- Incomeand expensesmay be presentedin the income
prises and interestin joint ventures statementin differentways so as to provide informa-
tionthat is relevantfor economicdecision-making.For
-- cash advancesand loansmadeto otherparties example,it is commonpracticeto distinguishbetween
* cash receiptsfrom the repaymentof advancesand those items that arise in the course of the ordinaryac-
loansmadeto otherparties tivities of the enterpriseand those that do not. Items
which should be disclosed in the income statement
* cash paymentsand cash receiptsfrom futures con-
tracts, forward contracts, option contracts, and iclude, but are not limitedto:
swapcontracts. * sales or other operatingrevenue
3. Financing Activities The separate dis- * depreciation
closure of cash flows arising from financingactivities interestincome
is importantbecauseit is useful in predictingclaimson
future cash flowsby providersof capital to the enter- * incomefrom investments
prise. Examplesof cash flows arising from financing * taxes on income
activitiesare:
* cash proceedsfrom issuing shares or other equity * unusualcharges
instruments * significantintercompanytransactions
* cash paymentsto ownersto acquire or redeemthe * net income
enterpriseshares
 ANNEXXII 95

SAMPLEOF PARTSOF FINANCIALSTATEMENTS

OF A PROJECTIMPLEMENTINGORGANIZATION

1. This sampleis to demonstratethe integrationof a World Bank-assistedProject's FinancialStatementinto

that of an ImplementingOrganization'sFinancialStatement.

2. The sample(pages 2-6) is based on a set of financialstatementspreparedby a borrower/countryfollowing

the UK stylepresentation.A SampleBalanceSheetand IncomeStatementof the sameentity followingthe US styleis
also attachedon pages 7-8.

3. Note 13 to the financialstatementsummarizesthe fixedassets of the organization:

a) Version1 (Page4) of this note showsseparatelythe Bank-assistedproject (calledthe Project). Fromthis

version,it is possibleto see how muchhas beenspentto date. The amountfinancedby the Bank wouldbe
agreedby the Auditor in the reconciliationof the loan (note 12 would summarizethe loans, showingthat
due to the Bank). In this version,no separate Project FinancialStatementmay be necessary. However,
otherexpenses,such as FinancialAssistance,wouldneedseparateidentificationin the Notes to the Finan-
cial Statement.

b) Version2 (Page 5) doesnot separatelyshow those assets of the Bank-assistedProject. In this version,a
separateAnnex(whichwouldneedto be referredto in the Auditor'sReport)wouldbe necessary.

4. Where a separate Project FinancialStatementis required- See page 6 for the Sample. This Financial
Statementwouldrequirea separateaudit report.

5. It is also suggestedthat, where practicable,the financialstatementsbe presentedfor submissionto the

Bank in both US$ and the local currency.
96 AN XEX
XII

ABC Power Company, Ltd. SAMPLE

BALANCESHEET Page2 of 8
As of June 30, 19XXand June 30, 19XY
(Indicatetype of currency.)

Notes 19XX 19XY

SHARECAPITAL 10 218,800 218,800

RESERVES 8 1.240.L0 955.8L0
SHAREHOLDERS'FUNDS 1,458.800 1,174,600
DEFERREDLIABILMES 11 50.000 76,600
LOAN 12 1.286,000 1.264.000

CAPITALEMPLOYED 2,794,800 2,515,200

Representedby:

FIXEDASSETS 13 2,965,000 2,556,700

CURRENTASSETS
Stocks 14 889,200 738,900
Debtors 15 776,000 595,900
Short term investments 85,700 2,000
Bank and cash balances 16 64.300 56.300
Subtotal:CurrentAssets 1,815,200 1,393,100

CURRENTLIABILITIES
Creditors 17 1,786.000 998,600
Taxation 6 10,800 50,800
Dividends- payable 4.000 3,200
- proposed 22,900 22,900
Loans repayablewithinone year 12 53,400 142,300
Deferred liabilitiesdue withinone year 11 26,800 26,800
BankOverdraft 16 81.500 190,000

Subtotal:CurrentLiabilities 1.985.4 1.434.6

NET CURRENTLIABILITIES (170,2001 (41L500)

NET ASSETS 2,794,800 2,515,200

The accountson this page and the pagesto followwere approvedby the Board
of Directorsand weresignedon its behalfby:

. Directors
 ANNEXXII 97

,SamTple

ABC Power Company,Ltd Page3 of 8

REVENUE ACCOUNT AND STATENIENTOF RETAINED
EARNINGS
For the Years Ended June 30,19XX and 19XY
(Indicate type or currency.)

June 30, June 30,

Notes 19XX 19XY

REVENUE 2.629,700 2,434,600

OPERATING EXPENSES 2 2.532,700 2,213.300

OPERATING INCOME 97,000 221.300

EXCHANGE LOSS 3 14,690 41,100

NET OPERATING INCOME 82,310 180,200

NET INTEREST EXPENSE 4 34.500 18.100

PROFIT BEFORE EXCEPTIONAL ITEM 47.810 162.100

EXCEPTIONALITEM 5 266.650 0

PROFIT BEFORE TAXATION 314,460 162.100

TAXATION 6 5,175 69.100

PROFIT AFTER TAXATION 309,285 93.000

RETAINED PROFITS

Prior year balance 479,040 438,840

Retained profit for the year 309.285 93,000
788,325 531,840

Less: Dividends declaired 7 24.800 24,800

Taxation equalization reserve 8 30,000 28,000
54,800 52,800

Retained profit carried forward (see Note below) 8 733.525 479,040

Note: Retained profit-carried-forwardis part of Reserves that would be detailed in Note 8.

 ABC PowverCompany. Ltd.

NOTES TO THE ACCOUNTS -Version I-

As of June 30, 19XX
(Indicatetypeof currency.)
13, FIXED ASSETS

Furniture,
Land and Buildings Transmission Lines Plant and Machinery Motor Equipment,
WB Project Other WB Project Other WB Project Other Vehicles and others Total
Cost
July 1, 19XY 30,000 709,000 127,000 1,511,800 32,500 478,600 206,600 314,950 3,410,450
Prior year adjustment 0 435 0 (680) 0 191 (1,235) (1,289)
Additions 10,000 105,327 50,410 36.190 17,500 48,200 75,100 81,500 424.227
Disposals - - - (865) - - (3,340) - (4,205)
June 30, 19XX 40,000 814,762 177,410 1,546,445 50,000 526,991 278,360 395,215 3,829,183

Depreciation
July 1, 19XY 2,500 88,170 27,500 355,760 5,500 198,300 128,150 138,300 944,180
Charge for the year 1.000 9,700 10.0W 50,400 2,200 16,000 24,600 23.700 137,600
On disposals - - (25) (775) - - (2,825) - (3,625)
June 30, 19XX 3,500 97,870 37,475 405,385 7,700 214,300 149,925 162,000 1,078,155

Net Book Value

June 30, 19XX 36,500 716,892 139,935 1,141,060 42,300 312,691 128,435 233,215 2,751,028

Add: Construction in
Progress l(o,0o0 15,0U0 37,500 94,000 0 57,472 0 0 213,972
TOTAL FIXED ASSEib 46.500 731,892 177,435 1,235.060 42,300 370,163 128,435 233,215 2,965,000

June 30, 19XY 27,500 620,830 99,500 1,156,040 27,000 280,300 78,450 176,650 2,466,270

Add: Construction in Progress 90,430 X

(1

00

Total at June 30, 19XX 2,556,700

* World Bank Project expenditures are summarized on Page 6.

 ALtI I'nwj1i
% Ciwir,myi. -t1.
NOTlS Tr 'IoIIE ACC(OUN'rS - Vcrsioni 2 -
As of Juie 30, 19XX
(Indicatc type (if curre:ncy.)

13. FIXED ASSETS Furniture,

Landanld Transmission Plantand Motor Equipment,
Buildings Lines Machincry Vehicles an(dothers Total
Cost
July 1, 19XY 739,000 1,638,800 511,100 206,600 314,950 3,410,450
Prior year adjustment 435 (680) 191 - (1,235) (1,289)
Additions 115,327 86,600 65,700 75,100 81,500 424,227
Disposals - (865) - (3,340) - (4,205)
June30, 19XX 854,762 1,723,855 576,991 278,360 395,215 3,829,183

Depreciation
July 1. 19XY 90.670 383.260 203,800 128,150 138,300 944,180
Charge for lheyear 10,70(0 60,400 18,200 24,600 23,700 137,600
On disposals - (800) - _(2,825) - (3,625)
June 30, 19XX 101,370 442,860 222,000 149,925 162,000 1,078,155

Net Book Value

June30, 19XX 753,392 1,280,995 354,991 128,435 233,215 2,751,028

Add: Construction in Progress 25,000 131,500 57,472 _ - 213,972

TOTAL FIXED ASSETS 778,392 1,412,495 412,463 128,435 233,215 2,965,000

June 30, 19XY 648,330 1.255,540 307,300 78,450 176,650 2,466,270

nX

Add: Construction in Progress 90,430 01

Total at June 30, I')XX 2,556,700 vo

100 ANNEXXII

Sample
Page 6of 8
ABC Power Company, Ltd.
Expansion Project - World Bank Loan No. 99999
Project Expenditures and Financing as of .Tune30. 19XX
(Indicate type of currency.)

Current Period Cumulative

Actual Budget Actual Budget

EXPENDITURES

Civil Works:*

Loodney Power House 35,000 42,000 133,000 152,500

Glasney Power House 25,410 21,000 84,410 89,000

Subtotal: Civil Works <Page 4> 60,410 63,000 217,410 241,500

Plant and Machinery:

Loodney Power House 10,000 10.000 28,000 39.500

Glasney Power House 7,500 7.500 22,000 26,500

Subtotal: Plant & Mach. <Page 4> 17.500 17,500 50,000 66.000

Technical Assistance:

Consultants - Institutional Dev 9,500 10.000 19,500 29,000

TOTAL EXPENDITURES 87,410 90,500 283,910 336,500

FINANCING
55,600 54,300 180,000 201,900
World Bank 17,700 18,100 60,000 67,300
Central Govt. Loan 14,110 18,100 43,910 67,300
Company Resources

TOTAL FINANCING 87,410 90,500 283,910 336,500

lncludes
I land, buildings, and transmission lines <World Bank Project on Page 4>.

