REPORT OF THE EXTERNAL AUDITOR

ON THE FINANCIAL STATEMENTS OF
THE FOOD AND AGRICULTURE ORGANIZATION OF THE UNITED NATIONS
FOR THE FINANCIAL PERIOD 1 JANUARY 1998 TO 31 DECEMBER 1999

REPORT OF THE EXTERNAL AUDITOR

ON THE FINANCIAL STATEMENTS OF

THE FOOD AND AGRICULTURE ORGANIZATION

OF THE UNITED NATIONS

FOR THE FINANCIAL PERIOD 1 JANUARY 1998 TO 31 DECEMBER 1999

General

Introduction

1. - The present report is being submitted on the results of the audit of the Food and Agriculture Organization (FAO) for the 1998-99 biennium. The scope of the audit was determined in compliance with Financial Regulations 12.1 to 12.10 of the Organization as well as with the Additional Terms of Reference Governing External Audit appended thereto. The audit was carried out at Headquarters and in the field offices. In 1999 and 2000, my staff visited two Regional Offices and nine Country Offices in Latin America, Africa, Middle-East and Asia where they carried out financial and management audits of the FAO Representations (FAORs) and of a selection of projects, especially the Special Programme for Food Security whenever applicable. Their observations and recommendations were reported separately to the Director-General following the conclusion of each visit. They have been incorporated in the present report when and where appropriate.

2. - The present report, which was written in English, includes the observations and recommendations arising from the audit of the financial statements of the FAO for the period 1 January 1998 to 31 December 1999 (first part) and from the management reviews conducted (second part). The third part addresses the cases of fraud or presumptive fraud reported.

Audit of the financial statements

3. - My staff audited the financial statements of the FAO for the period 1 January 1998 to 31 December 1999 which were submitted by the Director-General in accordance with Financial Regulations 10.3, 10.4 and 11.5 of the Organization. However, the compliance with Financial Regulation 11.5, which states that "the final and any interim accounts shall be submitted to the External Auditor not later than 31 March following the end of the period to which they relate" was only formal. My staff was indeed provided, on 31 March 2000, with the FAO financial statements and notes appended thereto for the period 1 January 1998 - 31 December 1999. However, a complete revised version of the financial statements and notes was submitted to my staff on 7 April 2000 following the last minute introduction of significant changes in accounting principles and presentation.

4. - As for previous biennia, both versions submitted were not complete. The statements of ex-gratia payments and losses written off during the financial period, defined by Financial Regulations 10.3 and 10.4, respectively, were not included. Furthermore, one of the statements (Status of Regular Programme Appropriations - Statement IV) was not comprehensive. Although I have not previously raised this issue, it has in fact been the custom in previous biennia that the two statements mentioned above were only provided after the 31 March deadline. In the case of Statement IV the only difference with past practice was that it used to be provided in complete form but on the understanding that the figures for budgetary transfers were provisional. This time, budgetary transfers were left out so that they could be inserted once the final figure for expenditures was known at audit end. As far as staff related liabilities were concerned, it should be further noted that both versions of the financial statements submitted (31 March and 7 April 2000) were still based on the actuarial value as at 31 December 1997. This was again in line with past practice since the actuarial review, which was based on the whole biennium transactions, could not be completed by the 31 March deadline.

5. - However, while for previous biennia, the results of the actuarial review were known by July following the biennium end at the latest, they were only available on 13 October 2000 for the 1998-99 biennium. The main reason for the delays encountered was due to the tendering process that took place to select the actuary, with which I concur. I recall that, in the past, waivers of competition had been granted on the grounds that the incumbent should be retained given its intimate knowledge of the schemes, time constraints and the complex nature of the work. On the basis of the lowest offer meeting specifications, a new actuary was selected. However, it overran the time requirements, which called for completion of the actuarial review by the first week of July 2000 at the latest. The Organisation agreed to extend the deadline on the basis of a revised timetable agreed with my staff in the meantime.

6. - In fact, as the audit continued after the traditional time for its completion, it became apparent that a new version of the statements would be needed to take into account the adjustments, which had arisen from my staff's review so far and from the "clean-up" work the Organization intended to do with the assistance of a consulting firm from July to September 2000, respectively. These adjustments were in fact reflected in the revised version of the financial statements my staff were provided with on 6 October 2000. As mentioned below [paras. 36 to 37], the "clean-up" led to the reclassification of certain receivables and payables with only a limited impact on Statement I. My staff was finally provided, on 17 October 2000, with a final version of the financial statement that took into account the actuary review results mentioned above.

7. - The audit was carried out in accordance with the common auditing standards of the Panel of External Auditors of the United Nations (UN), the Specialized Agencies and the International Atomic Energy Agency. These standards require that the audit be planned and carried out so as to obtain reasonable assurance that the financial statements are free of material misstatement. The Director-General is responsible for preparing these financial statements, and I am responsible for expressing an opinion on them.

8. - The audit included an examination, on a test basis, of evidence supporting the disclosures in the financial statements. Also, it included assessing the accounting principles used and the compliance with legal authority as well as evaluating the overall presentation of the financial statements. Finally, it was also carried out in connection with the audit I was requested to perform on the following separate financial statements for the programmes executed and/or implemented in cooperation and/on behalf of other organisations, namely:

• the FAO/World Bank Cooperative Programme Statement of Expenditure incurred for the period 1 January 1998 to 31 December 1999, submitted on 7 April 2000;
  
  
• the FAO/United Nations Development Programme (UNDP) Status of Funds and Schedule of Expenditure as at 31 December 1999, submitted on 5 May 2000; and
  
  
• the FAO/United Nations Population Fund (UNFPA) Status of Funds and Schedule by Project and Component as at 31 December 1999, submitted on 8 May 2000.

