External Audit

1. April 2012 External Audit

2. Audit Definition • Ex post reviewof the books of account, financial statements, records of transactions & financial systems • Examines the adequacy of accounting systems & procedures, capacity to maintain appropriate accounts & documentationof project/ grant expenditures Underlying objectives • Provides credibility& assurance of accountability • Verifies compliancewith financial matters inloan covenants • Identifies weaknesses in internal controls/ financial systems & makes recommendations thereon Frequency • Annual • Due at IFAD normally six months after year end

3. Types of Audit Financial Statements Audit Auditor expresses his opinion on the financial statements of the project Mandatory in IFAD projects Compliance Audit Auditor verifies compliance with internal rules, regulations, procedures and processes laid down by Management Operational Audit Thorough examination of the project’s management techniques & performance. Study of all functional areas, identifying implementation issues & recommending remedial actions to improve efficiency & effectiveness of operations

4. Audit Roles Borrower/ grantee External Auditor • Prepares TOR, manages auditor selection process (if relevant) and appoints auditor • Submits annual financial statements • Implements remedial action • Performs audit work including 3 audit reports/opinions • Indicates ineligible expenditures/ irregularities • Provides management letter IFAD • Provides no objection to TOR & appointment of auditor following assessment of capacity • Monitors timely submission and review of audit reports • Follows up on remedial action • Applies sanctions/ other remedies if relevant, including suspension of disbursements and/or cancellation of financing balance

5. Audit Requirements per General Conditions • Section 9.03 (a)of the General Conditions requires annual audit of project accounts with auditing standards acceptable to the fund • Section 9.03 (b)of the General Conditions requires the borrower/recipient the submission of the audit report to IFAD within six months after FY end • Section 10.04of the General Conditions requires the Borrower & the project party to cooperate fully with auditors in case of audit initiated by the Fund • Details of the project audit cycle contained in “IFAD guidelines on project audits”

6. Scope and Objectives of Audit • Auditors acceptable to the Fund must be appointed in a fair, timely and transparent mannerto conduct the audit of the project’s financial management systems for the 1st year of the project & every year thereafter (note: the obligation for the 1st year audit may be waived by the Fund if reasonable (e.g. no disbursements, etc) • The audit should include the audit opinion on the financial statements, compliance audit report on compliance with loan covenantsand a management letter. Operational auditmay be insisted upon by the Fund if it deems fit • Should be conducted according to acceptable auditing standards (usually deemed to be International Standards on Auditing standards (ISA) or INTOSAI standards or national standards, if acceptable), if not, extent of deviation from there must be reported.

7. External Auditor – Who Performs? Who performs? • Independent external professional • In certain countries, mandatory to be National AuditOffice(NAO)/ Supreme Audit Institution; if not, private sector firm to be agreed with IFAD External auditor outputs • Professional audit packagecontains opinions provided: • Project Financial statements • Use ofSpecial designated account(s)in compliance with financing agreement • Eligibility of expenditures included in WAs/ SOEs • Management letteron internal controls & systems • Reporting of ineligible expenditures

8. External Auditor – Basis of work Basis of work • Auditing standards: • Provide guidance on the objectives and general principles governing an audit of financial statements • Comprise a set of systematic guidelines used by auditors when conducting audits, ensuring the accuracy, consistency & verifiability of auditors' actions & reports • Various Generally Accepted Auditing Standards (GAAS) frameworks exist • IFAD’s projects are generally required to use International Standards of Auditing(ISA)/ International Organization of Supreme Audit Institutions (INTOSAI) • National standardsmay be used ifagreed with IFAD • The auditing standards applied should be specified in the auditor’s opinion

9. Financial Statement Audit verifies • Whether the financial statements are prepared according to internationally recognized accounting principles (IFRS/ IPSAS)or acceptable national standardsconsistently over a reasonable period • Whether expenditure is eligibleper provisions of the financing agreement • Whether the accounting & financial statements & records are accurate • Whether individual expenses aggregating to the totals reflected in SoEs are properly approved, classified, supported by documentary evidence & are eligibleunder the financing agreement. If ineligible expenses are found, the Fund may review the eligibility of the Borrower to use the SoE mechanism: the Borrower may be asked to reimburse the Special account to the extent of ineligible expenditure