Land & Buildings 10,000 40.000

Transmission Lines 50.410 177.410
60,410 217,410

This Annex, Project Financial Statement, is required as an annex to the organization's financial statements where
project cannot be identified (version 2). In version 1, this may not be needed.
 ANNEX XII 101

U.S. Model
ABC Power Company, Ltd.
BALANCESHEET Sample
As of June 30, 19XX and June 30, 19XW (preceding year) Page 7 of. 8
(Indicate type of currency)

June 30 June 30
Notes 19XX 19XW
ASSETS
Current Assets (A)
Cash 16 64,300 56,300
Stocks 14 889,200 738,900
Short term investments 85,700 2,000
Accounts Receivable (net of allowances) 1 776,000 595,900
Total Current Assets 1,815,200 1,393,100

Fixed Assets (net of depreciation) 13 2,965,000 2,556,700

TOTAL ASSETS 4,780,200 3,949,800

LIABILITIESAND STOCKHOLDER'SEQUITY
Current Liabilities (A)
Accounts Payable 17 1,786,000 998,600
Taxes Payable 6 10,800 50,800
Dividends- Payable 4,000 3,200
- Proposed 22,900 22,900
Loans Payable 12 53,400 142,300
Deterred Liabilities 11 26,800 26,800
Bank Overdraft 16 81,500 190,000
Total Current Liabilities 1,985,400 1,434,600

Long-term Debt (A)

Loans Payable 1,286,000 1,264,000
Deferred Liabilities 50,000 76,600

TOTAL LIABILITIES 3,321,400 2,775,200

Stockholder's Equity
Common Stock 18 218,800 218,800

RetainedEarnings 733,525 479,040

Reserves 3 506,475 476,760
Subtotal 1,240,000 955,800

TOTAL STOCKHOLDER'SEQUITY 1,458,800 1,174,600

TOTAL LIABILITIESAND STOCKHOLDER'SEQUITY 4,780,200 3,949,800

102 ANNEXXII

U.S. Model
ABC Power Company, Ltd.
STATEMENT OF INCOMEANDRETAINEDEARNINGS Sample
For the years ended June 30, 19XX and June 30, 19XW (preceding year) Page8 of 8
(Indicate type of currency)

June 30 June 30
Notes 19XX 19XW
STATEMENTOF INCOME:
Revenue 2,629,700 2,434,600
Operatingexpenses 2 2,532,700 2,213,300
Income from operations 97,000 221,300
Other income/(expense):
Exchangegain/(loss) 3 (14,690) (41,100)
Interest expense 4 (34,500) (18,100)
Total other income/(expense) (49,190) (59,200)

Income from operations before income taxes 47,810 162,100

IncomeTaxes 6 5,175 69,100
Income before extraordinaryitem 42,635 93,000
Extraordinaryitem - gain/(loss) net of tax 5 266,650 0
Net income 309,285 93,000

STATEMENTOF RETAINEDEARNINGS:
Retainedearningsat beginningof year 479,040 438,840
Add:
Net income 309,285 93,000
Subtotal 788,325 531,840

Less appropriations:
Dividendsdeclared 24,800 24,800
Taxes 30,000 28,000
Total appropriations 54,800 52,800

Retained earnings at end of year 733,525 479,040

 ANNEXXIII 103

SAMPLEOF PROJECTFINANCIALSTATEMENT
with SOE integrated
1. This samplesummarizesProjectexpendituresby main disbursementcategorieswith sub-headings.It may
also be summarizedby ProjectActivities,as per the SAR, whichevermaybe preferred. To demonstrate:-

Land Development heading

Civilworks sub-heading
Earth works sub-heading
Structureand building sub-sub-heading
Landcosts sub-heading
Equipment sub-heading

2. In addition,the financingof the Projectis summarizedto agree with the total Projectcosts.
3. Expendituresand Financingare summarizedby:
* Budgetor Plan for the periodand accumulatedto date;
* Actualfor the periodand accumulatedto date;
* VariancebetweenBudgetor Plan and Actualfor the periodand accumulatedto date.
4. Investmentcosts are separatedfrom recurrentexpenditures.
5. BalanceSheet This is requiredwherethere are assets and liabilities. However,in most governmentproj-
ects,expendituresare financedthroughthe budgetand operateon a cash basis. Whereaccrualaccountingis followed,
a balancesheetis essential. Whetherthe cash or accrualbasis of accountingis followed,a recordshouldbe kept of all
the fixedassets (vehiclesand equipment)requiredfor project implementation.This may form a listingto be addedto
the SummaryProjectExpenditures.
6. SOEs The SOE expendituresshouldbe integratedin the Project Financial Statements. Total financing
will show "Loan from Bank/IDA-- via SOE procedures",and the expenditureswould be incorporatedinto the head-
ings/sub-headingsas necessary. An Annexsummarizingwithdrawalapplicationsas in Page 3 wouldfacilitateagree-
mentwith the Bank's record.
7. Wherethe TM considersit necessary,or wherethe SOE (for someexceptionalreason) is separatelypre-
sented,thenthe withdrawalsshouldbe extendedto showthe categoriesof expenditures;see Page 3.
8. SpecialAccount Wherethe SA is usedto directlypay project expenditures,the SA may also be integrated
intothe ProjectFinancialStatements.In theseinstances,the SA FinancialStatementwouldbe attachedas an Annex.
The amountshown in the ProjectFinancialStatementas beingfinancedby the Bank would correspondwith that pro-
videdthroughthe SA, with a reconciliationprovidedwherenecessary.
9. The Audit Reportwouldalso includea sentenceto coverthe auditof the SA (see ChapterV of Handbook).
 104 ANNEXXIII

XYZ Project Financial Statement Sample

Summary of Sources and Uses of Funds Page2of5
as of June 30, 19XX
(Indicate type of currency)

Actual Budget (SAR) Variance

YTD Cumulative YTD Cumulative YTD Cumulative
FINANCING:
Loan from Bank/IDA
Direct Payment 10,000.00 15,597.84 13,000.00 19,500.00 (3,000.00) (3,902.16)
(A) SOE Procedures 5,000.00 10,900.00 3,000.00 8,000.00 2,000.00 2,900.00
Central Government 6,007.60 7,500.00 3,500.00 8,000.00 2,507.60 (500.00)
Provinces 3,300.00 5,360.00 2,500.00 8,000.00 800.00 (2,640.00)
Prefecturesand Counties 3,000.00 5,500.00 1,000.00 10,850.00 2,000.00 (5,350.00)
Farmers (cash or labor) 2,500.00 4,440.00 800.00 6,000.00 1,700.00 (1,560.00)

TOTALFINANCING 29,807.60 49,297.84 23,800.00 60,350.00 6,007.60 (11,052.16)

PROJECTEXPENDITURES (B):
Land Development 11,303.34 19,603.34 13,200.00 23,050.00 (1,896.66) (3,446.66)
ConservationEngineering 5,407.21 9,707.21 2,775.00 10,400.00 2,632.21 (692.79)
Forest Development 9,640.70 13,940.70 4,500.00 20,500.00 5,140.70 (6,559.30)
Processing 833.13 1,613.68 600.00 1,550.00 233.13 63.68
Support Services 854.22 1,603.68 800.00 1,550.00 54.22 53.68
Institutional Development 1,276.99 1,829.23 1,450.00 2,300.00 (173.01) (470.77)
Recurrent Costs 492.01 1,000.00 475.00 1,000.00 17.01 0.00

TOTALPROJECTEXPENDITURES 29,807.60 49,297.84 23,800.00 60,350.00 6,007.60 (11,052.16)

Notes:
(A) Refer to Annex XilI, page 5 for SOE withdrawalscheduleformat.
(B) Expenditurebreakdowns representmain disbursementcategories as identified in the SAR.
Refer to Annex Xill, page 3 for a detailed breakdownof each category.
 ANNEX XIII 105

XYZ Project Sample

Expenditure Detail Page 3 of 5
as of June 30, 19XX
(Indicate type of currency)
Actual Budget (SAR) Variance
YTD Cumulative YTO Cumulative YTO Cumuiative
INVESTMENTCOSTS (Al
LandDevelopment
(B1 Civil Works 8,730.14 14,230.14 10,000.00 17,050.00 11,269.86) (2,819.86)
Equipment 1,056.23 1,856.23 1,200.00 2,000.00 (143.77) (143.77)
Materials 1,516.97 3.516.97 2,000.00 4,000.00 (483.03) (483.031
Subtotal 11,303.34 19,603.34 13,200.00 23,050.00 (1.896.66i (3.446.66)
ConservationEngineering
Civil Works 2,563.23 4,563.23 300.00 4,400.00 2,263.23 163.23
Equipment 1,628.35 3,128.35 1,275.00 4,000.00 353.35 (871.65i
Maintenance 1,215.63 2,015.63 1,200.00 2,000.00 15.63 15.63
Subtotal 5,407.21 9,707.21 2,775.00 10,400.00 2,632.21 (692.79i
Forest Development
Equipment 5,632.98 7,632.98 2,000.00 11,000.00 3,632.98 (3.367.02)
Materials 2,649.31 4,149.31 1,500.00 4,500.00 1,149.31 (350.691
Training 1,358.41 2.158.41 1,000.00 5,000.00 358.41 (2,841.591
Subtotal 9,640.70 13,940.70 4,500.00 20,500.00 5,140.70 (6.559.30;
Processing
Equipment 415.23 638.95 300.00 600.00 115.23 38.95
Materials 105.32 268.48 100.00 250.00 5.32 18.48
Training 312.58 706.25 200.00 700.00 112.58 6.25
Subtotal 833.13 1,613.68 600.00 1,550.00 233.13 63.68
Support Services
Equipment 212.35 314.23 100.00 350.00 112.35 (35.77)
Technical Assistance 641.87 1,289.45 700.00 1,200.00 (58.13) 89.45
Subtotal 854.22 1,603.68 800.00 1,550.00 54.22 53.68
Institutional Development
Equipment 312.78 516.78 500.00 800.00 (187.221 (283.22i
Technical Assistance 964.21 1,312.45 950.00 1,500.00 14.21 (187.551
Subtotal 1,276.99 1,829.23 1,450.00 2,300.00 1173.011 (470.77)
TOTAL INVESTMENTCOSTS 29.315.59 48,297.84 23.325.00 59,350.00 5,990.59 (11.052.16)

RECURRENT COSTS
Salariesand Wages 278.56 500.00 275.00 500.00 3.56 0.00
Repairsand Maintenance 213.45 500.00 200.00 500.00 13.45 0.00
TOTALRECURRENTCOSTS 492.01 1,000.00 475.00 1,000.00 17.01 0.00
TOTALPROJECTEXPENDITURES 29.807.60 49,297.84 23,800.00 60,350.00 6,007.60 (11,052.16)

SUMMARYBY SUB-CATEGORY(8):
INVESTMENTCOSTS
Civil Works 11,293.37 18,793.37 10,300.00 21,450.00 993.37 12.656.63)
Equipment 9,257.92 14,087.52 5,375.00 18,750.00 3,882.92 (4.662.48i
Maintenance 1,215.63 2,015.63 1,200.00 2,000.00 15.63 15.63
Materials 4,271.60 7,934.76 3,600.00 8,750.00 671.60 (815.24)
Technical Assistance 1,606.08 2,601.90 1,650.00 2,700.00 143,921 198.101
Training 1,670.99 2,864.66 1,200.00 5,700.00 470.99 (2.835.341
TOTALINVESTMENTCOSTS 29,315.59 48,297.84 23,325.00 59,350.00 5.990.59 (11,052.161
RECURRENT COSTS
Salariesand Wages 278.56 500.00 275.00 500.00 3.56 0.00
Repairsand Maintenance 213.45 500.00 200.00 500.00 13.45 0.00
TOTAL RECURRENT COSTS 492.01 1,000.00 475.00 1,000.00 17.01 0.00
TOTAL PROJECTEXPENDITURES 29,807.60 49.297.84 23,800.00 60,350.00 6,007.60 11,052.16)

Notes:
(A) Investment cost categories are broken down basedon main disbursement categoriesidentified in the SAR.
(fB May be further detailed in subsequent schedules(see Annex XIII, page 41.
 106 ANNEX XIII

XYZ Project Sample

Expenditure Detail - By Subcategory Page 4 of 5
as ot June 30, 19XX
(Indicate type of currency)

Actual Budget (SAR) Variance

YTD Cumulative YTD Cumulative YTD Cumulative
CIVIL WORKS (A):

Earth Works 2,348.96 3,568.97 3,500.00 4,500.00 (1,151.04) (931.03)

Structure and Building 5,680.00 6,512.38 4,600.00 8,000.00 1,080.00 (1,487.62)
Land Costs 3,264.41 8,712.02 2,200.00 8,950.00 1,064.41 (237.98)

TOTALCIVILWORKS 11,293.37 18,793.37 10,300.00 21,450.00 993.37 (2,656.63)

Notes:
(A) This one category is shown for example purposes only.
 ANNEx XIII 107

EXAMPLE OF SOE WrTHDRAWAL SCHEDULE Sample

Page 5 of 5
XYZ Project
SOE Withdrawal Schedule
For the current year through: June 30, 19XX
U.S. Dollars (may also show local currency)

Disbursement Category (A)

W/D Technical
Number Civil Works Equipment Assistance Materials Total
16 534.87 0.00 0.00 524.89 1,059.76

