FC 107/4

FINANCE COMMITTEE

Table of Contents

Introduction

Part I

Definitions and methodology
Recent Trends
On-going and proposed measures to reduce the shortfall

Part II

Definitions
Status
Options for harmonization

Introduction

1. The Finance Committee at its 104^th Session noted the importance and complexity of project support cost recoveries, recalled that a shortfall in project support cost income could impact upon programme and budgetary transfers, and requested that the subject be revisited at its May 2004 Session.

2. The Committee further recognized that there was a lack of uniformity in project support cost rates for Commissions, noting that some of those established many years ago were not charged at all. It requested the secretariat to prepare a proposal on the harmonization of support costs rates of FAO Commissions for consideration at its next session, including the feasibility of introducing support costs for those Commissions that are currently exempt.

3. This paper responds to the specific requests of the Committee. Part I provides information on definitions and calculation methodology, recent trends in support costs and related income recoveries, as well as ongoing and proposed steps to reduce the shortfall. Part II presents the current structure of project support cost rates for Commissions and considers options for their harmonization.

Part I

DEFINITIONS AND METHODOLOGY

4. It is recalled that this Committee reviewed support cost issues in detail during formulation of the conceptual framework, principles and policy for support cost reimbursement rates at its 93^rd, 94^th and 95^th sessions¹. These were subsequently endorsed by the 119^th Session of the Council². This paper uses the definitions of support costs as reviewed and noted by the Committee at its 93^rd3 and 94^th4 sessions.

5. It is important to distinguish between expenditures incurred in supporting projects and the recovery of these costs from the projects concerned. As noted at the 93^rd session of the Committee, all such recoveries should be referred to as support cost reimbursements⁵, including recoveries from Regular Programme funded projects such as TCP and SPFS projects.

6. Two categories of support costs have been recognized: Administrative and Operational Support (AOS), which are indirect variable costs; and Technical Support Services (TSS), most of which are direct project costs⁶. The Committee's request relates to AOS in the context of its discussion on indirect variable costs. The reimbursement of AOS is generally made through a percentage charge on project delivery – known as project servicing cost (PSC) – as set out in the policy on project servicing cost rates⁷.

7. The methodology used to measure these costs on an annual basis was described in detail and reviewed by the Committee in documents FC 93/4, FC 94/4 (c)⁸ and FC 94/4 (d)⁹. The Committee endorsed the pattern of reporting whereby the Secretariat reports the extent of support costs incurred, and reimbursement received, in the biennial Programme Implementation Report (PIR), in the section on Cost of Field Programme Support¹⁰.

RECENT TRENDS

8. Annual AOS costs for 1998-2002 are provided in Table 1. The figures for 1998-2001 were published in the PIR 2000-01¹¹, while the figures for 2002 are based on the most recent cost measurement survey (CMS) carried out by the Organization. The CMS results for 2003 will be available in early June for publication in the PIR 2002-2003.

Table 1. Administrative and Operational Support Costs by component

9. The figures include the impact of the staff cost variance, to reflect actual costs at budget rate and thus focus on the costs movements only – leaving out the impact of currency effects, which are outside of the Organization's control. The composition of AOS costs has remained relatively stable except for project training, which has slowly declined as a proportion of cost. AOS as a percentage of total annual delivery has varied somewhat, with no evident trend, although it is certainly influenced by large swings in annual delivery.

10. Since 1998 AOS costs have fluctuated somewhat around US$ 31 million, except for 2000, the year when the decentralization of the project budget holder functions to country offices was implemented. This relative stability is particularly encouraging, as it means that - in real terms - the Organization managed to absorb its staff cost increases, and/or reduce the amount of time required to achieve project delivery.

11. The declining trend in support costs reimbursements received, shown in Table 2, was reversed in 2000. In 2003, total support costs reimbursements reached US$ 19 million – back to the levels of 1999.

Table 2. Administrative and Operational Support Costs and Extent of Reimbursement Received

12. PSC income is the main income component of the support costs reimbursements. Table 3 specifically illustrates the trend in PSC income earned, and compares it to the PSC forecasts included in the Programme of Work and Budget. PSC income levels have been slowly increasing and there has been a decline in PSC under-recovery against budget.