The audit enabled me to issue the unqualified audit opinion on the FAO financial statements, which is reproduced on page 3.

Review of management matters

9. - In addition to the audit of the accounts, my staff carried out a management review of the implementation of the following three policies:

• human resources management;
  
  
• publications; and
  
  
• Special Programme for Food Security (SPFS).

They also conducted a follow-up review of:

• the implementation of the new financial system to replace the legacy systems (Finsys/Persys), which included a specific review of the Finance Division reorganisation and staffing, in line with this implementation; and
  
  
• the decentralisation of operations to Regional Offices.

SUMMARY

FINANCIAL MATTERS

Format of financial statements

10. - During the financial period the Organization implemented a new financial system as a result of which certain transactions and balances were no longer grouped or classified in the same way as in the past. Furthermore, in line with my previous recommendations and applicable accounting standards, the FAO introduced a number of changes in its accounting policy and presentation, which reflected better the nature of the operations and the position of the Organization at the end of the financial period. [paras. 21 to 23]

Financial position of the Organization

11. - Compared to the previous biennium, the financial position of the Organization as at 31 December 1999 deteriorated with a net shortfall of income over expenditure of US$ 25.9 million, as opposed to a net excess of US$ 96.1 million for 1996-97. The gross excess of income over expenditure, which was more than double compared to the previous biennium was completely offset by additional expenditure generated notably by the redeployment and separation exercise and the new policy implemented for staff related liabilities for US$ 10.6 million and US$ 64 million, respectively. Other notable variations compared to the previous biennium were related to the liabilities, which increased overall by 33%. [paras. 24 to 25 ]

Specific financial and accounting issues

12. - As a follow-up on issues raised in my previous report and in view of the new accounting and financial system implemented in the course of the biennium, my staff examined the following specific financial and accounting issues:

• staff related schemes; [paras. 26 to 29]
  
  
• contribution receivable and incentive scheme for the prompt payment of contributions; [paras. 30 to 31]
  
  
• Tax Equalization Fund (TEF); [paras. 32 to 33]
  
  
• accounts payable and receivable; [paras. 34 to 37]
  
  
• unliquidated obligations. [paras. 38 to 39]

Cash and investments

13. - Many changes have occurred in the area of cash and investments since my previous report. A significant one took effect as at 1 January 1999 when WFP assumed direct control of its own Headquarters accounts previously managed by the FAO. Because of the importance of these accounts, funds controlled by the FAO reduced drastically. As at 31 December 1999, they amounted to US$ 454.1 compared to US$ 992.4 million as at 31 December 1997. Other changes were related to the provision of corporate banking services, assets management and oversight functions. However, while decisions were indeed taken in many areas, the staffing problems of the Finance Division did not allow the Organization to progress as planned on several issues. [paras. 40 to 71]

Review of two specific programmes: "Oil for food" and TeleFood

14. - My staff carried out specific reviews of two different programmes. The first was the "oil for food" programme, which financed humanitarian supplies to Iraq under the Security Council Resolution (SCR) 986. Like other UN agencies, the FAO, which was in charge of the agricultural component, supervised the Iraqi Government's implementation of the programme in the central and southern Governorates and directly implemented it in the three northern Governorates. The combination of the surging oil prices and the removal of the ceiling on Iraqi oil export made the programme reach unprecedented financial importance. It has become the largest programme ever managed by FAO in its history [paras. 72 to 91]. The financial importance of Telefood, on the contrary, was limited. As at 31 December 1999, 461 micro projects were approved using funds collected from the first two campaigns, with US$ 2.29 million expenditure recorded against US$ 3.69 million proceeds. [paras. 92 to 103]

MANAGEMENT MATTERS

Human resources management

15. - In mid-1999 my staff audited the human resources management in FAO. They analysed the evolution of the workforce as well as the policies implemented by the Organization to manage it according to set objectives or constraints. They also examined the distribution of responsibilities and the role of the Personnel Division (AFP), at the time, with a focus on the recruitment and appraisal procedures. [paras. 104 to 134]

Publications

16. - During the biennium my staff reviewed the management of the General Affairs and Information Department (GI). Their work was focused on the FAO publication policy, especially on the impact the new financial framework for the handling of documents and publications had on the functioning of the four pool accounts. [paras. 135 to 141]

Special Programme for Food Security (SPFS).

17. - The SPFS, which focused on Low-Income Food-Deficit Countries (LIFDCs) commenced its operations in late 1994. My staff's review of the programme was initiated at Headquarters in 1998 and pursued during the field visits conducted in 1999 and 2000. Out of the nine Country Offices visited, the programme had been launched, but not implemented in one country, and implemented in seven others (three in Africa, two in Asia, one in South America and one in the Middle East. [paras. 142 to 166]

Decentralisation

18. - The policy of progressive decentralisation away from Headquarters, which was approved by the Council, acting on behalf of the Conference with delegated power, at its 106^th Session in May/June 1994, was implemented in 1996 and further developed throughout the 1998-99 biennium. As a follow-up to previous reviews carried out in 1998, my staff visited two of the five Regional Offices between November 1999 and February 2000 in order to assess the state of implementation of the decentralisation of operations. [paras. 167 to 175]