17 0.00 0.00 250.00 0.00 250.00

18 0.00 498.32 0.00 0.00 498.32

19 542.31 0.00 250.00 0.00 792.31

20 234.57 0.00 0.00 0.00 234.57

21 547.52 85.32 0.00 0.00 632.84

22 0.00 298.32 0.00 0.00 298.32

23 0.00 0.00 0.00 400.00 400.00

24 0.00 0.00 250.00 0.00 250.00

25 0.00 583.88 0.00 0.00 583.88

TOTAL 1,859.27 1,465.84 750.00 924.89 5,000.00

Note:
(A) Disbursement category as defined by loan/credit agreement.
108 ANNEx XIII

NOTES
 ANNExXIV 109

FORMATFORSPECIALACCOUNTSTATEMENT

For year ending 31 December, 19xx

Account No
Depository Bank [Foreign Commercial Bank]
Address
Related loan/credit LN

Currency US$
Initial deposit (mnm/dd/yy)

Add:
World Bank replenishments $
Total interest earnings (if deposited in account)

Deduct:
Direct payments for goods and $
SOE reimbursements -- to borrowers
Total service charges if not included above in
amount withdrawn

Ending balance (mm/dd/yy) $

Note: 1. Projectpayments(both direct and SOEreimbursements)should be compared and agreed to "Bank Financing," as
shownin the ProjectFinancial Statement.
2. Special accountfinancial statementis usually a separatereport. Howeverit is sometimestreated as a part of the
projectfinancial statements,particularlywherethe specialaccountacts as the bank accountof the project.
110 ANNEX XIV

NOTES
 ANNEXXV 111

ONAUDITING(ISA)
STANDARDS
INTERNATIONAL
SUMMARYANDPUBLICSECTORPERSPECTIVES
(Preparedas of July1994)

This Appendix is a summary of IFAC/IAPC ISAs I to ISA 2: Audit Engagement Letters

31 (July 1994). It should be noted that the summary Summary. An auditor's engagement letter to the client
of each ISA is not a substitute for the ISA itself is designed to document and confirm the auditor's
Reference should always be made to the text of acceptance of the appointment, the scope of the
Standards when seeking guidance. (Paragraph auditor's work, the extent of the auditor's
references pertain to those contained in the responsibilitiesand the form of any reports. The
applicable ISA.) Where no public sector perspective Standard describes the principal contents of an
is provided after the Summary of the ISA then the ISA engagement letter, and the appendix contains an
has the same applicability in the public sector as it example of a letter.
has for the private sector.
ISA 1: Objective and Scope of the Audit of ISA 3: BasicPrinciplesGoverninganAudit
FinancialStatements Summary. This Guideline describes the basic
Summary. The Guideline describes management's principles governing an auditor's professional
Summary.
The .Guideline
describes management's responsibilitieswhich shouldbe exercisedwheneveran
repsb'lhty for
responsibility financial statements
for financial statementsand
and the
the overall
overall resons
audit is carried out. The basic principles identified
objectiveand scope of the audit of financialstatements involve: integrity, objectivity and independence,
of an entityby an independentauditor. confidentiality,skills and competence,workperformed
PublicSectorPerspective.The objectiveand scopeof by others, documentation,planning, obtaining audit
an audit, whetherin the private or public sector, are evidence,reviewingaccounting systems and internal
detem-inedby the audit mandate. The audit mandateis control,reviewingconclusionsreached, and reporting.
usually based on the law, professionalstandards and These basic principles are the comerstone of all
auditee requirements. Audit mandates in the public succeedingInternationalStandardson Auditing.
sector may be more specific than those in the private
secto,encopass
andofte widr rane of PublicSector Perspective. Irrespectiveof whether
an audit is being conducted in the private or public
objectives and a broader scope than is usually sector, the basic principles of auditing remain the
applicable for the audit of private sector financial 'n.W
statements. ~~~~~~~~same.
What may differ for audits carried out in the
public sector is the audit objective and scope, and
Paragraph11or ISA I deals with the action a private certain judgments criteria for risk and materiality.
sector auditor may take when there are attempts to These differencesare often attributableto differences
restrict the scope of the audit. In the public sector a in the audit mandateand legal requirementsof the form
different approach may be needed. Specific of financial reporting;for example,audit mandatesin
requirementsmayexist withinthe legislationgoverning the public sector may be more specific than in the
the audit mandate; for example,the auditor may be private sector and public sector entities may be re-
required to report directly to a minister or the quired to prepare additional financial reports. Dif-
legislature if management (includingthe department ferences in audit approach and style may also exist.
head)attemptsto limitthe scope of the audit. However, these differences would not constitute a
differencein the basicauditingprinciples.
112 ANNEXXV

ISA 4: Planning procedures"in this Standardrefer to tests adoptedto

Summary. The guidance applies to the plannmng evaluateand determinewhetherthe internalcontrolson
process of the audit of both financial statementsand which relianceis to be placed are operatingeffectively.
otherfinancialinformation.It is framedin the context These procedures should not be confused with
of recurring audits, identifies key elements in the complianceaudits undertakenwith the publicsectorfor
planningprocess and provides practical examples of the purposeof establishingthe complianceby the entity
items which should be consideredwhen planning an rwith
legislation,ordinances,regulationsand ministerial
audit. Adequate audit planning helps to ensure that directives,includingthe probity of those dealingwith
appropriateattention is devotedto importantareas of publicfunds.
the audit, that potential problems are promptly ISA 7: Controlof the Qualityof AuditWork
identified, and that the work is completed Summary. Controllingthe quality of audit work is
expeditiously. Planning also assists in proper essential in maintaining the high standards of the
utilization of assistants and in coordinationof work profession. This Standard distinguishes between
doneby other auditorsand experts. controls on individual audits and general quality
ISA 5: Usingthe Workof Another Auditor controlsadoptedby an audit firm. While recognizing
Summary. The auditor's considerationto be made the interrelationshipof the two types of controls,
intending to use the work of another auditor are generally quality controls "augment and facilitate"
described. The guidanceapplies whenan independent controlson individualaudits but do not replace them.
Controls over delegationof work to assistanceon an
auditor reporting on the financial statementsof an idvda ui nodrt opywt h ai
entity uses the work of another independentauditor individualauditi order to comply with the basic
with respectto the financialstatementsof one or more auditing principles are addressed, and practical
divisions, branches, subsidiaries or associated assistance is providedto an audit firm in controlling
companiesincludedin the financial statementsof the the generalqualityof their practice.
entity. ISA 8: AuditEvidence
ISA 6: Study and Evaluation of the Accounting Summary: Audit evidenceis informationobtainedby
SystemandRelatedInternalControls in Connection the auditor in arrivingat the conclusionsupon which
with anAudit an opinionon the financialinformationis based. The
Summary.Managementis responsiblefor maintaining nature and sources of audit evidenceare describedas
an adequate accountingsystem incorporatingvarious well as the sufficiencyand appropriatenessof audit
internalcontrols to the extent appropriateto the size evidenceandthe methodsbywhichit isobtainedbythe
and nature of the business. However,the auditorneeds auditor m the performance of compliance and
reasonable assurance that the accounting system is substantiveprocedures.
adequateand that all the accountinginformationwhich PublicSector Perspective. When carryingout audits
shouldbe recordedhas, in fact, beenrecorded. Internal of public sector entities,the auditor will need to take
controlsnormallycontributeto such assurance. This into account the legislativeframeworkand any other
Standard describes accounting systems, elements, relevant regulations, ordinances or ministerial
objectivesand limitationsof internal control and the directives which affect the audit mandate and any
audit procedures for the study and evaluation of special auditing requirements. Such requirements
internalcontrol. might affect, for example,the extent of the auditor's
PublicSectorPerspective. In respect of paragraph discretionis establishingmaterialityand judgmentson
4 of ISA 6, the auditor should be aware that the the nature and scope of audit proceduresto be applies.
"Managementobjectives"of public sectorentitiesmay Paragrph 9 of this ISA has to be applied only afer
be influenced by concerns regarding public ac- giving consideration to such restrictions on the
countabilityand may include objectiveswhich have auditor'sjudgment.
their source in legislation, regulations, government
ordinances, and ministerial directives. "Compliance
 ANNEXXV 113

ISA 8: Addendum 1, Additional Guidance on is provided as to the procedures that should be

Observation of Inventory, Confirmation of consideredby the independentauditorin assessing the
Accounts Receivable and Inquiry Regarding work of the internal auditor.
Litigation and Claims ISA 11: Fraud and Error
Summary. Guidance is provided on the application of Summary. The Standarddefines fraud and error, and
audit evidence gathering procedures (attendance at indicates that the responsibility for the prevention of
stocktaking, direct confirmation of accounts receivable fraud and error rests with management. The auditor
and direct communication with a client's lawyers) that should plan the audit so that there is a reasonable
are generally accepted as providing the most reliable expectation of detecting material misstatements
audit evidence in relation to certain assertions. The esultin of derror. mate stepedes
Addenumoulinesthe
crcumsanceswhen hese resulting from fraud and error. Suggested procedures
are provided which should be considered when the
procedures should be applied and the matters to be auditor has an indication that fraud or error may exist.
considered in their implementation. Observation of An appendix sets out examples of conditions or events
inventory is required (unless impracticable) when * *
inventories are matenral to the financial statements in
order to secure evidence of the physical existence and ISA 12: Analytical Procedures
condition of inventory. Confirmation of accounts Summary. A description of the nature of analytical
receivable is required when accounts receivable are
material, and provides evidence of the existence of te obeties im andex of reliance ob
debtors and the accuracy of recorded balances. aed on such po duresn pforminanc audit
Guidance is given on the selection of accounts to be plso on such procedures in perfostig g an audnt.
confirmned, the use of positive and negative fluctuations.
confirmations and the use of alternative procedures
when confirmation is inappropriate or replies to ISA 13: The Auditor's Report on Financial
confirmations contain exceptions. Direct Statements
communication with the entity's lawyer is required Summary. Guidance is provided to auditors on the
when litigation or claims have been identified or are form and content of the auditor's report issued in
believed may exist. Guidance is given on the form and connection with the independent audit of the financial
content of the communication, and the need for the statements of an entitv. The Standard includes
auditor to consider meetings with the lawyer if matters suggested wording to express an unqualified opinion
are complex or there is a disagreement. and discusses circumstances that may result in other
ISA 9: Documentation than an unqualified opinion. An appendix sets forth
examples of an unqualified, and adverse auditor's
Summary. Guidance is provided on the general form rexporsan andnialofoinion.
and content of working papers as well as specific
examples of working papers normally prepared or Public Sector Perspective. While the basic principles
obtained by the auditor. Ownership and custody of contained in this Standard apply to the audit of
working papers is also discussed. financial statements in the public sector, the legislation
giving rise to the audit mandate may specify the nature,
content and form of the audit report. Readers should
Summary. The internal audit function constitutes a note that the ISA does not address is the form and
separate component of internal control undertaken by content of the auditor's report in circumstances where
specially assigned staff within an entity. An objective financial statements are prepared in conformity with a
of the internal auditor is to determine whether internal disclosed basis of accounting, whether mandated by
controls are well-designed and properly operated. legislation or ministerial ( or other) directive.
Much of the work of the internal audit department may
be useful to the independent auditor for the purpose of
his examination of the financial information. Guidance
114 ANNEXXV