Table 3: Shortfall between PSC income recoveries and PSC income budgeted¹³

ON-GOING AND PROPOSED MEASURES TO REDUCE THE SHORTFALL

13. In the supplementary information presented to the Committee at its 95^th Session, the Secretariat provided a detailed analysis of the causes of the gap between project support costs and reimbursements¹⁴. The paper reviewed one major external factor (new UNDP arrangements) that caused a reduction in income recovery, and several causes for changes in costs. All external factors that were quoted as the major causes for the changes in costs (exchange rates, overall delivery, sudden changes in delivery, project size, project input mix) are still relevant.

14. The Organization is taking several measures to further reduce the gap between support cost income and AOS costs:

15. Change in the nature of FAO's involvement in Field Programme execution. The new Innovative Models for Leveraging Resources in Support of the Field Programme were endorsed by the Committee at its 102nd session¹⁵. As these new models are developed and applied, they should lead to reduced costs of project operations.

16. Restructuring of Field Programme operations. As mentioned in the PWB 2004-2005¹⁶, an inter-departmental task force has been established to review the operations of Regional Office management support units and regional units responsible for field project operations. Eventual implementation of the recommendations of such a review should lead to the streamlining of project administrative and operational procedures, workflows and improved access to information and central systems by Country Offices.

17. Review of support costs and income estimates in the planning process. Information systems (particularly FPMIS¹⁷) are facilitating more informed estimates of the services required and of the expected extra budgetary resources levels. These will serve as the basis for review and the negotiation with the relative support cost centres involved – such as the Regional Offices Operations Branches and hence increase our responsiveness to changes in demand.

18. Thematic Evaluation of Decentralisation of FAO's Programmes and Services. Recommendations on the extent and modalities of the decentralisation process may lead to changes to the current cost structures. The report of the evaluation will be presented to the Programme Committee at its session in September 2004.

19. Enhanced project design. Increasing attention is to be given at the planning stage to ensuring that adequate funding is provided in cases where modalities of project execution are particularly work-intensive.

20. Improved financial oversight of PSC income due to the Organization. Rigorous implementation of the PSC policy and closer monitoring of non conventional projects helped to increase reimbursements in 2003. The ongoing development of an improved accounting structure for the charging of AOS costs as direct costs, will also contribute to reducing the shortfall.

Part II

DEFINITIONS

21. The current policy on project servicing costs states that long-term trust fund accounts (e.g. Commissions established under the auspices of FAO) will be subject to a case by case estimate of the actual level of variable indirect support costs and charged accordingly. The Commissions referred to are those established under Article XIV of the FAO Constitution.

22. Bodies (e.g. Commissions) set-up under Article XIV of the Constitution are those established by conventions and agreements approved by the Conference or Council. These bodies fall into one of three categories: (a) bodies entirely financed by the Organization; (b) bodies that, in addition to being financed by the Organization, may undertake cooperative projects financed by members of the body; (c) bodies that, in addition to being financed by the Organization, have autonomous budgets¹⁸.

23. Contributions for such cooperative projects and autonomous bodies are remitted to the Organization and, in each case, administered through a trust or special funds in accordance with the Financial Rules and Regulations of the Organization, and the policy on project servicing costs noted above.

STATUS

24. There are currently six Article XIV bodies with seven active trust funds, as shown in Table 4. Their PSC rates range from zero to 13%, with two main modalities: a single rate or a combination of rates by components. The rates were set according to the policy at the time the trust funds were established. The average PSC rate earned calculated on actual expenditures for all the Commissions from 1998 to 2003 was 2.5%.