New financial system implementation

19. - The proposal to replace the legacy systems (Finsys/Persys) was endorsed by the Finance Committee at its 78^th Session in April 1994. In my previous report I had mentioned that a partial implementation of the original replacement plan was expected to be achieved at the end of 1999 at a cost of US$ 17 million, including equipment, software and implementation costs. In fact, the system went live at the end of May 1999. Development costs incurred since inception of the project amounted to US$ 19.5 million as at 31 December 1999 (exclusive of FAO staff costs), while maintenance costs incurred since implementation amounted to US$ 1.5 million. Furthermore, the first year and a half of the new system in operation was hampered by major implementation problems. The review my staff conducted analysed how this came about with a view to identifying the causes for such developments. [paras. 176 to 210]

OTHER MATTERS

Cases of fraud

20. - Pursuant to item 6 (c) (i) of the Additional Terms of Reference Governing External Audit, the present report mentions the cases of fraud or presumptive fraud known to the Organization and reported to my staff. [paras. 211 to 219]

LONG FORM REPORT

FINANCIAL MATTERS

Format of financial statements

21. - In line with my previous recommendations and applicable accounting standards, the FAO introduced a number of changes to its accounting policy and presentation, which reflected better the nature of the operations and the position of the Organization at the end of the financial period.

• The unutilised appropriation for the Technical Cooperation Programme (TCP) was no longer treated as a deduction from the assessed contributions income but as a charge to the General Fund. As a result, a new line entitled "Deferred income" has been added to Statement I.
  
  
• Voluntary contributions and funds received under inter-organisational arrangements income now strictly equalled the amount of projects expenditure since the interest on donors unutilised cash balances was no longer deducted from projects expenditure. As a result, a new line entitled "Transfer of interest to donors accounts" has been added to Statement I.

22. - Moreover, as the Organization started to amortise the unaccrued portion of its liability in respect to After Service Medical Care (ASMC), a new line entitled "Amortisation of after service liabilities" has been added to Statement I. Furthermore, in line with the Conference Resolution 10/99 that approved that any income generated from the investments held in respect of the Separations Payments Scheme (SPS) and Compensation Plan Reserve Fund (CPRF) be earmarked to the ASMC liability, another line entitled "Staff related schemes" has been added to Statement I. Other changes were related to the fact that:

• Staff fiduciary accounts, which were previously disclosed under the line "Staff related schemes" in Statement II, have been reported under "Accounts payable".
  
  
• Likewise, investments held on behalf of the World Food Programme (WFP), which were also disclosed under the line "Staff related schemes" in Statement II, have been reported under "Accounts payable".

All the changes linked to staff related schemes are further commented upon below. [paras. 26 to 29]

23. - Last but not least, a new line entitled "Redeployment and separation costs" has also been added to Statement I to disclose the expenditure incurred under the US$ 12 million Special Spending Authority granted by the Conference Resolution 7/97. I also noted that the financial statements, which used to be presented in millions of US dollars, are now presented in thousands of US dollars. Furthermore, as a result of the new accounting and financial system implementation, certain transactions and balances were no longer grouped or classified in the same way as the past. I, however, regret that the opportunity was not taken to eliminate the necessity of manually adjusting the Trial Balance in order to produce the financial statements. At the time of writing this report, my staff was, however, informed of the procedures and processes currently introduced to reduce the scope of the manual adjustments needed. The Organisation expected that when the reports would eventually be produced directly from the data warehouse, and monthly accounts closure procedures be strengthened, the practice of making manual adjustments would no longer be required.

Financial Position of the Organization

24. - Compared to the previous biennium, the financial position of the Organization as at 31 December 1999 deteriorated with a net shortfall of income over expenditure of US$ 25.9 million, as opposed to a net excess of US$ 96.1 million for 1996-97. The gross excess of income over expenditure was, however, more than double compared to the previous biennium (partly because of some of the above-mentioned changes in the presentation). However, it was completely offset by additional expenditure generated notably by the redeployment and separation exercise and the new policy implemented for staff related liabilities for US$ 10.6 million and US$ 64 million, respectively. However, while at the end of the previous biennium, indebtedness of the General Fund towards the Working Capital Fund (WCF) and the Special Reserve Account (SRA) stood at US$ 23.7 million and US$ 32 million, respectively, all advances had been reimbursed during the 1998-99 biennium. The only advance made during the biennium (on 29 October 1998 for US$ 30 million from the SRA) was reimbursed on 10 November 1998.

25. - As far as Statement II was concerned, an increase of 33% of the liabilities occurred with a total amount of US$ 561.3 million as at 31 December 1999 compared to US$ 421.1 million one biennium ago. While contributions received in advance increased by 6% only, the most significant increase (+109%) was related to accounts payable. As previously mentioned, part of the upsurge was related to the change that occurred in respect to staff related schemes. It was, however, also the result of the problems encountered in this area, which are commented upon further [paras. 34 to 37]. The increase in the unliquidated obligations (+86%) was mainly attributable to an increase in the accrued expenditures in respect to the "oil for food" Iraqi programme. [paras. 38 to 39].

Specific financial and accounting issues

Staff-related schemes

26. - The FAO sponsors the four following types of after-service benefit plans:

• Separation Payments Scheme (SPS) for general service staff in Headquarters;
  
  
• Compensation Plan Reserve Fund (CPRF) for separation due to death, disability or sickness;
  
  
• Termination Payments Fund (TPF), which covers accrued annual leave, repatriation grant, termination indemnity, repatriation travel and removal of household goods; and
  
  
• After-Service Medical Care (ASMC).