ISA 14: Other Information in Documents relationships and transactions with such parties in
Containing Audited FinancialStatements accordancewith the provisionsof IAS 24.
Summary. This Standarddefines"other information" Public Sector Perspective. In applying the audit
as financialand non-financialinformationincludedin a principles in this Standard auditors should make
documentwhich contains an entity's audited financial reference to legislative requirements which are
statementstogether with the auditor's report thereon. applicable to public sector entities and employeesin
An entityusuallyissues such a documenton an annual respect of relatedparty transactions. Such legislation
basis which is frequentlyreferred to as the "annual may prohibit entitiesand employeesfrom enteringinto
report." In circumstances,the auditor has statutory transactionswith relatedparties. Theremay be also a
obligationto report on other informationand in other requirementfor public sector employees to declare
circumstances he has no such obligation. This their interestsin entitieswith which they transact on a
guidancediscussesthe auditor's considerationof other professionaland/or commercialbasis. Where such
informationon which he has no obligationto report legislative requirements exist, the audit procedures
and the actions he should undertake if a material wouldneedto be expandedto detectinstancesof non-
inconsistency or material misstatement of fact is compliancewith theserequirements.
discovered. Readers should note that while PSC Guideline 1
ISA 15: Auditing in a Computer Information indicatesthat all IASs apply to businessenterprisesin
Systems (CIS) Environment the public sector, IAS 24 does not require that
S2.ummary. Guidance is provided to auditors on the transactions between state controlled enterprises be
duditional
proceduresnecessaryto complywith ISA 3 disclosed. Readersshouldalso note that definitionsof
"Basic PrinciplesGoverningan Audit,"whenauditing relatedparties includedin IAS 24 and ISA 17 do not
in a CIS environment. The skills and competence address all circumstancesrelevant to public sector
required of the auditor are described as well as his entities. For example, the status for purposes of
responsibility when he delegates such work to application of ISA 17, of the relationshipbetween
assistantsor usesworkperformedby others. ministersand departmentsof state and departmentsof
state and statutoryauthoritiesof govermmentagencies
ISA 16: Computer-AssistedAudit Techniques is not discussed.
Summary. This Standard provides guidance to the ISA 18: Usingthe Work of an Expert
auditorwhen using computer-assistedaudit techniques SuThIs Stdd provides guidance to the
(CAATs) --particularlyaudit software and test data. auditor in instanceswhen using the work of an expert
The ISA outlinesinstanceswhen CAATsmaybe used, (specialist) engaged or employed by the client or
factors to consider in determiningwhether to use a auditor. The ISA outlinesexamplesof cases when an
CAAT and the major steps to be performedin CAAT auditor may need to use the work of an expert an
application. In addition, special considerationswhen provides guidance on considerationsrelating to the
using CAATs ei a small business computer expert's skills, competenceand objectivity. ISA 18
environmentare highlighted, outlines considerationsthat should be made by the
ISA 17: Related Parties auditor for communicatingwith the expert and offers
Summary. Discussedare proceduresto be considered specificguidanceon evaluatingthe workof an expert.
in obtaining sufficient appropriate audit evidence ISA 19: Audit Sampling
conceming the existence of, and transactions with, Summary. The factorsthat an auditor shouldconsider
related parties. This Standard is premised on the when designing and selecting an audit sample and
definition and disclosure requirements set out in evaluating the results of audit procedures are
IntemationalAccountingStandard(IAS) 24, "Related identified.The ISA appliesto both statisticaland non-
Party Disclosures." ISA 17 provides guidance to
assist auditors in determiningwhethermanagementof statisticalsamplingmethodsand providesfundamental
an entity has properly disclosed related party yet practical guidance on such matters as sampling,
 ANNEXXV 115

risk, stratification,selectionmethodsand projectionof representations for reasonableness and consistency

errors. with other evidence and other representations,and
ISA 20: The Effects of an EDP Environment on the consi'osder whether the individual making the
Study and Evaluation of the AccountingSystem and representationcan be expectedto be well-informed.
Related Internal Controls ISA 23: Going Concern
Summary. This Standard addresses the study and Summary. Guidance is provided to auditors in
evaluation of the accounting system and related dischargingtheir responsibilitiesin situationsin which
internal controls in an EDP environmentand is an the appropriatenessof the going concemassumptionas
extensionof the guidance containedin ISA 6, "Study a basis for the presentationof financialstatementsis in
and Evaluationof the AccountingSystemand Related question. The Standard notes that an entity's
Intemal Controls in Connectionwith an Audit" and continuance as a going concem is assumed in the
ISA 15, "Auditing in an EDP Environment." It absence of information to the contrary. If this
describes the common characteristics of an EDP assumptionis unjustified,an entity may not be able to
environment, including the factors that affect the realizeits assets at the recordedamountsand theremay
organizationand structure, nature of processing and be changes in the amount and dates of maturity of
design and procedural aspects of the system of liabilitiesresultingin the needfor financialstatements
accountingand intemal control and differentiatesand to be adjusted.
explainsthe interrelationshipof general EDP controls Public Sector Perspective. The appropriatenessof
(those that affect the EDP environment)and EDP the going concer assumption is generally not in
application controls (those that affect accounting questionwhen auditing either a central governent or
applications). those public sector entities having funding
ISA 21: Date of the Auditor's Report; Events After arrangements backed by a central government.
the Balance Sheet Date; Discovery of Facts After However, where such arrangementsdo not exist, or
the FinancialStatements Have Been Issued where centralgovernmentfundingof the entity may be
Summary .Guidance is provided on dating of the
Summary. Guidance is provided on dating of the
withdrawnand the existenceof the entity may be at
auditor's report;the auditor's responsibilityin relation nsk, theISA willprovidedusefulguidance.
to subsequent events, which are significant events ISA 24: Special Purpose Auditor's Reports
occurringafter the balancesheetdate; and the auditor's Summary This Standard provides guidance to
responsibilityin connectionw"iththe discoveryof facts auditors that issue audit reports that are other than
after the financial statementshave been issued. The those covered by ISA 13, notably, (A) fancial
Standarddescribesstepsthe auditorgenerallyperforms statements prepared in accordance with a
to identify subsequent events, responsibilities in
to 1 1 ~~~~~~~~~comprehensive
basis of accounting other tha
relationto eventsafter the date of the auditor's report interational accountingstandards or relevantnational
but before the financial statements are issued, and standards,(b) specificaccounts,elementsof accounts,
discovery of facts after the financial statements are
or items of financialstatements,(c) compliancewith
adisrsu A nappendixsetsthmanem contractualagreements,and (d) summarizedfinancial
statements. Appendicescontain illustrationsof special
ISA 22: Representation by Management purposeauditor's reports.
Summary. This Standard provides guidance to the ISA 25: Materiality and Audit Risk
auditor on using managementrepresentationsas audit Summary. This Standard defines the concepts of
evidence, procedures the auditor should apply in materiality and audit risk, their interrelationshipand
evaluatingand documentingthem, and circumstances t
in which writtenrepresentationsshouldbe obtained. It plninand conductingan audit and evaluatingthe
indicates that wth regard to representations for resultsof his procedures. Materialityis definedas the
materialfinancil statementmatters,the auditor should
seek corroborative evidence, evaluate the magnitudeor nature of a misstatementincluding an
116 ANNEXXV

omission of financial information either individually or ISA 28: First Year Audit Engagements--Opening
in the aggregate that, in the light of surrounding Balances
circumstances, makes it probable that, as a result of Summary. This Standard provides guidance as to the
the isstatement, the judgment of a reasonable person uditor's responsblities for opening balances when the
relying on the information would have been influenced anciastae arepbeiingladite
for thef tie
or his decision affected. The assessment of materiality I
is a matter of the auditor's professional judgment and or were audited by another auditor in the prior year.
Isamatteredat
bofthe
anoverall level Judg
iThe
and t ISA outlines the audit procedures by which
is considered at both an overall level and in relat o sufficent appropate audit evidence may be obtained
the individual account balances and disclosures. in
bot cicustnce t dene weh te opening
in both circumstances to deterrnine whether the opening
Public Sector Perspective. In assessing materiality balances were misstated, correctly brought forward or
the public sector auditor must, in addition to exercising restated and appropriate accounting policies
professional judgment, consider any legislation or consistently applied. The auditor's reporting
regulation which may impact on that assessment. considerations are set out where the auditor is unable
ISA 26: Audit of Accounting Estimates to obtain sufficient appropriate audit evidence and
where the prior year audit report was other than
Summary. Guidance is provided to auditors on the unqualified. Appendices contain illustrations of other
audit procedures that should be performed in order to than unqualified reports.
obtain reasonable assurance as to the appropriateness
of accounting of estimates
acountng contained
etimaes cotaind in financial
infinacial ISA 29:
Their Inherent
Impact and ControlProcedures
on Substantive Risk Assessments and
information. An accounting estimate is defined as an
approximation of the amount of an item in the absence Summary. Guidance is provided to the auditor in
of a precise means of measurement. It is noted that assessing inherent and control risk and using such
management is responsible for making accounting assessments to determine the nature, timing and extent
estimates based upon its judgment of the uncertain of substantive procedures so as to restrict detection
outcome of events that have occurred or are likely to risk to an acceptable level.
occur and that the auditor is responsible for evaluating ISA 30: Knowledge of the Business
the reasonableness of such estimates.
ISA 27: The Examination of Prospective Financial Summary: This Standard provides guidance on what
Information is meant by a knowledge of the business, why it is
important to the auditor and to members of the audit
Summary. This Standard deals with the examination staff working on an engagement, why it is relevant to
and reporting procedures where an auditor is asked to all phases of an audit, and how the auditor obtains and
report on prospective financial information being either uses that knowledge. In performing an audit of
a forecast, based on best-estimate assumptions, or a financial statements, the auditor should have or obtain
projection based on hypothetical assumptions. a knowledge of the business sufficient to enable the
Recognizing the future oriented nature of the auditor to identify and understand the events,
engagement, the examination procedures recognize the transactions, and practices that, in the auditor's
speculative nature of the evidence available to the judgment, may have a significant effect on the financial
auditor, and while acknowledging a consistent audit statements or on the examination or audit report. The
objective, differentiates between the evidence auditor's level of knowledge for an engagement would
requirements and process for best-estimate as distinct include a general knowledge of the economy and the
from hypothetical assumptions. Emphasis is given to industry within which the entity operates, and a more
the importance of adequate disclosure of significant particular knowledge of how the entity operates. A list
assumptions to an understanding of prospective of matters to consider in a specific engagement is set
financial information and the auditor's role in ensuring out in the appendix to this ISA.
this occurs.
 ANNEX
XV 117

ISA 31: Considerationof Laws and Regulations in should then perform procedures to help identify
an Audit of FinancialStatements instances of noncompliancewith those laws and
Summary: This Standard provides guidance on the regulationsto be consideredwhen preparing financial
auditor's responsibility to consider laws and statements and should obtain sufficient appropriate
regulationsin an audit of financialstatements. When audit evidenceabout compliancewith those laws and
planning and performing audit procedures and in regulationsgenerallyrecognizedby the auditor to have
evaluatingand reportingthe results thereof,the auditor an effect on the determinationof materialamountsand
shouldrecognizethat noncomplianceby the ent itrh disclosuresin financial statements. The appendixto
laws and regulationsmay materiallyaffectthe financial the ISA sets out examplesof the type of information
statment.
statements. However, anaudi
an Hoeve,
audit canot e execte
cannot be expectedto
to that might
indicate come to the auditor's
noncompliance. attention
The Standard alsothat may
outlines
detect noncompliancewith all laws and regulations. rocedures to follow when noncompliance is
Detectionof noncompliance,regardlessof materiality, provered and when noncompliance is
Tequires consideration of the implications for the discovered and when noncomplianceis reported to
integrityof managementor employeesand the possible management,to the users of the auditor's reporton the
effecton otheraspectsof theaudit. financialstatements,and to regulatoryand enforcement
effect ~~~~~~~~~~~~~~authorities.
The Standardalso definesmanagement'sresponsibility Public Service Perspective. Many public sector
to ensurethat the entity's operationsare conductedin Public incluce additive. any publicis
accordance with laws and regulations. The engagementsinclude additional audit responsibilities
responsibility for the prevention and detection of with respect to considerationof laws and regulations.
rsoncompliance rests with the management. Even if the auditor's responsibilitiesdo not extend
beyond those of the private sector auditor, reporting
The Standardalso providesguidanceon proceduresfor responsibilitiesmay be different as the public sector
the author's considerationof compliancewith laws and auditor may be obliged to report on instances of
regulations. The auditor should obtain a general noncomplianceto governing authorities or to report
understandingof the legal and regulatoryframework them in the audit report. (In respect of public sector
applicableto the entity and the industry and how the entities, the Public Sector Committee intends to
entity is complyingwith that framework. The auditor supplementthe guidance includedin this ISA with a
Study.)
118 ANNEX XV

NOTES
 ANNEXXVI 119

ORGANIZATION
INTERNATIONAL OF
(INTOSAI)
SUPREMEAUDITINSTITUTIONS

Auditing Standards

The INTOSAIauditingstandardsconsistof four parts: government will facilitate the accountability

process. Management is responsible for
correctnessand sufficiencyof the form and content
(a) Basicpostulates of the financialreportsand their information.
(b) Generalstandards
(c) Fieldstandards 5) Appropriate authorities should ensure the
(d) Reportingstandards promulgationof acceptable accountingstandards
for financial reporting and disclosure relevantto
the needs of the government,and audited entities
a) Basic Postulates shoulddevelopspecificand measurableobjectives
and performancetargets.

