ISLAMIC REPUBLIC OF AFGHANISTAN ENERGY SECTOR DEVELOPMENT

139 Pages·2010·3.63 MB·English

Supplementary Appendix C

ISLAMIC REPUBLIC OF AFGHANISTAN
ENERGY SECTOR DEVELOPMENT INVESTMENT PROGRAM – ADB
Periodic Financing Request 2
FINANCIAL MANAGEMENT ASSESSMENT REPORT

Table of Contents

I. INTRODUCTION...................................................................................................1
II. ENERGY SECTOR FINANCIAL MANAGEMENT.................................................1
A. Summary Project Description....................................................................1
B. Country Issues...........................................................................................2
C. Risk Analysis.............................................................................................3
D. Institutional Arrangements.........................................................................4
E. Fund Flows Arrangement..........................................................................5
F. Personnel..................................................................................................6
G. Accounting Policies and Procedures, and Financial Reporting and
Monitoring..................................................................................................7
H. Internal Audit.............................................................................................8
I. External Audit............................................................................................8
J. Budgeting System.....................................................................................9
K. Information System....................................................................................9
L. Procurement Arrangement........................................................................9
M. Disbursement Arrangement.....................................................................10
N. Financial Covenants................................................................................10
O. Supervision Plan......................................................................................10
Supplementary Appendix C 1
FINANCIAL MANAGEMENT ASSESSMENT

I. INTRODUCTION

1. The objective of the financial management assessment (FMA) is to determine
whether the entities implementing the project components have acceptable financial
management arrangements including procedures for making payments, accounting
treatment of transactions, financial reporting, audit of financial statements, and internal
control procedures to avoid misuse or misappropriation of funds / assets.

2. The financial management arrangements can be considered acceptable if they
are considered capable of making timely payments as they become due, recording
correctly all transactions and balances, supporting the preparation of regular and reliable
financial statements, safeguarding the entities’ assets, and are subject to appropriate
auditing. The FMA also provides the stakeholders an opportunity to discuss any issues
relate to the existing or proposed funds flow and financial management structure.

3. This FMA is prepared for Tranche 2 project, building on the FMA for Tranche 1
project under the same Multitrache Financing Facility (MFF).1 The Financial
Management & Accounting Questionnaire (FMAQ) was completed with the help of the
executing agency’s staff and consultants, and is attached with the report.

4. The assessment indicates that the project is being prepared in a high financial
management risk area, the risk is high due to a number of factors including low financial
management (FM) capacity, infantile fiscal devolution, and use of outdated and manual
systems at the operations level of the existing state owned enterprise (SOE) Da
Afghanistan Breshna Moassasa (DABM) or its successor, a new corporatized power
utility, Da Afghanistan Breshna Sherkat (DABS) which was expected to be fully
operational in July 2009 but now delayed to March 2010. Recruitment of adequate
number of FM staff at competitive market rates, adoption of an accounting and financial
management manual in a computerized environment and concentrated FM
arrangements in the Project Management Office (PMO), together with targeted capacity
building at both DABS management and PMO levels, are the key mitigation steps to
minimize such risk. The PMO, which is primarily supported under Tranche 1, will be
engaged in administering all the projects under the MFF, including this Tranche 2.

5. Developing the internal audit capacity, which is currently non-existent, would be
difficult in the short term keeping in view the limited resource availability in DABS both
within and outside the company. To mitigate this and to enhance the fiscal
accountability, an external auditor would audit the project accounts on a bi-annual basis
instead of annually where the audited financial statements would be submitted to ADB
within 6 months of each accounting period.
II. ENERGY SECTOR FINANCIAL MANAGEMENT

A. Summary Project Description

1 AFG: Energy Sector Development Investment Program.
2 Supplementary Appendix C
6. The Tranche 2 project is a part of the Energy Sector Development Investment
Program under MFF designed to provide all grid-connected consumers with adequate
and reliable supply of electricity, which will support the Government’s objective of 8.1%
economic growth per annum.2 Substantial investments in rehabilitation, augmentation,
and expansion of the power transmission system will increase the reliability of supply to
residential, agricultural, commercial, and industrial consumers in Afghanistan. A secure
and predictable electricity supply will lead to social and economic benefits and improve
conditions for schools, hospitals, and other social services.