27. - In the 1996-97 biennium, the Organization started implementing new policies, which consisted of:

• reporting the accrued liability in respect of staff as a consolidated amount, with details of the Organization's future obligations provided in notes to the financial statements;
  
  
• reporting the accrued liabilities at their actuarial value supported by actuarial reviews;
  
  
• distributing the investments held by the Organization between the various schemes, on the one hand, and the General Fund, on the other hand and;
  
  
• crediting the income generated by such investments to Statement I.

28. - As of the present biennium, the Organization started amortising the unaccrued portion of its liability in respect to ASMC. An amount of US$ 21.1 million was, therefore, recognised as at 31 December 1999. Furthermore, in line with the Conference Resolution 10/99, the excess income generated from the investments held in respect of the SPS and the CPRF and the portion of the SPS and CPRF investments exceeding liabilities were earmarked for the ASMC. These amounted to US$ 42.8 million and US$ 10.9 million, respectively, on the basis of the actuary review as at 31 December 1999. As a result and together with the excess of contributions over disbursements for the biennium, which amounted to US$ 4.3 million, an amount of US$ 79.2 million has been recognised as ASMC liability at the end of the 1998-99 biennium. Since the actuary review as at 31 December 1999 led to a AMSC valuation inferior to the one computed as at 31 December 1997 (US$ 188.8 million versus US$ 195.1 million), almost 42% of the liability related to ASMC has been recognised as at 31 December 1999.

29. - In view of this achievement, I, therefore, reiterate the recommendation I have made in my previous report with respect to termination of service benefits. As mentioned at the time, this obligation was funded, in part only by the TPF, the other part not being funded. The Organization accounted for the expenditure on cash paid, rather than an accrual basis. Since the operation of the TPF had become extremely complex as a result of successive modifications in contributions, eligible staff and eligible benefits since its creation in 1972, its assets covered only US$ 2 million of the US$ 22.4 million actuarial liability as at 31 December 1997. Based on the results of the new actuary review, the situation deteriorated as at 31 December 1999 since the US$ 23.6 million liability was not provided for at all. I reiterate, therefore, my previous recommendation to thoroughly review the purpose and operation of the TPF with a view to establishing a consolidated mechanism to provide for the funding of all recognised end of service liabilities. At the time of writing this report, my staff was informed of the Organization's intention to submit, to the May 2001 Session of the Finance Committee, a paper, which would address my concerns with respect to termination payments.

Contributions receivable and incentive scheme for prompt payment of contributions

30. - Contribution receivable for the General and Related Funds increased from US$ 154 million as at 31 December 1997 to US$ 169.2 as at 31 December 1999. As detailed in the note 14 to the financial statements, most of the contributions outstanding were related to the Regular Programme assessed contributions (US$ 151.2 million). One hundred and five Member Nations were still in arrears for the payment of their assessed contributions at the end of the biennium. For 14 of them arrears exceeded US$ 1 million, altogether accounting for 89% of the total arrears. Other contributions receivable were in respect of Governments cash contributions towards FAORs operating costs (US$ 5.4 million), the WCF (US$ 1.6 million) and the SRA (US$ 10.9 million).

31. - To encourage prompt payment of Regular Programme contributions, an incentive scheme was introduced, on a trial basis, on 1 January 1993. Assessed contributions paid in full prior to 31 March of the year of assessment qualified for a discount on the condition that there were no arrears outstanding. Following a revision of the modalities for its calculation, adopted by the Conference in November 1997, the applied discount became, as of 1 January 1998, proportional to the promptitude of payment during the first quarter of the year when the contribution was due. As shown in the table below, contributions paid in the first quarter of the year amounted to US$ 93 million in 1998 and US$ 92 million in 1999. They were more or less in line with the amounts recorded for the previous years, with the notable exception of 1997 whose exceptionally high amount resulted from the payment of a large contribution at the end of March. On the basis of the new modalities, the discount applied was, however, greatly reduced since it only amounted to US$ 617,577 in 1998 and US$ 357,791 and 1999.

Tax Equalization Fund (TEF)

32. - National taxation of income earned from FAO was reimbursed to staff members and charged back to the Member Nations concerned through the Tax Equalization Fund (TEF). Following the recommendation I made in my previous report, the Organization made arrangements with Member Nations to clear the amounts receivable and payable, which were still pending at the end of the previous biennium.

33. - However, my staff noted that during the data migration process from the legacy systems to Oracle applications the opening balance was posted in Oracle General Ledger as a total figure. This meant that the detailed balances by staff member had to be reconstituted in the new system. The work was made more complicated by the fact that since tax advances and reimbursements fell under the responsibility of the Liaison Office in Washington (LOWA), postings done through an imprest account had been processed through the Field Accounting System (FAS). As a result, at the time of my staff's review, over US$ 1 million of advances, which should have been posted to the relevant TEF account, were still recorded in two accounts receivable accounts, namely 2800 "prepayments" for FAO staff and 2805 "WFP" for WFP staff. The problems were being addressed at the time of writing this report. In view of the recurrent need to speed up the recovery process of the advances, I recommend that some sort of automatic salary recovery be set up and that the corresponding system change be implemented.

