FC 93/11


Ninety-third Session

Rome, 13 - 17 September 1999

Progress Report on Implementation of the External Auditor's Recommendations

Attached for the information of Finance Committee Members is the Progress Report on the Implementation of the External Auditor's Recommendations.

External Auditor's Recommendation Action taken Auditor's Comments

Financial Position of the Organisation

Tax Equalisation Fund

I recommend that the necessary arrangements be made with the Member Nations concerned with a view to reducing their credits from the tax equalisation fund by the amount of tax reimbursement to their nationals.

The introduction of the new financial systems and related procedures has brought about a significant improvement in the control and follow-up of amounts reimbursed to FAO staff obliged to pay national taxation on their FAO derived income. The new AFF Receivables Unit is now responsible both for authorisation and accounting for tax payment amounts to be reimbursed to staff and for management of contributions due from member states, including any amounts to be offset against their Tax Equalisation Fund credit. The Unit will in future follow-up with the member state concerned on any such adjustments to be made and issue an appropriately adjusted invoice for the contribution due.

Invoices are now being sent routinely to those member nations which assess tax on the FAO salaries of its nationals.

The new financial system became operational too recently for us to be in a position to assess the improvement it can bring. The same applies for the AFF reorganisation.

Our review of the 1998 interim financial statements (conducted in April 1999) disclosed that some TEF outstanding balances remained to be cleared. Our next review will cover actions taken since that date.

Currency Exchange Arrangements

As a result of the audit of the 1996-97 accounts, I wish to put forward the two following recommendations:

a) that the FAO review the present methodology for accounting for and reporting on currency exchange differences with a view to simplifying it, making it more comprehensive and better differentiating notional and real gains and losses;

b) that the FAO review their current policy for hedging against changes in exchange rates (flat two-year forward purchase contract) with a view to better taking into consideration the new, more unstable, international exchange environment. Because of the narrowing interest rate differential, forward purchase may no longer be the preferable option.

a) A detailed review of the various rates of exchange which are used for certain functions (i.e. the UN rate, market rate, forward rate and budget rate) has been performed. The only one of these rates which is an accounting rate is the UN rate because this is the one which is used exclusively for recording all non-dollar transactions and balances. This practice complies with UN accounting standards but if the UN rate does not approximate the actual rate at the date of the transaction this approach may not conform to generally accepted accounting standards.

With effect from 1 January 1999 the UN Operational rate of exchange for the Euro, is communicated by the UN New York to FAO based on parities set by the European Central Bank two working days before the end of the month. To the extent that the use of a monthly UN rate is an approximation of the market rate, this approach conforms to generally accepted accounting standards which foresee the use of approximations or averages for practical reasons.

The other two rates referred to above (budget and forward) are not accounting rates because they are not used for converting non dollar transactions or balances and they do not give rise to exchange differences requiring to be recognised as income or as expenses.

The forward rate is the rate at which we contract to purchase lire and occurs whenever any enterprise enters into forward purchases of its exchange requirements. There is no way of avoiding this rate if we continue to do forward purchases. However, we believe that the recent issue of IAS 39 provides us with the opportunity to introduce hedge accounting, which should simplify/rationalise our accounting for the staff currency variance. Following the standard we would book the assets and liabilities arising from our financial instruments at inception and record the unrealised gain or loss in the Special Reserve. The latter provision would be released over the period of the contract to the income statement neutralising our currency risk. Providing our hedge matches our requirements the effect will be that the currency variance will not arise, in which case there will no longer be an appropriation from or to the Special Reserve account in this respect.

The budget rate is used to determine the amount of the appropriation that should be transferred from and to the Special Reserve Account in accordance with Conference Resolution 27/77. Transfers are not subject to accounting legislation and are the prerogative of an enterprise. In the present case, we believe that the objective of the Conference is to ensure that funds received in excess of requirements are set aside as a reserve for future use. This situation arises where the exchange rate assumptions underlying the budget do not materialise. We do not consider that the Conference would wish to give up its prerogative and change this mechanism.

b) The possibility of using a structured forward purchase has been considered and submitted to Top Management for its consideration. After consulting with various institutions (World Bank, IMF), it was the decision of the Director-General not to proceed with this tool.