10. Financial Statement Audit verifies • Whether the Special/designated Account mechanismis operated properly, the SA /DA is correctly reconciled, if the withdrawals from the SA / DA are properly authorized • Whether the year end financing balance is reconciled with IFAD’s records • Whether the project has adequate internal and accounting controls to record & report financial transactions in atimely & accurate manner& to safeguard project assets. Whether the internal audit system is commensurate with the size & complexity of the project • Whether the project assets physically exist are in good working order& are held in the name of the project • Any other matterwhich the Fund may specifically ask the auditors to report on, whether included in the Financing Agreement or not

11. Audit Reports – Contents The report should follow a set format: • Paragraph 1: sets out audit work performed.Identifies respective responsibilities of the auditor& auditee • Paragraph 2: details the scope of audit work,provides a general description of the nature of the work, examples of procedures performed, any limitations the audit faced based on the nature of the work. This paragraph also states that the audit was performed in accordance with the GAAS of reference • Paragraph 3: states the auditor’s opinion on the financial statements,i.e., whether free of material misstatement (i.e. important and significant errors), show a true and fair view of the operating results, financial position & cash flows of the auditee and whether they are in accordance with the stated accounting principles of reference The auditor may also add additional information to the report if deemed necessary without changing the overall opinion of the report

12. Audit Reports – Opinions There are 4 different standard types: Unqualified Opinion/“Clean” opinion report* Qualified Opinion/“Except for” Opinion** Adverse Opinion report*** Disclaimer of Opinion report*** * In some cases the clean audit opinion issued is not entirely consistent with audit findings in the financial data, management letter or IFAD’s findings in supervisory activities ** Potentially not acceptable to IFAD – IFAD’s audit standards foresee that an unqualified opinion should be received for all its projects, programmes & grants. A qualified opinion may be accepted only if there is evidence of a time-bound workplan to implement changes or if the qualification does not impinge on IFAD’s fiduciary responsibilities *** Not acceptable to IFAD. Financial statements to be re-done and re-audited

13. Audit Reports – Opinions (1) 1. Unqualified Opinion/“Clean” opinion This is regarded as the equivalent of a “clean bill of health” to a patient 1a. Unqualified Opinion/Emphasis on matter This is not a qualification of the financial statements but it is meant to draw the attention of the readers of the financial statements either on: -An information relevant for the interpretation of the financial statements (such as an uncertainty relating to the future outcome of exceptional litigation or regulatory action ) -An information not disclosed in the financial statements that is important to understand the audit, the auditor’s responsibilities or the auditor’s report (such as a major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position)

14. Audit Reports – Opinions (2) 2. Qualified Opinion • There are 2 types of qualification: • Single deviation from GAAP/ “Except for”– at least one area of the accounts does not conform to GAAP but the rest of the financial statements are fairly presented, e.g. incorrect depreciation expense • Limitation of scope- the auditor could not audit one or more areas of the financial statements. For example, the auditor was not able to observe and test an entity’s inventories • Usually a qualified opinion indicates that the financial statements are fairly presented except for some material but not pervasive error. 3. Adverse Opinion report The financial statements do not conform to GAAP. It is the opposite of an unqualified opinion; In this case the financial statements present both material and pervasive errors 4. Disclaimer of Opinion report This Opinion is rare; issued when the auditor could not form an opinion, as he cannot complete the audit work due to various reasons, such as significant scope limitations

15. Management Letter • Should accompany audit report • Should identify weaknesses, if any, of the internal controlsand recommend corrective action. • Management must reply in writing within 30 days • Management response should indicate agreement/ disagreement with auditor & must contain a time bound action plan to address the issue(s)

16. Audit – Responsibilities of PMU • Prepare auditor’s TORand obtain IFAD no-objection • Ensure mandatory datais included in financial statements • Submit the financial statements to IFAD 4 monthsafter the end of the FY • IFAD will provide comments on missing/unclear itemsthat can be corrected by the PCU, rather than make it an issue of audit report review • If in doubt, ask IFAD!