Accounts payable and receivable

34. - As previously mentioned, accounts payable increased significantly reaching US$ 54.4 million as at 31 December 1999 compared to US$ 26 million as at 31 December 1999 (a 108.8% increase). For the main part, the increase was related to the change that occurred in respect to staff related schemes. Staff fiduciary accounts, which were previously disclosed under staff related schemes were now reported under accounts payable and accounted for US$ 12.8 million at the end of the biennium. Likewise, the amount in respect of the investments held on behalf of the WFP (US$ 19.3 million) was no longer disclosed under staff related schemes but under accounts payable. However, the increase was also the result of the problems encountered in this area with backlogs in payment. In fact, considering the number of complaints from users in FAO and payees, the Office of the Inspector-General (AUD) brought forward the review it had intended to carry out on accounts payable. The review's results were, however, not yet available at the time of writing this report.

35. - As far as accounts receivable were concerned, the surge between the two biennia was not as significant: from US$ 39.5 million as at 31 December 1997 to US$ 55.4 million as at 31 December 1999, or a 40% increase. It was mainly attributable to the growth of the debt of other organisations towards the FAO (+152%). Out of a global amount of US$ 22.3 million, the largest shares were related to the World Bank and the WFP with amounts of US$ 6 million and US$ 14.7 million, respectively. The amount receivable from WFP represented the net salaries paid by the Organization for WFP from September to November 1999. Due to the late issuance of the corresponding invoice, WFP had not reimbursed FAO at the end of the biennium. My staff further noted that the amount recorded as payable in WFP's Books did not reconcile with the ones of FAO as receivable. As noted in my report on the financial statements of the WFP for the 1998-99 biennium, the unexplained difference was not material enough to qualify my opinion. However, as already recommended to the WFP, the reconciliation initiated between both organisations should become a routine exercise performed on a monthly basis. At the time of writing this report, my staff was informed of the improvements made in the timing of the accounting for the monthly payroll cost, which was the main invoicing component for WFP. As a result, the Organization targeted for a monthly issuance of invoices in the near future. As for now, the FAO has started a reconciliation procedure with WFP for each quarterly invoice. Moreover, the Organization had written to WFP seeking its agreement to increase the current payroll advance lump sum payment from US$ 4 million to US$ 8 million, which would lead to a further reduction of the receivable balance towards WFP at any point in time.

36. - In my previous report I recommended that, in line with the new financial system implementation, the accounting and organisational procedures for posting transactions to receivable and payable accounts be reviewed with a view to making them easier to identify, monitor and clear throughout the biennium. This objective has already been partially attained. Two new units, specially dedicated to accounts receivable and payable, respectively, had been set up. Nevertheless, because of the overall staffing problems in the Finance Division, both units did not have the resources to tackle outstanding issues that dated back from the legacy systems and were related to the reconciliation of Finsys General Ledger with the sub-ledgers. As a result, several accounts were still in need of extensive cleaning up and reconciliation when the first and second version of the financial statement were submitted to my staff.

37. - Additional work was carried out with the assistance of a consulting firm from July to September 2000. As a result of the adjustments that were subsequently posted, accounts payable were reduced by 8% while accounts receivable were increased by 8% between the 7 April 2000 version of the financial statements and the 6 October 2000 one. The consulting firm had also issued several recommendations, with which I concur, to improve internal control and procedures by obtaining contracts and supporting documentation for all prepaid expenses and by strengthening accounting systems for recording the transactions. I further recommend that automatic recovery of travel advances to staff members, which was put on hold at the end of April 2000 because of travel expense claims backlogs, be re-initiated as soon as possible.

Unliquidated obligations

38. - As previously mentioned, unliquidated obligations increased significantly from US$ 59.4 million as at 31 December 1997 to US$ 110.2 million as at 31 December 1999. This increase (+86%) was mainly attributable to an increase in the accrued expenditures in respect to the "oil for food" Iraqi programme [paras. 72 to 91]. In my previous report, I had commented on the complex and time-consuming exercise to determine unliquidated obligations. In this connection, I had recommended that, for the future, the Organization might consider simplified criteria, which could be incorporated into the accounting systems for recognising the validity of non-disbursed commitments at the end of a biennium.

39. - The implementation of the new financial system and related procedures brought significant improvements in this area. On the one hand, only outstanding purchase orders were automatically accrued. On the other hand, the accruals procedures for transactions which were processed through the sub-systems (Atlas for travel and FAS for the field) have been simplified to include only those non-disbursed commitments related to the biennium. In the case of travel, the period end accruals were based upon travel advances processed as at 31 December 1999. For the field, the accruals were based upon information provided by imprest account holders and checked by either the Office for Coordination of Normative, Operational and Decentralized Activities (OCD) or the AFF's Project Accounting Unit for FAORs accruals and project accruals, respectively. The random and judgmental samples reviewed by my staff did not disclose any invalid accruals.

Cash and investments

Background

40. - Many changes have occurred in the area of cash and investments since my previous report. A significant one took effect as at 1 January 1999 when WFP assumed direct control of its own Headquarters accounts previously managed by the FAO. Because of the importance of these accounts, funds controlled by the FAO reduced drastically. As at 31 December 1999, they amounted to US$ 454.1 compared to US$ 992.4 million as at 31 December 1997. They were made up of current and deposit bank accounts for US$ 290.6 and long-term investments earmarked to provide for staff related-liabilities for US$ 163.5 (US$ 19.3 million held on behalf of WFP included).