We welcome the introduction of the hedge accounting policy as an opportunity to simplify the Organisation's accounting practices. We will pursue our review on these practices as part of our audit on the biennium financial statements. As far as the forward contract is concerned, the interim financial statements disclosed that the losses due to the current international exchange environment amounted to US $4.5 million in 1998, of which US$1.35 million were not covered by the currency variance
Unliquidated Obligations

I wish to reiterate my previous recommendation to carry out closer checking of ULO at the end of the biennium. I understand that this is a complex and time consuming exercise with a variety of criteria to be applied across objects of expenditure. In this connection, I would recommend that, for the future, the Organisation might consider simplified criteria which could be incorporated into the accounting systems for recognising the validity of undisbursed commitments at the end of a biennium.

The introduction of the new financial systems and related procedures will bring about a significant change in how FAO prepares its accruals (unliquidated obligations) at the period end.

The most significant change results from the fact that, in Oracle, only approved Purchase Orders in place at the period end will be automatically accrued. The Oracle applications implemented have no equivalent to non-Purchase Order related commitments.

With regard to transactions which will not be processed through Oracle Purchasing, (e.g. travel transactions), the accruals procedure will be simplified to include only those transactions which can be demonstrated to relate to the year being closed.

Accordingly, in simple terms, period end accruals procedures will now concentrate on identifying items to accrue rather than identifying existing commitments which should be excluded from the accrual.

The review we conducted on a sample of the ULOs recorded as at 31/12/1998 did not disclose any material invalid balances. However we are not yet in a position to assess the improvements that will result from the new closure procedures which will be used for the first time in December 1999.
Cash and Investments

Control of Bank Accounts

The number of bank accounts derives, at least in part, from their dedication to specific groups or transactions (e.g. Regular Programme, Trust Funds, etc.). In my previous report I had recommended that such complex arrangements be abandoned and cash managed centrally at the Organisation level, while maintaining the identification of transactions necessary for reporting purposes. While consideration was given to this recommendation in the context of the implementation of the new financial management and accounting software, the situation had not changed yet at the end of 1997.

At the last meeting of the ACI, it was noted that although there was more work to be done, FAO had made considerable progress in reducing the number of bank accounts. With the assistance of IFAD, the Organization intends to utilize the SWIFT network for payments and receipts using existing IFAD arrangements. This would significantly reduce the requirement to maintain bank accounts. While the Audit recommendation that cash resources for the Regular Programme and Trust Funds be pooled and detailed accounting for each handled in sub-accounts is noted, for reasons of transparency in Trust Fund donor operations, donor covenants and reporting and the fact that Trust Fund donor monies are provided in trust as set out in donor agreements, complete pooling is not possible either legally or politically. During discussions held at the recent meeting of the ACI, the Organization's approach and current treatment were endorsed by members of the committee as sound practice. As part of our continuing audit on cash and investment management we will review the actions taken on the basis of the recommendations resulting from the ACI meeting held in May 1999. We will also examine the use of the existing IFAD arrangements once they have been implemented.
Cash and Investments

Cash Management

I wish to recommend formally that the Organisation call for international bids for the provision of corporate banking services.

My staff noted that a consultant had recommended to "externalise" the management of cash to achieve higher returns at reduced risks and free up treasury unit resources for other tasks. I recommend that such proposals be carefully considered by the Organisation. If they were to be implemented, the FAO should call for bids from several international cash managers and start revamping and upgrading the treasury unit to allow it to become a professional counterpart to the selected cash manager.

The following actions have been taken:

A tender was issued for the Organisation's Banking Services on 26 March 1999 with a closing date of 10 May 1999.

A total of 28 Banks were invited to bid and it is envisaged that the new contract will be operational by 1 September 1999, provided that no major delays are experienced in the award process.

The Procurement Committee approved the criteria for the Evaluation of Bids.

An Evaluation Panel was appointed to evaluate the bids and they have completed the Technical Evaluation of valid bids.

The Evaluation Panel has been requested to complete deliberations by the end of June 1999 and put forth a recommendation for the selection of the bank to which the contract should be awarded.

It is expected that a recommendation will shortly be submitted to the Director-General.