The basic auditingpostulatesstipulatethat:

6) Consistent application of acceptable accounting
1) The Supreme Audit Institution should consider standards shouldresult in the fair presentationof
compliance with the INTOSAI standards in all the financialpositionand the results of operations.
matters that are definedmaterial. Certainmay not
be applicableto some of the work done by SAIs
those organizedas Courts of Account,nor to the 7) The existence of an adequate system of internal
non-auditconductedby the SAI. The SAI should control minimizes the risk of errors or
determinethe appropriatestandardsfor such work irregularities.
to ensurethat it is of consistentquality.

8) Legislative enactments would facilitate the co-

2) The SAI should apply its own judgment to the operation of audited entities in maintainingand
diverse situations that arise in the course of providingaccessto all relevantdata necessaryfor
governmentauditing. a comprehensiveassessmentof the activitiesunder
audit.
3) With increased public consciousness,the demand
for public accountabilityof persons or entities 9) All audit activitiesshouldbe withinthe SAls audit
managing public resources has become mandate.
increasinglyevidentso that there is a greater need
for the accountabilityprocess to be in place and
operatingeffectively. 10) SAls should work towards improvingtechniques
for auditingthe validityof performancemeasures.

4) Developmentof adequate information, control,

evaluation and reporting systems within the
120 ANNEXXVI

11) SAIs shouldavoidconflictof interestbetweenthe 2) The work of the audit staff at each level and audit
auditorand the entityunderaudit. phase should be properly supervised during the
audit and documentedwork shouldbe reviewedby
a seniormemberof the audit staff.
b) GeneralStandards
1) The auditorand the SAI must be independent. 3) The auditorin determrining the extent and scope of
the audit, should study and evaluatethe reliability
2) The auditor and the SAI must possessthe required of internalcontrol.
competence.
4) In conductingregularity (financial)audits, a test
3) The auditor and the SAI must exercisedue care should be made of compliance with applicable
and concernin complyingwith INTOSAIauditing laws and regulations.
standards.
5) In conductingregularity (financial)audits, a test
4) The SAI should adopt policies and proceduresto should be made of compliance with applicable
recruit personnelwith suitablequalifications. laws and regulations. The auditor should design
audit steps and proceduresto provide reasonable
assurance of detecting errors, irregularities,and
5) The SAI should adopt policies and proceduresto illegal acts that could have a direct and material
developand train SAI employeesto enablethemto effect on the financial statement amounts or the
performtheirtask effectively. results of regularity audits. In conducting
performanceaudits,an assessmentshouldbe made
of compliancewith applicablelaws and regulations
6) The SAI should adopt policies and proceduresto whennecessaryto satisfythe audit objectives.The
prepare materials and offer written guidance and auditor should design the audit to provide
instructionsconcerningthe conductof audits. reasonableassuranceof detectingillegalacts that
could significantly affect audit objectives. The
auditor also should be alert to situations or
7) The SAMshould adopt policies and proceduresto transactionsthat couldbe indicativeof illegalacts
support the skills and experienceavailablewithin that mayhavean indirecteffect on the audit results
the SAI and identifythose skillswhichare absent. The regularity audit is an essential aspect of
government auditing. One important objective
which this type of audit assigns to the SAI is to
8) The SAI should adopt policies and proceduresto makesure, by all the meansput at its disposal,that
reviewthe efficiencyand effectivenessof the SAIs the State budget and accounts are complete and
internalstandardsand procedures. valid. This will provideParliamnentand other users
of the audit report with assurance about the size
and developmentof the financialobligationsof the
State. To achieve this objective the SAI will
c) Field Standards examinethe accounts and financial statementsof
the administrationwith a view to assuringthat all
1) The auditor should plan the audit in a manner operations have been correctly undertaken,
which ensures that an audit of high quality is completed,passed,paid and registered. The audit
carried out in an economic,efficientand effective procedure normally results, in the absence of
way in a timelymanner. irregularity,in thegrantingof a "discharge."
 ANNEXXVI 121

6) Competent, relevant and reasonable evidence out the findingsin an appropriateform;its content
should be obtained to support the auditor's should be easy to understand and free from
Analysis of financial statements should be vaguenessor ambiguity,include only information
performedto such a degreethat a rationalbasis is which is supported by competent and relevant
obtained to express an opinion on financial audit evidence,and be independent,objective,fair
matters, judgment and conclusionsregarding the and constructive.
organization,program, activity or functionunder
audit.
2) It is for the SAI to which they belong to decide
finally on the action to be taken in relation to
7) In regularity(financial)audit, and in othertypes of fraudulent practices or serious irregularities
audit when applicable,auditorsshouldanalyzethe discovered by the auditors. With regard to
financial statements to establish whether regularity audits, the auditor should prepare a
acceptable accounting standards for financial written report, which may either be a part of the
reporting and disclosure are complied with. report on the financial statementsor a separate
Analysis of financial statements should be report, on the tests of compliancewith applicable
performedto such a degreethat a rationalbasis is laws and regulations. The report shouldcontaina
obtained to express an opinion on financial statement of positive assurance on those items
matters. tested for compliance and negativeon those
items not tested. With regard to performance
audits, the report should include all significant
d) Reporting Standards instances of non-compliancethat are pertinentto
1) At the end of each auditthe auditorshouldprepare the audit objectives.
a writtenopinionor report,as appropriate,setting
122 ANNEX XVI

NOTES
 ANNEXXVII 123

REVIEWOF AUDIT FIRMS-- PRELIMINARYQUESTIONNAIRE

(mainly for Private Auditors7 )

Basic Information

Legal name of Auditor or Audit Firmn(s):

Audit Law Registration Number:

Date of comunencingAudit Practice:

Street Address:

Postal Address:

Telephone (with area code):

Telefax/Telex Number:

Address and Telephones of

Branches (if any):
Name/Address of Foreign
Affiliations(if any:

7 The acceptabilityof governmentauditorswould normallybe reviewedon a countrybasis and this annex would only
apply for limited aspects.
 124 ANNEXXVII

OUTLINE OF THE AUDIT FIRM

1. Statethe legalnature of the Audit Firm (soleproprietor,partnershipetc.)

2. State the total numberof auditors(excludingsupportstaff) whoare ownersor employeesof the Firnn.
Indicatehowmanyof theseare licensedauditors.

3. Indicatewhich of the followingservicesare providedby the Firm and show approximateshare of

each serviceto the Firn's total Fee Income.
% of Total
Fee Income
Auditing
Accounting
Other share

TOTAL I 0Q

4. For EACH licensedauditor who is an owner/employee,provide a separate attachmentwith their

namesand a briefsummaryof their qualificationsand experience,including
* academiceducationand qualifications
* membershipsof professionalaudit or accountingassociations
* details of audit and accountingworkexperience,includingany workexperienceoutsidethe Country
* writtenand spokenfluencyin Englishor other languages

5. Does the firm have any associationor affiliationwith any other professionalfirm such as auditors,
accountants,consultantsor lawyers,eitherin the Countryor abroad? If so, please supplydetails.

INDEPENDENCE

6. Are any of the individualslisted above (or spouses or close relatives)employedby any level of
Governmentor Legislative Bodyor PublicAgency?If so, please supplydetails.
 ANNEX
XVII 125

7. If a potential client -- the agency executing a World Bank-financed project -- proposed your firm for
considerationas auditorsfor the project,would you be preparedto providewrittenconfimnation(at that time) that
the Firm has no conflictof interestor lack of independencein acceptingappointmentas an auditor.

YES/NO

8. Confirmthat, shouldyour Firmnbe appointedauditorto a World Bank-financedproject,you would

allow World Bank staff to carry out a quality assurancereviewof the audit workingpapers supportingany Audit
Report issued.
YESINO

AUDITPRACTICE

9. Attach (separately)a list of the Firm's major currentand past clients(particularlyany internationalor
joint ventureclients)and statethe type of service(audit,consultingadvice,accountancy)providedto each client.

10. Have you perforned any auditsjointly with intemationalaudit firms? If so, pleaseprovidedetails.

11. Are you willingto conductaudits jointly, under the general directionof an intemationalaudit and
accountingfirm?
YESINO

12. State brieflythe basis on whichyou deterninefees chargedto clients for professionalservicesthat you
provide.

AUDITSTANDARDS
ANDPROCEDURES

13. State whetherthe Firm is aware of internationallyacceptedauditingand accountingstandards,and of

local accountingrules?

YESINO
126 ANNEXXVII

14. How do the Firm's audit proceduresand methodsensurethat these auditingand accountingstandards
are compliedwith? State briefly.

15. Are the Firm's auditproceduresand methodsrecordedin a manual or similardocument?

YESINO

If not, how are audit staff trained in auditing and accountingconcepts? Also, how is day-to-day
guidancein audittechniquesprovidedto them?

16. State brieflyhowthe workof employeesis supervised.

17. Statebrieflythe internalproceduresyou employto assureintemal qualityof workand service,such as

a second review(for quality assurance)withinthe Firm, consultationwith experts, or reviewof work by extemal
parties.

18. Shouldthe WorldBank wishto consideryou for selectionas auditorto World Bank-financedprojects,
wouldyou permitWorldBank representativesto reviewthe Firm's audit proceduresand method?

YES/NO

GENERAL

19. Attach copiesof any referencesfrom clients,any brochures,or other promotionalmaterialdescribing

your Firm.

Listbelowthe headingsand numberof pagesof any attachmentsthat you have enclosedwith this questionnaire.
 ANNEXXVIII 127

GUIDELINESFORAUDITORS
TERMSOF REFERENCEAND ENGAGEMENTLETTER

1. Normally, the Bank approves the terms of reference (TOR) of the auditor to be engaged by a
borrower or project entity. Preferablystaff shouldnot be involvedin the draftingof the TOR, though there
is no objectionto staff membersgivingadviceto the borrowerbased on these guidelines.

2. The guidelinesshould not be regarded as universallyapplicableto audits of Bank projects or

project entities. Staff should select those componentsthey consider appropriate for a particular audit
engagementand add relevantmattersthat are not in the guidelines. This relatesonly to the appointmentof
auditors to carry out an audit of an organization'sfinancial statements, project financial statements,
adjustmentoperations,statementsof expenditure(SOEs), and specialaccounts (SAs). It is not intended
for any specialreviews,investigation,or consultingwork.

3. Terms of reference for an Auditor

The form and content of the TOR may vary for each project, and some aspects may be includedin
an engagementlatter. In general, it shouldincludethe pointsoutlinedbelow.