41. - As outlined in the paragraphs below, other changes were related to the provision of corporate banking services, short-term assets management and oversight functions. In February 1999 the Organization also contracted out a consulting firm for the provision of investment advisory services. Fees up to the end of December 1999 amounted to US$ 20,285. The firm was selected through a competitive process, which was not managed, however, by the procurement services but directly by the Finance Division in application of the derogatory procedures provided for in section 502.14 of the FAO manual. Three firms were invited to bid. Although they could be considered as leaders in this kind of service, the fact that they were all based in the same country outside the Euro zone could be questioned. Considering the amount of funds, which would eventually be received and disbursed in Euro, I recommend that future invitation to bid be more geographically open especially towards the Euro zone.

Number of bank accounts

42. - In my previous report, I had recommended that the number of bank accounts be reduced. There were still 25 Headquarters bank accounts as at 31 December 1999. Although this constituted an improvement compared to the 31 December 1997 situation (36 accounts), it was far above the Organization's target of 13 announced in my previous report. Apart from the reduction of Telefood accounts from 87 to 62, no other substantial change was made to decrease the number of field accounts.

43. - The Organization had indeed recognised the need to restructure its banking arrangements and had formulated a three-tiered approach but because of problems in field bank reconciliation [paras. 45 to 46], and staff shortage [paras. 200 to 207] notably, only partial implementation had been made to date. The strategy envisaged involved:

• A banking relationship to manage Headquarters payments in Lire, Euro and staff accounts held in Italy.
  
  
• A banking relationship with a major international bank to handle international payments outside of Italy, with one or more specific currency accounts opened and the use of the bank's global system and software to relay the payments to zero balance accounts in the country concerned and monitor the transactions.
  
  
• Several banking relationships with other international banks with strong retail presence in particular regions of the world, to operate other field banking required.

44. - At the time of writing this report, the first tier of the strategy was in place. As detailed in the following paragraphs, a contract had been concluded in May 2000. Another contract had also been concluded for the second tier, but its full implementation was only expected to take place over the next few months. No action had been taken yet with regards to the third tier. My staff was informed of the Organization's intention, with which I concur, to select the banks needed through a competitive process. Once fully implemented, the Organization expected that the envisaged strategy would reduce the number of retail banking relationships and accounts drastically and the cost of banking to FAO by a significant amount.

Control of bank accounts

45. - Some of the difficulties noted in my previous report regarding bank accounts continued throughout the 1998-99 biennium. Records kept of the bank accounts opened by the Organization, the persons authorised to operate them and their terms and conditions, were not up-dated as often as required because of staffing problems in the Treasury Unit [para. 207]. The bank reconciliation remained a time-consuming and cumbersome procedure for all the field accounts. The cash management module of Oracle applications, which had been implemented at the end of May 1999, had only been used for the reconciliation of the main Headquarters bank accounts. For the others, the bank reconciliation remained a manual exercise, which was rendered even more difficult than in the past because of the FAS problems [paras 184 to 190].

46. - As noted in my previous reports, the FAO was still not organised to manage its cash in an optimal manner. Cash flow forecasts remained insufficiently timely and reliable. A cashbook treasury module had been acquired on 29 December 1995 for US$ 130,769. Being a component of the initial offer made by Oracle, this module was meant to be interfaced with Oracle Financials once implemented. However, a very limited use of the module was made before it was decided to abandon it in October 1998. With the addition of installation and maintenance costs up to 31 March 1998, a total amount of US$ 157,222 (excluding FAO staff costs) was spent on the project for results close to nil.

Corporate banking services

47. - In my previous report, I underlined the fact that the Organization had never entered into specific written agreements with its banks to detail the banking conditions applied. Even for the accounts opened in a major bank at Headquarters, which carried average monthly balances of US$ 100 million, no comprehensive document existed. Written agreements indeed existed but they addressed specific issues such as the services rendered to FAO staff (yearly negotiated by the Joint Staff Committee), the use of FAO premises by the bank and the conditions to be applied to the official bank accounts. Also, on a similar note, I noticed that no competition had been organised, from time to time, for the provision of banking services. The Organization had indeed solicited the interest of banks to provide Headquarters banking services several years ago but the granting of licences from the relevant authorities was a major obstacle at the time. Since these conditions changed in the early 1990's, the decision to issue a tender was taken in March 1995. It was, however, postponed because of the Finance Division's involvement with the new financial system. I therefore recommended that the Organization called for international bids for the provision of corporate banking services.

48. - Initial steps to implement this recommendation had been taken in 1997 and the bank was informed in April 1997 of FAO's decision to issue a tender for corporate banking services. Nevertheless, a few months later, the Organization decided to postpone it for two years "to avoid a conflict of interest situation". Such would have arisen from the fact that the bank had offered a voluntary contribution of It.L 500 million for the Telefood 1997 event. The donation was not paid to the Organization itself but to an association. The bank made a similar donation for the 1998 campaign, which was also paid to an association.

49. - Invitations to bid were eventually issued on 26 March 1999 to 28 international banks. Prior to this issuance, my staff had further advised the Organization to carry out separate tenders for the corporate banking services required and the retail banking services to staff members, respectively. My staff specifically pointed out the risks that might stem from a decision to link both services. Some leading international banks, which might have been willing to compete for corporate banking services, might not have bid because of their reluctance to open a branch on the premises for the provision of staff banking services. However, since the Organization's intention was to have one single bank physically located on the premises to provide overall Headquarters services both to the FAO and its staff members, only one tender was issued. As a result, only three Italian banks provided validated bids.