The consultant's recommendation referred to in the recommendation was reviewed by the FAO Advisory Committee on Investments ( ACI ) held last year. In this regard, the Committee concluded that on the grounds of increased returns, reduced risk and operational efficiency, it was appropriate that the FAO short-term assets invested in time deposits and call accounts be outsourced to a commingled short-term investment fund at The Northern Trust Company. Effective 1 January 1999, such arrangements have been implemented.

With regard to long term assets, following the meeting of the ACI held at the end of May 1999, it was recommended that half of the assets presently managed by Fiduciary Trust be apportioned to other managers by appointing an equity manager with a value bias and a specialist fixed income manager. It was also agreed that FAO should take IFAD's guidance on the selection of both the fixed income and equity managers, with the assistance of the Organization's Investment consultant, Cambridge Associates.

With regard to the strengthening of the Treasury function, adequate steps are currently being taken and we have recognised the staff time, training and travel expenses needed to adequately supervise external managers. As a first step, IFAD has offered FAO its assistance in the training of staff and in the evaluation of investment management performance. Following IFAD and FAO senior management approval, we expect to commence the proposed arrangements with IFAD with respect to both training and performance management.

In line with our recommendation, the Organisation has called for a competitive process for the provision of corporate banking services. We will pursue our review on the handling of these services and will examine the tender process and its outcome.

As far as the "externalisation" of the management of cash is concerned, we noted that the decision was endorsed by the ACI in May 1998. However the manager was chosen without resorting to a competitive process.

Regarding the management of long-term assets, our statement whereby a closer monitoring of the fund manager(s) performance was necessary has been taken into consideration. We will look at the arrangements the Organisation is entering into with the equity and fixed term managers, as well as with IFAD.

Long-term Investments

Closer monitoring of the fund manager(s) performance including visits to the manager's office, is necessary and will require revamping and upgrading of the Treasury.

The steps we propose to take in the short term with regard to the above recommendation are outlined in the paragraphs above.  
Support Costs

In view of the current proliferation of support costs of various types which obscure the purpose and the measurability of the policy, I recommend that the Secretariat be requested to prepare a comprehensive but much simplified framework for support cost arrangements. In my opinion there are two possible approaches to this question:

a) either tailor support costs to the requirements of individual projects and clearly identify support costs in project budgets;

b) or limit support cost to broad but well defined activities and charge such support costs to projects by applying a pre-agreed recovery percentages to expenditure.
Of course a combination of the two approaches may also be implemented, provided that the resulting policy document submitted to the Governing Bodies is kept both comprehensive and simple to apply.

The development of a less complex pricing structure is one of the issues which will be included in a document on the broader subject of support costs and field programme support which is planned to be presented to the current session of the Finance Committee. No specific comment can be made at this stage as we are pursuing our review on that matter.
Audit of Field Transactions

In order for local audits of field expenditure to support a decentralised accounting structure at a reasonable cost, I recommend that the periodicity of reporting be lengthened (one or two reports a year), the number of contracting auditors reduced and the auditors required to provide audit assurance that imprest reports convey a true and fair view of field transactions.

In accordance with the External Auditor's recommendation, 1999 audits will be performed on a six-monthly basis. This approach will lead to a reduction in the cost of local audits.

With regard to the reduction in the number of contracting auditors, our plan is to identify a suitable firm in each Region with correspondents in countries where FAO has Representations. To this end we are collecting information to determine how best to award contracts on a Regional basis, but this work has been slowed by the introduction of the Field Offices Accounting System which requires priority.

In view of the high cost involved in doing a full audit, the limited scope of the local audit (agreed upon procedures) will remain valid for 1999. A cost-benefit analysis of the merits of changing the audit scope will then be performed as part of a more general review of risk within the Organisation.

We noted that our recommendation has been followed and that it was decided to limit the frequency and the costs of local audits. We understand also that efforts will be made to rationalise the contracts on a Regional basis, which is consistent with the decentralisation policy of the Organisation.
Payable and Receivable Accounts

I recommend that, in the context of the installation of the new financial and accounting software being implemented in FAO, 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.

The planned reorganisation within AFF has now clarified responsibility for all balance sheet accounts, including payables and receivables balances. In addition to the establishment of the Accounts Payable and Accounts Receivable Units, the new financial systems include Accounts Payable and Accounts Receivable sub-ledger applications managed by the respective units.

