External AuditExternal AuditApril 2012

AuditAuditAuditAudit

► Ex post review of the books of account, financial statements, records of transactions & financial systems

► Examines the adequacy of accounting systems & procedures, capacity to maintain appropriate accounts & documentation of project/ grant expenditures

DefinitionDefinition

► Provides credibility & assurance of accountability ► Verifies compliance with financial matters in loan covenants► Identifies weaknesses in internal controls/ financial systems & makes

recommendations thereon

Underlying objectivesUnderlying objectives

► Annual► Due at IFAD normally six months after year end

FrequencyFrequency

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Types of AuditTypes of AuditTypes of AuditTypes of Audit

Financial Statements Audit Auditor expresses his opinion on the financial statements of the project

Compliance AuditCompliance AuditAuditor verifies compliance with internal rules, regulations, procedures and processes laid down by Management

Operational AuditOperational 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

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Mandatory in IFAD projects

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Audit RolesAudit RolesAudit RolesAudit Roles

Borrower/ grantee

• Prepares TOR, manages auditor selection process (if relevant) and appoints auditor

• Submits annual financial statements• Implements remedial action

External Auditor

• 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

⇉ Section 9.03 (a)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)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 10.04Section 10.04 of 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”

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Audit Requirements per General ConditionsAudit Requirements per General ConditionsAudit Requirements per General ConditionsAudit Requirements per General Conditions

Scope and Objectives of AuditScope and Objectives of AuditScope and Objectives of AuditScope and Objectives of Audit

► Auditors acceptable to the Fund must be appointed in a fair, timely and

transparent manner to 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 covenants and a

management letter. Operational audit may 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.

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External Auditor – Who Performs?External Auditor – Who Performs?External Auditor – Who Performs?External Auditor – Who Performs?

► Independent external professional

► In certain countries, mandatory to be National Audit Office (NAO)/ Supreme Audit Institution; if not, private sector firm to be agreed with IFAD

Who performs?Who performs?

► Professional audit package contains opinions provided:

o Project Financial statementso Use of Special designated account(s) in compliance with financing

agreemento Eligibility of expenditures included in WAs/ SOEs

► Management letter on internal controls & systems

► Reporting of ineligible expenditures

External auditor outputs

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External Auditor – Basis of workExternal Auditor – Basis of workExternal Auditor – Basis of workExternal Auditor – Basis of work

Basis of work

► Auditing standards:

o Provide guidance on the objectives and general principles governing an audit of financial statements

o Comprise a set of systematic guidelines used by auditors when conducting audits, ensuring the accuracy, consistency & verifiability of auditors' actions & reports

o 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 standards may be used if agreed with IFAD

► The auditing standards applied should be specified in the auditor’s opinion

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Financial Statement Audit verifiesFinancial Statement Audit verifiesFinancial Statement Audit verifiesFinancial Statement Audit verifies

Whether the financial statements are prepared according to internationally

recognized accounting principles (IFRS/ IPSAS) or acceptable national

standards consistently over a reasonable period

Whether expenditure is eligible per 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 eligible under 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

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Financial Statement Audit verifiesFinancial Statement Audit verifiesFinancial Statement Audit verifiesFinancial Statement Audit verifies

Whether the Special/designated Account mechanism is 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 a timely & 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 matter which the Fund may specifically ask the auditors to

report on, whether included in the Financing Agreement or not

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Audit Reports – Contents Audit Reports – Contents Audit Reports – Contents Audit Reports – Contents

The report should follow a set format:

Paragraph 1: Paragraph 1: sets out audit work performed. Identifies respective responsibilities of the auditor & auditee

Paragraph 2: 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: 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

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Audit Reports – OpinionsAudit Reports – OpinionsAudit Reports – OpinionsAudit Reports – Opinions

There are 4 different standard types:There are 4 different standard types:

1. Unqualified Opinion/“Clean” opinion report*

2. Qualified Opinion/“Except for” Opinion**

3. Adverse Opinion report***

4. Disclaimer of Opinion report***

** In some cases the clean audit opinion issued is not entirely consistent with audit findings 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 activitiesin 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 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 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 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 responsibilitiesor if the qualification does not impinge on IFAD’s fiduciary responsibilities