50. - My staff also noted the incompleteness of the tender document prepared by the Organization. In particular, this document did not give any indication of the expected volumes of transactions by type and value. Since the vagueness of the tender document did not permit bidders to figure out the optimum pricing strategy, it provided an obvious advantage to the current contractor. My staff was assured that, following a request from a specific bank, all banks were provided with the missing information. Nevertheless, it would have been better to provide the information at the outset. The contract was awarded to the current contractor in July 1999, in accordance with the Tender Evaluation Panel's recommendation to the Director-General. However, it took ten more months for the Organization to finalise the contract with the bank, which took only effect in May 2000. The subsequent negotiations that took place in the meantime dealt with the software changes to be made by the bank and the specific service standards for both corporate and retail services.

51. - My staff could not be provided with an overall assessment of, on the one hand, the improvements to the banking services rendered to the Organization or its staff and, on the other hand, the savings the new contract brought compared to former arrangements. However, they noted that, firstly, the Organization no longer paid for the annual charges that it had paid since 1991, and secondly, the bank agreed to pay for the rent of the space provided to it on the FAO premises, which was previously free of charge. These new arrangements resulted in an annual saving of It.L 272 million for the former and additional revenue of It.L 75 million for the latter. Last but not least, I noted the significantly improved interest rates applied to the balances of FAO bank accounts as shown in the table below.

52. - As previously mentioned, another contract had also been concluded for the second tier of the envisaged banking strategy. The agreement was signed in September 2000 with a non-Italian bank, with which the Organization already had a banking relationship. However, unlike the above-mentioned case, no competitive tendering process was carried out. The agreement covered the set-up, under an existing account, of zero balance accounts for the field transactions and the provision of the bank's software to get on-line tracking, transaction control and reconciliation services. I am of the opinion that calls for proposals to other banks would have guaranteed that the Organization would indeed be getting the services required at the best prices and conditions.

Short-term investments

53. - An important shift in the Organization's short-term investments has occurred since my previous report. In fact, throughout the 1998-99 biennium, FAO has adhered successively to three different strategies for the management of these investments. Before 1999 short-term assets not held in current accounts were invested in deposit and call accounts with an average maturity of six months. Banks were selected from an approved list of highly rated banks and maximum ceilings per bank were established. Therefore, the capital risk, which could only have resulted from the bankruptcy of one of the banks selected, was minimal and the Organization managed to get returns corresponding to the best offered rates through quotations with the listed banks. The assets were liquid.

54. - As already mentioned in my previous report, a consultant had recommended in 1998 to "externalise" the management of cash to achieve higher returns at reduced risks and free up Treasury Unit, which spent much of their time placing and tracking three-month deposit certificates placed with the banks, for other tasks. This new strategy was discussed at the 24^th Session (18 May 1998) of the FAO Advisory Committee on Investments (ACI), during which the consultant's report was presented. At the time, the ACI concluded that "on the grounds of increased returns, reduced risk and operational efficiency" it made sense to move the Organization's short-term assets to a commingled Short-Term Investment Fund (STIF). This STIF was managed by the same firm that was used for the custody of the Organization's long-term investments, which I found questionable. I found even more questionable the fact that the firm was not chosen through a competitive process. I recall that in my previous report I had specifically recommended that, should the proposal to "externalise" the management of short-term assets be considered, FAO should call for bids from several international cash managers.

55. - An addendum to the initial contract signed for the custody of the long-term assets was concluded and funds were subsequently transferred in early 1999. An amount of US$ 193.8 million was managed under this new strategy, as at 31 December 1999 and invested in debt issues of a major contributor with an average maturity of three months. In my opinion, the fact that the risks, though still minimal, were indeed "reduced", as announced at the above-mentioned Session of the ACI, could be disputed. If losing value through bankruptcy became unlikely, the value of the debt issues could be impaired by the rise in interest rates. Moreover, returns were not "increased". I noted that the returns obtained in 1999 (5%) were in fact lower than the ones attained by the Credit Union on its US dollar bank deposits (6.01%) as disclosed in note 4 to the financial statements for the period ending 31 December 1999. The fees paid to the manager amounted to US$ 316,000 for 1999.

56. - During its 25^th Session (28 May 1999), the ACI felt that the funds placed in the STIF "could safely be invested in bank deposits or other good quality short-term securities rather than government securities" and that "this would increase yields at little additional risk". The ACI endorsed the recommendation of the Organization's consulting firm on treasury matters to shift some of the assets to a one to three year portfolio, but cautioned that such a strategy would expose FAO to periodic losses. The matter was then discussed by the Investment Committee (IC) during its 2^nd Session held on 20 October 1999. The IC decided that a short list of potential managers be selected from a longer list of managers considered by WFP and IFAD with the help of the FAO's consulting firm. Four firms that specialised in the management of fixed income assets were interviewed by the IC on 10 December 1999. It should be noted that, in spite of the views of certain members that the role of custodian and fund manager be separate, the current custodian and short-term manager was part of the four pre-selected firms.

57. - Based on the different presentations, two firms were eventually selected by the IC to manage a short-term assets portfolio of US$ 100 million each. Their mandate would be to seek higher returns by placing the investments at a longer maturity (one to three year securities) and by taking selective credit risks (a wide range of securities being authorised). Furthermore, the portfolio should be sufficiently liquid such as US$ 12.5 million could be withdrawn on 24 hours notice. At the 26^th Session of the ACI (26 May 2000), guidance was sought on the appropriate benchmark, which was proposed at 25 base points above the three-month LIBOR rate net of costs. The ACI cautioned, however, that before proceeding with any changes to the current situation the Organization should assess the relative value at risk and ensure the appropriateness of the controls in place.