Procedures relating to travel advances and LRIs have also been changed, resulting in both streamlining of accounts and increased control. All staff related transactions are now accounted for in the same way: through an account opened for each staff member within the sub-ledger, managed by the Accounts Receivable Unit.

Standard functionality within the Oracle sub-ledgers permits ageing of the balances and the responsibilities of the Accounts Payable and Receivable Units include ensuring that the ageing of balances are at acceptable levels. Also in this regard, one of the responsibilities of the Controls Unit will be to review the reports used by the Accounts Receivable and Payable Units to manage their business and ensure that the relevant functional units take appropriate action to resolve problem cases.

As previously mentioned the new financial system and AFF reorganisation became operational too recently for us to be in a position to assess the improvement they could bring to the accounting and financial management of the Organisation. They were not yet implemented and therefore had no impact on the 1998 interim financial accounts we audited last April. We will review their impact on the final biennial statements.
Personnel Related Liabilities

a) I recommend that, in the future, the liability relating to the SPS be reported in conformity with stated policy (actuarial value) and that an agreement be reached with the WFP to implement such policy.

b) I recommend that the purpose and operation of this fund (Terminal Payments Fund) be thoroughly reviewed with a view to establishing a consolidated mechanism to provide for the funding of all recognised end of service liabilities.

With effect from the accounts for this biennium, amounts owed to other participating organisations, whether by way of amounts invested on their behalf or accrued income, will be shown as a liability towards those organisations and not as part of the staff related scheme liabilities of FAO. We have written to WFP informing them on this and have suggested that they set up their accounts to reflect this and will shortly be writing to other participating organisations as well to this effect. Meanwhile, also in the accounts of this biennium, all staff related liabilities, including those related to the SPS, will be reported at the actuarial value and the amounts disclosed as liabilities for the staff related schemes will constitute the amounts owed by FAO in respect of its staff only.

With effect from the accounts for this biennium, the TPF has been incorporated into the Staff Related Liabilities of the General and Related Funds and the funding is being provided in accordance with and on the basis of the actuary's report at 31 December 1997. We will be reviewing with the actuary the advisability of setting a consolidated funding rate as opposed to having separate rates for each scheme in view of the fact that the investments are now managed as one fund.

Finally, as part of the reorganisation within AFF a new unit has been esteablished with responsibiity for reserve accounting. This unit will be headed by a social security accountant who will be responsible for monitoring all the social security plans and reserves, including the accounting for assets/liabilities and charges.

We commend the efforts made to follow-up on our recommendations and appreciate the clarification and improvement they should bring to the disclosure of the biennial financial statements.

Since the Telefood operation is going to be continued and expanded in the current and successive biennia (Conference Resolution 3/97, refers), I should recommend that, if special audit arrangements are again deemed necessary, their implementation be more strictly monitored.

Whilst it had initially been intended that the audit of Telefood accounts would be included as part of the local audit programme, this proved not to be efficient as the recording of Telefood transactions is separate from the activities of the FAOR offices.

Income received into Telefood bank accounts is booked at Headquarters on the basis of Telefood account bank statements. Telefood transactions, like all other transactions will be subject to audit by AUD.

New policy and procedure statements relating to the processing of Telefood transactions are currently being drafted. These will be in place prior to the 1999 Telefood initiative.

We have no specific comment to make at that stage. We will pursue our review, especially on the audit arrangements, when they are in place.


I recommend that the Organisation finalise and formalise the delegation of authority to the regional representatives.

A new Circular on Responsibilities and Relationships (FAO Headquarters and decentralised offices) has been issued in final form. In addition, various Manual Sections have been revised and new manuals have been issued for the Finance function. These steps will result in improved operations between Headquarters and field locations. We noticed that the Organisation followed our recommendation to clarify the delineation of responsibilities and the scope of the delegations of authority to the regional representatives. Our next audit field missions will provide us with an opportunity to assess the improvement of the relationship between the Decentralised Offices and Headquarters.
Replacement of Personnel and Financial Management Systems   We will pursue our audit on the development and implementation of the new financial system, Oracle.