4. Summary of Contents of TOR/Engagement Letter

a) Descriptionof the employingauthorityor entity,

b) Deliveryof auditreport,

c) Descriptionand timing of the financialstatementsand other materialto be providedby the

managementfor the audit,

d) the fact that the audit shouldbe carried out in accordancewith internationalstandards on
auditing,

e) "managementletter,"
128 ANNEX XVIII

f) statement of access to records and personnel available to the auditor,

g) submission of proposal and work plan by the auditor.

5. Detailed Contents to be Included in the TOR/Engagement Letter

a) The TOR should describe the institution engaging the auditor and whether it is acting on
behalf of, or is a constituent part of, a larger deterrnining his/her independence and the
scope of work.

b) Both a legal and a general description of the entity should be provided in sufficient detail to
enable the auditor to understand fully the nature and objective of the entity. The following
additional information would be helpful:

(i) organizational charts;

(ii) names of senior managers;
(iii) name and qualification of the person(s) responsible for financial management,
accounting, and internal audit;
(iv) name and address of any existing external auditor;
(v) data processing facilities in use; and
(vi) a copy of the latest financial statements (where available).

c) The auditor should be invited to:

(i) submit a proposal for the audit of the financial statements
(i.e., financial statements of the executing entity, adjustment operations, project
financial statements, SOEs, SAs, or a combination of the above);

(ii) deliver an opinion based on the scope and detail of the audit of such statements; and
 ArNNEx
XVIII 129

(iii) provide a "management letter" describing the improvements needed, if any, in the
accounting and internal control systems of the entity and the proper use of
resources.

The TOR/Engagement Letter should specify whether the engagement is for more fiscal
years (or for another specified period).

d) While the auditor is responsible for forming and expressing opinions on the financial
statements, the responsibility for their preparation lies with the management of the entity.
Therefore, the form of the annual financial statements and supporting documentation that
will be supplied to the auditor should be specified. The estimated time for the provision of
these documents to the auditor should be given (e.g., two months after the close of the
fiscal year).

e) The scope and detail of the audit should be clearly explained so an auditor can determine if
there are requirements beyond those of a routine audit. Below are examples of typical
requirements:

(i) The audit should be carried out in accordance with international standards on
auditing. The auditor should indicate the extent (if any) to which the examination
would not conform to those standards.

(ii) The auditor should comment on and confirm the extent to which generally accepted
accounting principles have been and are being consistently applied. The auditor
should indicate any material differences from international accounting standards,
where relevant, and their effect on the annual financial statements.

(iii) Statement of Expenditures (SOEs)

The auditor should be required to verify SOEs with accounting records, supporting
documentation, and physical inspection of work done, or goods and services
130 ANNExXVIII

acquired. He/she should also establish (with reference to the disbursement letter)
that expenditures claimed for reimbursement are eligible for financing under the
Loan Agreement.

(iv) Special Account (SA)

The auditor should be required to verify the correctness of SA financial transactions,
including the reconciliation of receipts with payments by the Bank, the find
balances, and the operation and use of SAs in accordance with the Loan Agreement.

Management Lefter

The management letter should include comments and recommendations for improvements to the
borrower's financial and administrative systems and controls, as well as remarks on other matters to
which the management's attention should be drawn. To supplement the management letter, the
auditor may be asked to conduct a special review of one or more of the following8 :

A. economy, efficiency, and effectiveness in the use of resources;

B. achievement of the planned results of the project;
C. legal/financialobligations and commitments of the entity and extent
of compliance or noncompliance;
D. specific systems (e.g., improvements in accounting and data
processing operations that may be under development) on which the
auditor's comments are necessary to ensure accuracy, efficiency, and
proper controls; and
E. any other activities on which an auditor may report.9

Providedthesematters are within the scopeof the auditor's professionalcompetence.

The foregoinglist is not exhaustive,nor should all mattersbe addressedin everyproject. The scopeand detail of an
auditarelikelyto be uniqueto eachprojector projectentity.
 ANNExXVIII 131.

6. Other Aspects Related to the Audit Engagement

a) The selected auditor should be asked to prepare an engagement letter (see Annex X>). In
countries where an auditor's specific obligations are provided for by law, this step may not
be necessary, but such a letter would still be informative for the borrower. To help avoid
misunderstandings, it is in the interest of both the auditor and the borrower that the auditor
send the engagement letter before the engagement commences. The form and content of
the audit engagement letter may vary for each client, but it should generally include
reference to the matters addressed in this annex. In addition, it should:

(i) State management's responsibility for specifying the timing and nature of financial
statements, and disclosing requirements or other information that is expected to be
provided under the audit arrangements.

(ii) Establish a timetable for providing the audit opinion and reports.

(iii) Estimate staff time and audit fees as an indication of the intensity of the audit effort
and the level of staff engaged on the assignment.

b) On recurring audits, the auditor should not be asked to issue a new engagementletter each
year. However, the following factors could call for a new letter:

(i) any indication that the client misunderstands the objective and scope of the audit,
(ii) any revised or special terms of the engagement,
(iii) a recent change of management,
(iv) a significantchange in the nature or size of the client's business, and
(v) legal requirements.
132 ANNEXXVIII

7. The reporting package to be provided by the auditor would normally comprise

a) the annual financial statement of the implementing organization (where required), of the
project including SOEs and the SA;

b) an opinion by the auditor acceptable to the Bank on (i) the required financial statements, (ii)
a separate reference in the above opinion on the audit of the special account in accordance
with the stipulations of the legal documents, and (iii) a separate reference in the above
opinion on withdrawals from the loan account on the basis of SOEs in accordance with the
Legal Agreements:

c) a management letter; and

d) where required in the TOR, the status of compliance with the legal covenants.
 ANNEXXIX 133

SAMPLETERMSOF REFERENCEFOR THE

AUDITOF PROJECTFINANCIALSTATEMENTS
(and AccompanyingSOE and SA Where Applicable)

Objective
The objectiveof the audit of the Project FinancialStatement(PFS) is to enable the auditor to express a
professionalopinionon the financialpositionof I project at the end of each fiscal year and of the funds
receivedand expendituresfor the accountingperiodendedmm/dd/yy,as reportedby the PFS, [as well as an opinion
on the Statementof Expenditures].
The project accounts(booksof account)providethe basis for preparationof the PFS and are establishedto
reflect the financial transactions in respect of the project, as maintainedby the project implementingagency
I I.

Scope
The audit will be carried out in accordancewith InternationalStandardsof Auditing,and will includesuch
tests and controls as the auditor considers necessaryunder the circumstances. In conductingthe audit, special
attentionshouldbe paid to the following:

(a) All externalfunds have been used in accordancewith the conditionsof the relevantfinancingagreements,
with due attentionto economyand efficiency,and only for the purposes for which the financingwas provided.
Relevantfinancingagreementsare (--------nameof loanagreement);
(b) Counterpartfunds have beenprovidedand used in accordancewith the relevantfinancingagreements,with
due attention to economyand efficiency,and only for the purposesfor whichtheywere provided;
(c) Goodsand servicesfinancedhavebeenprocuredin accordanc with the relevantfinancingagreement;
(d) All necessarysupportingdocuments,records,and accountshave beenkept in respectof all project ventures
[includingexpendituresreportedvia SOEs or SAsl. Clear linkagesshouldexist betweenthe books of account and
reportspresentedto the Bank.
(e) Where SpecialAccountshavebeenused, theyhave beenmaintainedin accordancewith the provisionsof the
relevantfinancingagreement
134 ANNEX XIX

(f) The project accountshave beenpreparedin accordancewith consistentlyappliedInternationalAccounfing

Standards and give a true and fair view of the financialsituationof the project at nmu/dd/yyand of resourcesand
expendituresfor the yearendedon that date.

Project Financial Statements

The ProjectFinancialStatementsshouldinclude
(a) a Summaryof Funds received,showingthe World Bank, project funds from other donors, and counterpart
funds separately;
(b) a Summaryof Expendituresshownunderthe mainproject headingsand by maincategoriesof expenditures,
both for the currentfiscal yearand accumulatedto date;and
(c) a BalanceSheetshowingAccumulatedFunds of the Project,bank balances,other assets of the project, and
liabilities,if any.
As an annex to the Project FinancialStatements,the auditor shouldprepare a reconciliationbetweenthe
amountsshown as "receivedby the projectfrom the WorldBank" and that shown as being disbursedby the Bank.
As part of that reconciliation,the auditorshouldindicatethe mechanismfor the disbursement,i.e. SpecialAccounts,
Statementsof Expenditures,or direct reimbursement,

Statements of Expenditures
In addition to the audit of the PFS, the auditor is requiredto audit all SOEs used as the basis for the
submissionof withdrawalapplications. The auditor shouldapply such tests and controlsas the auditor considers
necessaryunder the circumstances.These expendituresshouldbe carefullycomparedfor project eligibilitywith the
relevantfinancing agreements,and with reference to the Staff Appraisal Report for guidance when considered
necessary. Where ineligibleexpendituresare identifiedas having been includedin withdrawalapplicationsand
reimbursedagainst, these should be separatelynoted by the auditor. Annexedto the Project FinancialStatements
shouldbe a schedulelistingindividualSOE withdrawalapplications by specificreferencenumberand amount. The
total withdrawalsunder the SOE procedureshould be part of the overall reconciliationof Bank disbursements
describedabove.

Special Accounts
In conjunctionwith the audit of the Project FinancialStatements,the auditor is also requiredto audit the
activitiesof the SpecialAccountsassociatedwith the Project. The SpecialAccountsusuallycomprise
* depositsand replenishmentsreceivedfromthe Bank
* paymentssubstantiatedby withdrawalapplications
* interestthat maybe eamed fromthe balancesand whichbelongto the borrower;and
* the remainingbalancesat the end of eachfiscal year.
The auditormust form an opinionas to the degreeof compliancewiththe Bank's proceduresand the balance
of the SpecialAccountat year-end. The audit shouldexaminethe eligibilityand correctnessof financialtransactions
during the periodunder reviewand fund balances at the end of such a period, the operationand use of the SA in
 ANNEXXIX 135

accordancewith the financing agreement, and the adequacy of internal controls for this type of disbursement
mechanism.
For this project, the Special Accounts are referred to in [cite references] of the relevant financing
agreements.SpecialAccountsstatementsand the auditor's reportshouldwith the ProjectFinancialStatements.

Audit Opinion
Besides a primary opinion on the Project Financial Statements,the annual audit report of the Project
Accountsshouldincludea separateparagraphcommentingon the accuracyand proprietyof expenditureswithdrawn
under SOE proceduresand the extent to which the Bank can rely on SOEs as a basis for loan disbursement. The
financialstatements,includingthe audit report, shouldbe receivedby the Bank no later than [threeto six] months
after the end of the accountingperiod to which the audit refers. The auditor should submit the report to the
borrower's designatedagent rather than to any staff memberof the project entity. The agent shouldthen promptly
forwardtwo copiesof the auditedaccountsand reportto the Bank.

Management Letter
In additionto the audit reports,the auditor will preparea "managementletter," in whichthe auditorwill:
(a) give commentsand observationson the accountingrecords,systems,and controlsthat were examinedduring
the course of the audit;
(b) identifyspecific deficienciesand areas of weaknessin systemsand controlsand make recommendationfor
their improvement;
(c) report on the degreeof complianceof each of the financialcovenantson the financingagreementand give
comments,if any, on internaland externalmattersaffectingsuch compliance;
(d) communicatematters that havecometo attentionduringthe audit which mighthave a significantimpacton
the implementationof the project;and
(e) bring to the borrower'sattentionany othermattersthat the auditorsconsiderspertinent.