58. - At the time of writing this report, this third strategy had still not been implemented. Finalisation of the draft contracts with the two managers selected had been awaiting the implementation of improved controls. In this regard, my staff was informed that the FAO had proposed an arrangement whereby, for an annual fee, the IFAD would take over the monitoring, control and other investment management functions in support of FAO investment management. The arrangement, with which IFAD was in agreement, was expected to be finalised in the coming weeks. After this, FAO would proceed to request a value at risk analysis.

59. - Considering the present difficulties in forecasting cash flows in particular and in monitoring investments in general, the amount of the investments to be managed under this new strategy (US$ 200 million) could be questioned. Moreover, I am concerned that the Organization has shifted from a prudent strategy of investing its funds in excess, in bank deposits with acceptable returns to a riskier one, which could lead to periodic losses in capital. Since 85% of the cash in excess was usually related to Trust Funds, it should be kept in mind that any losses of funds that donors had entrusted to the FAO would have to be supported by the Organization's budget. At the time of writing this report, my staff was informed that the short term investment strategy would be reviewed by the ACI at its May 2001 Session and that the concerns I raised would be given to the Committee along with management's views on how it should manage this component of liquidity.

Long-term investments

60. - As for previous biennia, assets earmarked to provide for staff related liabilities were invested long-term. As mentioned in my previous report, the managing function and the custodial function of these long-term investments were separated in 1997, which I considered a positive move since these functions should be clearly segregated. In view of the difficulties the Treasury Unit had in overseeing the fund manager, I also considered the Organization's intention to entrust its long-term assets to two fund managers to be a very sensible solution, which should be implemented as early as possible through a competitive selection process. At the time of writing this report, no concrete changes were, however, introduced in spite of the extensive review and discussion of this issue undertaken by the two committees mentioned above (ACI and IC). In fact, once again the staffing problems of the Finance Division did not allow the Organization to progress on this issue.

61. - At its 25^th Session (28 May 1999), the ACI examined a review of the performance of the current long-term assets manager, which was operating under a balanced mandate (that allowed investing in both stocks and bonds). The review, which was conducted by the Organization's consulting firm on treasury matters, concluded that the manager had, overall, exceeded its benchmark. It nevertheless proposed that all fixed income assets, for which the manager's performance was below the average, be transferred to a specialist fixed income manager. For prudence reasons, it also proposed that part of the equity assets be transferred to an equity manager, considering that superior equity performance of the current manager was linked to growth stock in which it specialised but that could become less profitable. The ACI further recommended that FAO should take IFAD's guidance on the selection of both the fixed income and equity managers. The plan was to draw up a short list of potential managers with the assistance of IFAD and the FAO's consulting firm. On that basis, the interview and selection process would be carried out by FAO.

62. - Regarding fixed income long-term assets, the Organization felt that the two managers selected for managing the short-term assets could also manage them. The objectives were to have a sufficient asset base to achieve lower fees and to limit the number of managers for control purposes. It was endorsed by the IC at its 2^nd Session held on 20 October 1999. In December 1999 the IC decided accordingly that, in addition to the US$ 100 million worth of short-term investments, the two managers selected would also be awarded each with US$ 50 million to be invested in global fixed income portfolios. Such a decision raised the following issues:

• The selection process was originally launched in May 1999 in view of appointing short-term assets managers. However, it was decided to appoint them as long-term assets managers as well, whereas the criteria used to select the firms had been initially established in view of short-term assets management, only. It remained to be seen whether the managers selected could achieve good performance on both goals.
  
  
• The decision taken to transfer US$ 100 million of long-term assets, from the portfolio presently managed by the current manager to be invested in global fixed income portfolios, appeared premature. At its 25^th Session (28 May 1999), the ACI had recommended completing a certain number of "exercises" such as developing a statement of the long-term liabilities including their currency composition, asset allocation policies and guidelines, "before appointing any new managers". My staff was not provided with evidence that this preliminary work was carried out.

63. - The transfer was decided in December 1999, but had still not been implemented at the time of writing this report. After reviewing the improved performance of the current long-term manager for 1999, the Organization had second thoughts. During the 26^th Session of the ACI (26 May 2000), the consulting firm noted though that in spite of the improvements, the current manager's performance "could at best be classified as average". Nevertheless, since it was also pointed out that fixed income results did not vary as much between managers as equity results, the recommendation to await the introduction of adequate controls and reporting before making any management changes was endorsed. Regarding the second proposal, made by the ACI, to transfer part of the equity long-term assets to an equity manager, the consulting firm advised the ACI, during its 26^th Session, not to diversify the equity assets at that time. Its recommendation was endorsed by the ACI.

64. - As a result, none of the long-term assets had been transferred to new managers at the time of writing this report. While I do acknowledge that the current manager had, overall, exceeded its benchmark in 1999 and 2000, I still reiterate my previous recommendation to review the existing arrangements through a competitive process. The diversification, which had also been recommended by the ACI, would minimise the risks of having all long-term assets with the same manager implementing its own strategy, which might not be successful under all market conditions. It might also lead to a further reduction of the present fees that amounted to US$ 640,000 for 1999 on the basis of a contract renegotiated in September 1998. At the time of writing this report, my staff was informed that none of the long-term assets had been transferred to new managers because of lack of staffing and managerial time available to carry out the complex and time intensive processes involved in moving forward on this agenda. They were further informed that the Organization did not intend to move forward until it had: (i) completed the placement of the short-term portfolio; (ii) concluded the agreement with IFAD on investment management support; and (iii) reviewed the issue of long-term investments at the May 2001 Session of the ACI.