****** Not acceptable to IFAD. Financial statements to be re-done and re-auditedNot acceptable to IFAD. Financial statements to be re-done and re-audited

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1. Unqualified Opinion/“Clean” opinion

This is regarded as the equivalent of a “clean bill of health” to a patient

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Audit Reports – Opinions (1)Audit Reports – Opinions (1)Audit Reports – Opinions (1)Audit Reports – Opinions (1)

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)

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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

Audit Reports – Opinions (2)Audit Reports – Opinions (2)Audit Reports – Opinions (2)Audit Reports – Opinions (2)

Management LetterManagement LetterManagement LetterManagement Letter

Should accompany audit report

Should identify weaknesses, if any, of the internal controls and recommend corrective action.

Management must reply in writing within 30 days

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Management response should indicate agreement/ disagreement with auditor & must contain a time bound action plan to address the issue(s)

Audit – Responsibilities of PMUAudit – Responsibilities of PMUAudit – Responsibilities of PMUAudit – Responsibilities of PMU

Prepare auditor’s TOR and obtain IFAD no-objection

Ensure mandatory data is included in financial statements

Submit the financial statements to IFAD 4 months after the end of the

FY

IFAD will provide comments on missing/unclear items that can be

corrected by the PCU, rather than make it an issue of audit report review

If in doubt, ask IFAD!

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Audit – Responsibilities of IFADAudit – Responsibilities of IFADAudit – Responsibilities of IFADAudit – 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 disbursements may occur if:

Untimely submission of reports

(180 days from due date)

Non compliance with IFAD standards

(e.g. qualified accounts without satisfactory action plan)

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Selection & Appointment of AuditorsSelection & Appointment of AuditorsSelection & Appointment of AuditorsSelection & Appointment of Auditors

Usually through a competitive process usually from 3-6 qualified firms

Should be on the basis of technical and financial evaluation

Should have past experience & satisfactory performance in similar assignments

Should produce satisfactory references

Should give a declaration that the neither the firm nor the staff have any conflict of interest in 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

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Contents of Audit Engagement LetterContents of Audit Engagement LetterContents of Audit Engagement LetterContents of Audit Engagement Letter

Description of the project, the finance and parties thereto

Description of financial statements and 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 submission of audit report

Deliverables, outputs and opinions

Submission of audit program, staffing plan & audit proposal

Submission of Management Letter

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Responsibilities of the AuditorResponsibilities of the AuditorResponsibilities of the AuditorResponsibilities of the Auditor

► Submit a proposal outlining audit methodology, staffing plan, audit programme & audit fees

► Express audit opinions as per ToR

► Provide a Management Letter as per ToR

► Provide an IFAD official language translation of the audit report in case the report is in the local language

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Follow up of audit recommendationsFollow up of audit recommendationsFollow up of audit recommendationsFollow 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 compliance with audit recommendations in a timely manner

A Log of Audit Observations must be prepared

The log must record each audit observation & the validation by the auditor that corrective action has been taken

Should be updated periodically and submitted to Supervision Missions

Follow up status must be reviewed by the Project Coordinator/ IFAD/ Internal Auditor/ External Auditor periodically

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Log of Audit Observations

Status of auditsStatus of auditsStatus of auditsStatus of audits

For each project, a status of audits must be prepared as per the following format

Should be updated regularly and submitted to Supervision Missions

Audit Report for the Period

Due Date Submitted by Auditors on

Submitted by IFAD on

Remarks

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Desk review of audit reports - 1Desk review of audit reports - 1Desk review of audit reports - 1Desk 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

Desk review of audit reports - 2Desk review of audit reports - 2Desk review of audit reports - 2Desk 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

Audit Review Form/ChecklistAudit Review Form/ChecklistAudit Review Form/ChecklistAudit Review Form/Checklist

⇉ ARTS is an aIterative tool, prepared by IFAD for implementation support

⇉ Increased importance due to renewed emphasis on fiduciary

responsibilities under direct supervision

⇉ Analyses completeness and reasonableness of:

financial statements

audit opinions

audit work performed

⇉ Lists major follow up action to be performed by project

⇉ May require action plan to be prepared

⇉ Updated format launched with new audit report tracking system (ARTS)

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Project Audits - ChallengesProject Audits - ChallengesProject Audits - ChallengesProject 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)

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