General
The auditor should be given access to all legal documents,correspondence,and any other information
associatedwith the projectand deemednecessaryby the auditor. Confirmationshould also be obtainedof amounts
disbursedand outstandingat the Bank [and of amountsdisbursedunder [specifyother donor, loan or grant, if any].
BankTask Managerscan assistin obtainingtheseconfirmations.
It is highly desirablethat the auditor becomefamiliar with a copy of the Bank's Guidelineson Financial
Reporting and Auditing of Projects Financed by the World Bank, which summarizes the Bank's financial reporting
and auditing requirements. The auditor should also be familiar with the Bank's DisbursementManual. Both
documentswillbe providedby the Task Manager.
136 ANNEx XIX

NOTES
 ANNExXX 137

EXAMPLEOF AN AUDITENGAGEMENTLETTER

(usually prepared by the auditor)

To the Board of Directors or the appropriate representative of senior management:

You have requested that we audit (insert names of financial statements) as of and for the year
ending.. We are pleased to confirm our acceptance and our understanding in this
engagementby means of this letter. Our audit will be made in accordance with applicable authoritative
pronouncementsin [nameof country]with the objectiveof our expressingan opinionon the financialstatements.
In formingour opinionon the financialstatements,we will perform sufficienttests to obtain reasonable
assuranceas to whetherthe informationcontainedin the underlyingaccountingrecords and other source data is
reliableand sufficientas the basis for the preparationof the financialstatements. We will also decide whetherthe
informationis properlycommunicatedin the financialstatements.
Becauseof the test nature and other inherentlimitationof an audit, togetherwith the inherentlimitationsof
any system of intemal control, there is an unavoidablerisk that even some material misstatementsmay remain
undiscovered.
In addition to our report on the financial statements,we expect to provide you with a separate letter
concerningany materialweaknessesin internalcontrolwhichcometo our notice.
May we remind you that the responsibilityfor the preparationof financial statementsincluding adequate
disclosureis that of management. This includesthe maintenanceof adequate accountingrecords and intemal
controls,the selectionand applicationof accountingpolicies,and the safeguardingof the assets. As part of our audit
process,we will requestfrom managementwrittenconfirmationconcemingrepresentationsmadeto us in connection
with the audit.
We look forwardto full cooperationwith your staff and we trust that they willmakeavailableto us whatever
records,documentationand otherinformationare requestedin connectionwithour audit.
Our fees, whichwillbe billed as workprogresses,are based on the time requiredby the individualsassigned
to the engagementplus direct out-of-pocketexpenses. Individualhourly rates vary according to the degree of
responsibilityinvolvedand the experienceand skillrequired.
This letterwillbe effectivefor futureyears unlessit is terminated,amendedor superseded.
Please sign and return the attached copy of this letter to indicate that it is in accordance with your
understandingof the arrangementsfor our audit of the financialstatements.

XYZ & Co.

Note: Additionalitems may be includedin accordancewith the Guidelinesfor TOR and Engagement Letters --
Annex XVIII.
138 ANNEX XX

NOTES
 ANNEXXXI 139

MODELAUDITREPORT
UnqualifiedOpinion
(For an Organization)

Addressee'0

Introductory Paragraph
We have audited the accompanying [indicate names of each financial statement] of the XYZ Companyas of
December 31, 19XX [indicate any other additional years necessary] for the year(s) then ended. These financial
statements are the responsibility of [identify Borrower]. Our responsibility is to express an opinion on these financial
statements based on our audit.

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

Opinion Paragraph
In our opinion, the financial statements give a true and fair view of the financial position of the XYZ Company
as of December 31, 19XX, and of the results of its operations and its cash flows for the year then ended in accordance
with [indicate International Accounting Standards or relevant national standards].

[Name and Address of Audit Firm]

[Date - Completion Date of Audit]

10 The auditor's report should be appropriatelyaddressed as required by the circumstancesof the engagementand local
regulations.
140 ANNEXXXI

MODEL AUDIT REPORT

UnqualifiedOpinion
(for Project FinancialStatementincludingSOE)

Addressee"

IntroductoryParagraph
We have audited the accompanyingfinancialstatementsof the f [ Project [financedunder World
Bank LoanNo. /IDA as of December31, 19XX[indicateany other additionalyears necessary]for the year(s)
then ended.Our responsibilityis to expressan opinionon thesefinancialstatementsbased on our audit.

Scope Paragraph
We conductedour audit in accordancewithInternationalStandardson Auditing[or relevantnationalstandards
or practices,and/orWorldBank guidelines].Those Standardsand/orWorldBank guidelinesrequirethat we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includesexamining,on a test basis, evidencesupportingthe amountsand disclosuresin the
financialstatements.An audit also includesassessingthe accountingprinciplesused and significantestimatesmade by
management,as well as evaluatingthe overallfinancialstatementpresentation. We believethat our audit providesa
reasonablebasis for our opinion.

OpinionParagraph
In our opinion,the financialstatementsgivea true and fair view of the Sourcesand Applicationof Funds'2 of
_Project for the year ended December 31, 19XX, in accordance with [indicate International
AccountingStandards or relevant national standards. Add "financial position" at December 31, l9XX where a
balancesheetis required.]

In addition, (a) with respect to SOEs, adequatesupportingdocumentationhas been maintainedto support

claims to the World Bank for reimbursementsof expendituresincurred; and (b) which expendituresare eligiblefor
financingunderthe Loan/CreditAgreement[Ln/Cr. Il.

[Nameand Addressof AuditFirm]

[Date - Completion Date of Audit]

The auditor'sreportshouldbe appropriatelyaddressedas requiredby the circumstancesof the engagementand local

regulations.
12 A "SourceandApplicationof Funds"statementis alwaysrequiredforeachproject.Abalancesheetis alsorequired
wheretheprojecthasassetsandliabilities.
 ANNEXXXI 141

MODELAUDITREPORT
UnqualifiedOpinion
(Special Account)

Addressee"3

IntroductoryParagraph
We have audited the accompanying[Sourcesand Applicationof Funds] of the 'Special Account"of the
Project (Loan/Cr.No. ) for the year endedDecember31, 19XX.Our responsibilityis to
expressan opinionon the financialstatementsof the SpecialAccountbased on our audit.

Scope Paragraph
We conductedour audit in accordancewith InternationalStandardson Auditing[or relevantnationalstandards
or practices, and/or World Bank guidelinesfor Special Accounts]. Those Standards and World Bank guidelines
requirethat we plan and performthe auditto obtainreasonableassurancethat the SpecialAccountfinancialstatement
is freeof materialmisstatement.We believethat our audit providesa reasonablebasis for our opinion.

OpinionParagraph
In our opinion,the financial statementsof the Special Accountgive a true and fair view of the financial
positionof the Special Accountas of the Project (Loan/Cr.No. ) December31, 19XX, for
the year then endedin accordancewith InternationalAccountingStandards[or relevantnationalstandards and World
Bank guidelines],and of the Sourcesand Applicationof Funds..

[Nameand Addressof Audit Firm]

[Date - Completion Date of Audit]

13 The auditor'sreport should be appropriatelyaddressedas requiredby the circumstancesof the engagementand

local regulations.
142 AMNEX XXI

EXAMPLESOF AUDIT REPORTS

OTHERTHANUNQUALIFIED14

QualifiedOpinion:
Exception: (Separateparagraphrequiredafter Scopeparagraph)
The companyis defendantin a lawsuitwhich alleges that the companyhas infiinged patent rights
amountingto $30 million. Directorsand counselbelievethat the companyhas a reasonableprevailing,
but the ultimate outcome of the lawsuit cannot presentlybe determined,and no provision for any
liabilitythat mayresulthas beenmadein the financialstatements.
(RevisedOpinionparagraph)
In our opinion,subject to the effect, if any, on the financialstatementsof the matter discussedin the
precedingparagraph,the financialstatements.
Adverse: (Separateparagraphs requiredafter Scopeparagraph)
Note X to the Financialstatementsof the companystates that value of shares in ZZZ Company,a
subsidiary of the XYZ company, at cost, to be $2 million. The accounts of the company as of
December31, 19XX reportsignificantlosseson operationsfor the periodendedas of that date.
The value of the investmentrecordedin the ZZZ Companyexceedsthe marketvalue by $1.5 million.
In our opinionthe investmentshould have been written down by $1.5 millionand a charge of $1.5
millionshouldhavebeenmadeto the incomestatement. Sucha chargewouldresult in the net incomeof
the companyto be reducedfrom $2.3 millionto $0.8 million.
(RevisedOpinionparagraph)
In our opinion,subjectto the matter discussedin the precedingparagraph,the financialstatements.do
not givea true and fair view.
Disclaimer: (RevisedIntroductoryparagraph)
We were engagedto audit the accompanying... for the years then ended. Thesefinancialstatementsare
the responsibilityof [borrower].(Omitthe sentencestatingthe responsibilityof the auditor.)
(Scopeparagraphwouldeitherbe omittedor amendedaccordingto the circumstances.)
(Separateparagraphrequiredafter Scopeparagraph,if any.)
In the valueof the year-endinventory,as shownin the balancesheet,an amountof $50 millionhas been
included as the estimated margins on sales. The XYZ Company has not conducted a physical
verificationof its inventorysincethe end of the previousreportingperiod. The company's records do
not permitthe applicationof alternativeauditproceduresto determinethe existenceof such inventories.
(RevisedOpinionparagraph)
Becauseof the significanceof the matters discussedin the precedingparagraph,we do not express an
opinionon the financialstatements.

14 An auditor maynot be able to express an unqualified opinion when there is a limitationon the scope of the auditor's work; or there
is a disagreementwith management regardingthe acceptabilityof the accountingpolicies selected,the method of their application
or the adequacyof financial statement disclosures.
 ANNExXXII 143

OUTLINEOFA MANAGEMENT
LETTER

Dear:
We have auditedthe financialstatementsof the (companyname)for the year endingmm/yyand have issued
our reportdate mmn/yy.In planning and performingour audit of (company name), we considered its internal
accountingcontrolstructurein order to determineour auditingproceduresfor the purposeof expressingour opinionon
the financialstatementsand not to provide assuranceon the internal accountingcontrol structure. We noted no
matters involvingthe internalaccountingcontrolstructureand its operationthat we considerto be materialweaknesses
in accordancewith the standardsreferredto above.
This report is comprised of three sections. Section I contains recommendationsrelated to certain
improvementsin the existing systems and proceduresnoted in the current year. Section II contains prior year
recommendationswhichhave not yet been fullyimplemented.SectionIII containsprior year recommendations which
havebeenfullyresolved(managements'commentswouldbe notedfollowingeach recommendation).
This report is intendedsolelyfor the informationand use of managementand others within the organization
andshouldnotbe usedfor any otherpurpose.
Duringthisyear'sauditwe notethat the (companyname)has addressedmost of the recommendationsincludedin our
prioryearreport. With respect to our current and carryoverrecommendations,we suggest that an implementation
timetablecontinueto be prepared
and approvedby appropriatemanagement.