17. Audit – Responsibilities of IFAD • Monitor timeliness of audit report submission • Check auditor’s compliance with TOR, including all 3 audit opinions & management letter • If report is qualified, consider seriousness of qualifications, & if immediate action is required • Suspension of disbursementsmay occur if: • Untimely submission of reports (180 days from due date) • Non compliance with IFAD standards (e.g. qualified accounts without satisfactory action plan)

18. Selection & Appointment of Auditors • Usually through a competitive processusually from 3-6 qualified firms • Should be on the basis of technical and financialevaluation • Should have past experience & satisfactory performancein similar assignments • Should produce satisfactory references • Should give a declaration that the neither the firm nor the staff have any conflict of interestin accepting the assignment • Should deploy staff with adequate qualifications & experience • Should not be appointed for any other assignment–management consultancy, internal auditor, accounting, consultancy, etc • Should be able to able to undertake the assignment with complete independence– no relationship with project party or other related party

19. Contents of Audit Engagement Letter • Description of the project, the finance and partiesthereto • Description of financial statementsand samples thereof • Stipulation regarding use of acceptable auditing standards • Availability of books, records, documents and personnel during audit • Tenure of the appointment- two or more fiscal years (subject to satisfactory performance in previous year) • Follow up on prior year issues • Contents of audit report& specific opinions to be provided. • Deadline for submissionof audit report • Deliverables, outputs and opinions • Submission of audit program, staffing plan & audit proposal • Submission of Management Letter

20. Responsibilities of the Auditor • Submit a proposal outlining audit methodology, staffing plan, audit programme & audit fees • Express audit opinionsas per ToR • Provide a Management Letteras per ToR • Provide an IFAD official language translationof the audit report in case the report is in the local language

21. Follow up of audit recommendations • Follow up of audit recommendations is as important as conducting the audit • The Project Party should have a system for following up compliancewith audit recommendations in atimely manner • A Log of Audit Observations must be prepared • The log must record each audit observation & the validation by the auditor that corrective actionhas been taken • Should be updated periodicallyand submitted to Supervision Missions • Follow up status must be reviewed by the Project Coordinator/ IFAD/ Internal Auditor/ External Auditorperiodically

22. Status of audits • For each project, a status of auditsmust be prepared as per the following format • Should be updated regularlyand submitted to Supervision Missions

23. Desk review of audit reports - 1 - Fulfilment by the auditor of all audit requirements specified in TORs - Whether all financial reporting requirements have been met (including SA reconciliation, use of SOE procedure, financial performance of project, inventory of assets, accounting & audit standards used, compliance with procurement procedures) - Review of the adequacy of internal control mechanisms (accounting system, segregation of duties, etc.) - Qualifications or other significant points in auditor’s report - Suggest an action plan to address main weaknesses identified in internal control system - Follow-up on actions noted in previous year’s Desk Reviews

24. Desk review of audit reports - 2 - Overall financial reporting & auditor’s performance are assessed – to be used as one criteria for classification of project at risk (with direct impact on disbursement, supervision intensity, upgrade design report of project by ensuring audit weaknesses are addressed with pragmatic solutions) - Current risk assessment methodology uses traffic light indicators (red, yellow, green) - Desk review findings, as per IFAD requirements, are used to report on annual basis to Audit Committee, support regional divisions for preparation of Annual Portfolio Performance Review, etc. - Inform IFAD Investigation Office where irregularities such as fraud & corruption are identified by auditors, or where desk review raises serious concerns in relation to possible fraud & corruption

25. Audit Review Form/Checklist • ARTS is an aIterative tool, prepared by IFAD for implementation support • Increased importancedue to renewed emphasis on fiduciary responsibilities under direct supervision • Analyses completeness and reasonablenessof: • financial statements • audit opinions • audit work performed • Lists major follow up actionto be performed by project • May require action planto be prepared • Updated formatlaunched with new audit report tracking system (ARTS)

26. Project Audits - Challenges • Periodic audits by independent auditor • Delays in recruitment of auditors • Acceptable audit standards • Audit TOR consistent with complexity of project • Impossibility to produce audit report due to delays in preparing financial statements • Poor quality or incomplete Audit reports (not including opinion on FS, SOEs, special account, management letter) • No review of previous year’s recommendations in audit report • No follow-up on plan of action by PMU • Late submission of audit report (risk of suspension)