Table 4 Active Trust Funds established for Article XIV Bodies

25. Utilizing the derived rates by account code based upon the Cost Measurement Survey data for 2002 and assuming these Commissions are akin to trust funds operated at FAO Headquarters, an average rate 7% for variable indirect support costs can be implied. With 45% of their expenditures on human resources, the majority of which relates to long-term posts, these trust funds can be considered to be reasonably in line with the cost structures of normative projects and other projects operated at Headquarters. However, significant variations between the cost structures and the functions of Commission budgets (e.g. the extent to which they provide operational services) tends to suggest quite widely divergent costs of support.

OPTIONS FOR HARMONIZATION

26. It is recalled that the Committee based its decision not to approve the request of the Indian Ocean Tuna Commission (IOTC) to reduce its PSC rate on the basic principle that the Organization should aim at fully recovering the indirect variable costs associated with delivery of activities funded from extra-budgetary sources. As mentioned above, it requested the Secretariat to prepare a proposal on the harmonization of support costs rates of FAO Commissions for consideration at its next session, including the feasibility of introducing support costs for those Commissions that are currently exempt.

27. From the above analysis and the conclusion that the indirect variable costs will vary from Commission to Commission, a standard rate for all Commissions cannot be recommended. Instead, the current policy should be applied; that is, long-term trust fund accounts (e.g. Commissions established under the auspices of FAO) will be subject to a case by case estimate of the actual level of variable indirect support costs and charged accordingly. Therefore it is recommended that this policy be confirmed for all newly established Commissions.

28. The Secretariat has examined the question of applying this policy to pre-existing Commissions, most of which do not have rates based upon this policy (i.e. only the IOTC had its rate determined by a cost study using the agreed definitions). On balance, the Secretariat recommends against such an action for the following reasons:

• while a review of the existing project agreements shows that there is no legal impediment to revising the PSC rates for these funds, it would have to be done in consultaton with the Commissions and could be a protracted process, especially in those cases where the PSC rate would need to be increased;
• it may be questioned on the principal that application of a policy change involving additional costs beyond pre-existing agreements is not good practice particularly as the current rates were negotiated and approved under the policies applicable at that time;
• detailed cost studies of each of the Commission trust funds would require resources for both the studies and the negotiations with each Commisssion concerning any proposed changes in PSC rate and;
• the potential benefit for the Organization is limited; if the average rate was increased from 2.5% to 6%, the annual gain in AOS income would be about US$ 80,000 [160,000] based on 2002-03 delivery.

29. In conclusion, in view of the limited net benefit of revising PSC rates, the Secretariat recommends against the application of the current policy to the PSC rates to pre-existing Commission trust funds.

¹ CL 117/4, CL 119/12, CL 119/13

² CL 119 Rep paragraph 70, CL 119/13 Annex 2

³ FC 93/4 – Support costs

⁴ FC 94/4 (d) Review of Support Costs – Proposed Principles for Support Costs Reimbursement Rates for Field Programmes and Other Programmes Funded from Voluntary Contributions

⁵ FC 93/4 – paragraph 10

⁶ FC 93/4 paragraphs 14-17, FC 94/4 (d) paragraph 11

⁷ CL 119/13 Annex 2

⁸ FC 94/4 (c) – Review of Support Costs – Methodology used to calculate the cost of supporting the field Programmes and Other Programmes Funded from Voluntary Contributions

⁹ FC 94/4 (d) – paragraphs 38 and 42(c)

¹⁰ CL 119/12 paragraph 14

¹¹ C 2003/8 – Programme Implementation Report 2000-2001 – Table 2.7 and Table 2.8

¹² Including recoveries for Regular Programme funded projects (see para 5 above)

¹³ Source: Annual Reports of Budgetary Performance and Programme and Budgetary Transfers for 1998 (FC 92/4), 1998-1999 (FC 95/2); 2000 (FC 96/4), 2000-2001 (FC 99/2); 2002 (FC 102/3); 2002-2003 (FC 107/2)

¹⁴ FC 95/6 - Review of Support Costs - Supplementary Information, paragraphs 5, 9-14

¹⁵ FC 102/5

¹⁶ C 2003/3 paragraphs 183-185

¹⁷ FPMIS – Field Programme Management Information System

¹⁸ Basic Texts of FAO (2000 edition), Volume II, Section R