Yours verytruly,
144 ANNEX XXII

NOTES
 ANNEXXXIII 145

[nameof country]

FORREVIEWOF GOVERNMENT
TERMSOF REFERENCE
ACCOUNTINGANDAUDITINGARRANGEMENTS

(Partof CountryAssessment)

(This TOR does not cover the Public Sector management issues of laws, regulations, staffing and training.)
1. The objectiveof this assignmentis to assess the status of accounting,financialreportingand auditingfor
all spending units financed by funds from the Government of . (Approximately two thirds of the time
allocatedfor the assignmentwillbe spenton accountingand financialreportingaspectsand about onethird on auditing
arrangements.)
2. AccountabilityBackground-- managingpublic programsrests on an elaboratestructureof relationships
amongall levelsof government. Officialsand employees,whomanagethese programs,needto renderan accountof
their activities to the public. While not always specified by law, this accountabilityconcept is inherent in the
governingprocessesof most countries. Whilethe presentreviewis fact finding,the consultantwill inevitablyobserve
situationwhereorganizations,programsand servicesare not beingoperatedeconomicallyand efficiently;these should
be noted.
3. Accountingand FinancialReporting.
3.1. A governmentaccountingsystemmust makeit possibleboth (1) to presentfairly and with full disclosure
the financialpositionand results of financialoperationsof the fundsand account groups (or spendingunits) of the
governmentalunit in conformity with the generally accepted accounting principles, and (2) to determine and
demonstratecompliancewith financerelatedlegal and contractualprovisions. With this in mind,the consultantwill
carry out an assessmentof
(a) the financialsystems,proceduresand regulationsmanualsof Governmentfor use by spendingunits.
(b) the accountingstandards (GenerallyAcceptedGovernmentAccountingStandards) that are required by
Governmentto be used by the spendingunits and the extentto whichthey relateto accountingstandardsin the private
sector, to internationalaccountingstandards of IASC or reconmnendations of the public sector committeeof the
InternationalFederationof Accountants,and
(c) prepare an evaluationof the appropriatenessof the systems,procedures,regulationsand standardsand the
extentto whichtheyreflectmodernpractice.
3.2. Reviewwith each SpendingUnit (or Ministry,Departnent or Agencyfor severalspendingunits)the status
of their accountingand financialreportingby determining:
146 ANNExXXIII

* thetype of financialreportingrequired
* last periodfor whichreportsare available
* applicableaccountingstandards
* basic of accounting(cash,modifiedcash, modifiedaccrualor full accrual)
* last periodaudited
* date of audit certificate
* Auditor's Opinion(clean,qualified,adverse,or disclaimed)
* Nameof Auditor(Government/Private)

4. AuditingArrangements
4.1 Auditingof annual financialstatementsof spendingunits will generallybe undertakenby the Auditor-
General.However,in certaincircumstances,especiallyfor revenueearning/commercially orientedenterprises,the audit
may be carried out by an independentaudit firm from the private sector. The Consultantwill assess the general
competencyof such audit firms to carry out such audits and note any cases where impartialitymay be questionable
(for example,wheremorethan about 30% of the firm's fee incomemay comefrom a singleclient). Compliancewith
IntemationalStandardson Auditingof IFAC or nationalaudit standardsshouldbe noted.
4.2 Where the audits are carried out by the Auditor-Generalthere is a general obligationon him/her for
ensuringthat:
a) the audit is conductedby personnelwhocollectivelyhavethe necessaryskills;
b) the Auditor-Generalis independent;
c) applicablestandards (IFAC/IAPC,INTOSAI,Govermments
own standardetc.) are followedin planningand
conductingauditsand reportingthe results;
d) the Auditor-Generalhas an appropriateinternalqualitycontrolsystemin place;and
e) the Auditor-General'sofficeperiodicallyundergoesan externalqualitycontrolreview.
Thesematters will needto be discussedwith the Auditor-Generalto assess the extent of his own compliancewith the
aboveobligations.
4.3 Similarlythe typesof auditscarried out shouldbe reviewedto determinethat in the case of financialaudits,
(includingfinancialstatementaudits)-
(a) they providereasonableassuranceabout whetherthe financialstatementsof an auditedspendingunit present
fairly the financial position, results of operations, and cash flows in conformity with generallyaccepted
accountingprinciples;
(b) they determinewhether(1) financialinformationis presentedin accordancewith establishedor states criteria,
(2) the spendingunit has adheredto specificfinancial compliancerequirements,or (3) the spendingunit's
intenal control structure over financial reporting and/or safeguarding assets is suitably designed and
implementedto achievethe controlobjectives.
(c) they may also includeauditsof:
 ANNEXXXIII 147

* budgetrequestsand variancesbetweenestimatedand actualfinancialperformance

* internalcontrols over compliancewith laws and regulations,such as those governingthe bidding for,
accountingfor, and reportingon grants and contracts(includingproposals,amountsbilled, amountsdue
on terminationclaims,and so for the)
* internalcontrolsover financialreportingand/or safeguardingassets, includingcontrolsusing computer-
based systems
* compliancewith laws and regulationsand allegationsof fraud.
The consultantshouldcommenton the generalextentand scopeof financialaudits.
4.4. The consultantshouldalso commenton the extentto whichperformanceaudits havebeencarried out by
either private sector or governmentauditors. A performanceaudit is an objectiveand systematicexaminationof
evidencefor the purpose of providingan independentassessmentof the performanceof a governmentorganization,
program,activity,or functionin order to provideinformationto improvepublic accountabilityand facilitatedecision-
makingby partieswith responsibilityto overseeor initiatecorrectiveaction. Performanceaudits includeeconomyand
efficiencyand programaudits.
(a) Economyand efficiencyaudits includedetermiining (1) whetherthe entity is acquiring,protectingand using
its resources (such as personnel, property, and space) economicallyand efficiently, (2) causes of
inefficienciesor uneconomicalpractices,and (3) whetherthe entityhas compliedwith laws and regulationson
matters of economyand efficiency. Questionsand issuesto be raisedby the consultantin this area would
includethe extentto whichthe spendingunit is:
* followingsoundprocurementpractices;
* acquiringthe appropriatetype, quality,and amountof resourcesat an appropriatecost;
* properlyprotectingand maintainingits resources;
* avoidingduplicationof effortby employeesand workthat serveslittleor no purpose;
* avoidingidlenessand overstaffing;
* usingefficientoperatingprocedures;
* using the optimumamount of resources(staff, equipmentand facilities)in producingor deliveringthe
appropriatequantityand qualityof goodsor servicesin a timelymanner.
* complyingwith requirementsof laws and regulationsthat could significantlyaffect the acquisition,
protection,and use of the spendingunit's resources;
* has an adequate managementcontrol system for measuring,reporting, and monitoringa program's
economyand efficiency;and
* has reportedmeasuresof economyand efficiencythat are validand reliable.

b) Programaudits includedetermining(1) the extentto whichthe desiredresults or benefitsestablishedby the

legislatureor other authorizingbody are being achieved,(2) the effectivenessof organizations,programs,
activities, or functions, and (3) whether the entity has compliedwith significant laws and regulations
applicableto the prograrn. The consultantmay be able to determinefrom specimenprogramaudits whether
the followingmattershave beenaddressedto givecredibilityto such reports for scope and depth:
148 ANNEXXXIII

* assess whether the objectives of a new, or ongoing program are proper, suitable, or relevant;
* detem-ine the extent to which a program achieves a desired level of program results;
* assess the effectiveness of the program and/or of individual program components;
* identify factors inhibiting satisfactory performance;
* determine whether management has considered altematives for carrying out the program that might yield desired
results more effectively or at a lower cost;
* determine whether the prograrn complements, duplicates, overlaps, or conflicts with other related programs;
* identify ways of making programs work better;
* assess compliance with laws and regulations applicable to the program;
* assess the adequacy of the management control system for measuring, reporting and monitoring a program's
effectiveness; and
* determine whether management has reported measures of program effectiveness that are valid and reliable.
The consultant will report his findings in writing within 4 weeks of the completion of his field visit. Such report shall
also include a suggested action plan to indicate how improvements can be made in both financial reporting/accounting
arrangements as well as for the annual or other periodic audit reports.
 INDEX 149

INDEX

accountability 1, 35 financial statement 1, 127, 134

financial 35, 36, 37, 38 implementingagencyfinancial
managementletter 32, 143
accounting public sector 28-29, 37
accrualvs. cash 43 statement 23
educanon 8 provision 11
for leases 7 report 14, 15, 32, 89, 135, 139-142
public sector 36,37 reviewofauditfirms 123
sectors 9, 36, 75 terms of reference 14, 30, 127-137
structure 3-4 timingof audit report 32

accountingand auditingcovenant 11, 15 auditingstandards 26, 37, 39, 111, 119

accountingprofossion 39 auditor
government 27, 38
accountingstandards 4, 6, 17, 36, 43 independence 29
developmentof 40 private sector 28
international 6, 46,47,53,90,162 questionnaire 123-126
national 39 selection of 27
reminderto borrowerof require-
accountingsystens 3, 4, 13, 36 ment to appointauditors 83
accrualvs. cash 43
commerciallyorientedvs. government 5 AuditorGeneral 37
decentralizedvs. centralized 5
for entitiesimplementingrevenue auditor'sopinion
earningprojects 61-69 qualified,adverse,dis-
non-revenueearningprojects 71-73 claimerof 31, 142,
review 145 unqualified, 23, 31-32, 139-141

accrualbasis accounting 4, 43 balancesheet 17

applicationof funds 17, 19, 22 bank reconciliation 8

ARCS 16 budget
budgetarycontrol,system 36
Articlesof Agreement(Bank) 1 budgetingsystem 4
management 43
audit problemsin developingcountries 5
arrangements 3, 14, 139
commission 37 BP 21,22
compliance 4-16, 23, 26
financial 32 CAAT 114
type of:
adjustmentops. 51, 59, 80 cash basis accounting 7, 43
compliance,operational,subsidiary 23
engagementletter 30, 111, 127-137 cashflow statement 17-18
150 INDEX

chart of accounts 46, 62 fixed assets 46, 67, 95

CIS 114 GAAP 6

COD 15 GAAS 30

Controler Geneal 37 goverment acunting 43

CountryFinancialAccountability govermnentaounig system 4-5, 36, 145

Assessments 16, 35, 145
governmentauditors 27
countzyreview 16, 35, 40
graceperiod 14
Courtof Accounts 37
IFAC 6, 111
covenants 11
IAPC 111, 146
CPPR 16
lASC 6, 47, 93
disclosurerequirements 6
IAS 6
EDP 115
incomestatement 18, 24
finncial information 4, 81, 112-113
qualiftiesofgoodfinancial informa- independence 29, 39
tion 1, 13
interimreports 17
financialmanagement 44
checklistfor assessingrevenue-earning intemnalauditors 38
projects 9
environment,information,structure 3 internalcontrol 7-8, 54
for sectors 9 risk 45, 55
reviews 61-69, 71 - 73 structure 3
system 1-2, 9, 10, 13 system 3
weaknesses 14
financialreporting
arrangement 3
linkageto performancemonitoring 14 INTOSAI 37, 119
requirement 3, 38
the Bank'srequirements 15, 17 inventory 46,50,63,68

finncial services ISA 26-27, 111-117

private sector 3840
leases 7, 56
financialstatnents
elementsoffinancial statements 93 legal
for project 19 enironment 10
of implementingorganizations 17, 95 covenants 11
specimen 96 - 106
 INDEX 151

lendingoperations PSC 114

adjustment,emergency,
hybrid 22,26 public sectoraccounting 36-37

publicsectoraudifing 37, 111

managementletter 14, 32, 135, 143
regulatoryenvironment 10
matching 6
revenue-eaningentities 9, 61-69
modifiedaccrualbasis 43-44
SA 17, 21, 109
monitoringfor performance 13, 14 audit of 25, 135

multi-stateloan 16 SAI 27, 37, 119

nonrevenue-mningentities 4, 9, 71-73 SAL 22

note and supplementaryinformation 17 SAR 10

OP 21, 22 SECAL 22

opinions SGSA 21
auditor 31
SOD 15
performanceindicators 3, 4, 13
SOE 15- 16, 19-22,25, 103
privatesectoraccounting 28, 38 auditof 25, 134
procedures 15
project TMreviewof 79
accountingstructure 3 withdrawalschedule 107
accounts 17
appraisal 3, 68 sourceof fuids 17, 19, 22
cycle 3
budget 13 subsidiaryaudits 33
financial information 83
for schools 10 technicalassistance 40
implementation 1, 13-14,83
management 13-14 TORS- Auditors 127, 133
monitoring 14 GovernmentAccountingand
organization 5 Auditing 145
types 8
VAT 36
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