7. The Tranche 2 project connects over 50 towns/villages over a 40 square
kilometer area in South-West Kabul comprising 60,000 households, or 420,000 people.
The project provides about 30 km of double circuit 200kV transmission line from
Chimtala S/S to the new Kabul Southwest S/S (with 2x40 MVA transformers), which will
form part of the national grid connecting NEPS to the south. 65 km of medium voltage
(20kV) and 500 km of low voltage (0.4kV) overhead distribution lines, together with
distribution transformers will be provided. The project also has non-physical
components to assist DABS build management and operational capacities, in addition to
project implementation supervision consultancy.

B. Country Issues

8. Since 2002 the Government of Afghanistan (GOA) has made progress in
establishing a functioning public financial management system under the direction of the
Ministry of Finance (MOF). The MOF is producing annual budgets that meet basic
requirements of the GOA-Donor approved Medium Term Financing Framework (MTFF),
and meeting internationally accepted standards of pubic financial management
performance at an acceptable level. Importantly, the GOA has also established the basic
legal framework underlying the PFM and procurement systems.

9. However, these achievements have been obtained with a high degree of direct
donor assistance for costly direct operations contracts with international firms, including
the hiring of qualified Afghans on local-hire contracts. This is not considered a
sustainable situation, i.e. one in which more of the responsibility and accountability for
pubic financial management resides directly with the civil service in MOF. The
Afghanistan National Development Strategy (ANDS) has identified both improving the
performance of financial management services and capacity building to permit these
services to be mainstreamed into the MOF and line ministries as part of their core
operations. The MOF has developed a Strategic Plan for the years 1384-89 (2006-2010)
to accomplish this.

10. The plan for making this transition would be (i) to continue to provide operational
support for basic operations through the services of internationally recruited firms, while
(ii) making further steps to re-organize the MOF and line ministries in a more de-
concentrated public financial management system; (iii) deepening the regulatory
framework and building human resource capacity to facilitate mainstreaming of
operations; and (iv) managing these changes to assure their longer term sustainability.

2 Afghanistan National Development Strategy [1387-1391(2008-2013)]: A Strategy for Security, Governance,
Economic Growth and Poverty Reduction, Government of Islamic Republic of Afghanistan, 2008.
Supplementary Appendix C 3
11. To achieve its goals, however, the MOF will have to address several
organizational and capacity constraints, including: an internal ministry organization that
is only partially modernized; an overly centralized, donor driven and “transaction-based”
financial management and control system that assures credibility but not efficiency;
inadequately trained, managed and remunerated civil service personnel; and resistance
to changes that may require several years. The government also faces the challenge of
maintaining a high level of credibility and accountability in its financial management while
making reforms.

C. Risk Analysis

12. The FM risks of the project, arising from the identified weaknesses, together with
their mitigating measures are highlighted in the following table:

Table A3.1: Financial Management Risk Analysis
Risk Risk Rating Risk Mitigation Measures
-low financial management - Hiring of adequate FM
capacity of the staff in staff at competitive market
government departments / rates.
PMO and difficulty in High
attracting adequately - Targeted FM capacity
qualified accountants from building to be provided
the market. under the MFF

-Weak financial - Simplify and concentrate
management systems in the payments and other
the country and provinces, financial management
and DABS, the EA. High arrangements in the PMO
through the FM
professionals under the
direct supervision of the
Project Director

-Adaptation of Accounting
and Financial
Management Manual in a
computerized environment
to facilitate objective and
informed decision making
and transparent control
mechanisms.

-Staffing of CFO office in High Priority should be given to
the DABS Opening Team complete the staffing and
(OT) to date is less than provide training to the
satisfactory because of staff.
difficulty in finding FM staff
in Kabul. As of 6 August
2009, only 9 of the 26
4 Supplementary Appendix C
professional staff had been
recruited. The OT team
takes over the financial
management function as
soon as the assets are
transferred from DABM to
DABS, expected within
2009
Overall Risk Rating High PMO will be established to
specifically ensure the
management and
administration of the
project. PMO will be
strengthened with the
assistance of project
implementation
consultants. Further,
Tranche 2 will provide
management assistance
at the EA level, with a
focus on the accounting
and financial
management.

D. Institutional Arrangements

13. Since 2003, the Afghan electricity sector has undergone considerable technical,
commercial and institutional reform, all of which are designed to support market-oriented
operations that are cost-recoverable, to protect the consumer and to develop sustainable
power. In March 2008, Government took a significant step toward building a new
electricity market structure when Cabinet approved the Articles of Incorporation of
DABS.

14. DABM, which had been responsible for all operations of grid-supplied power in
Afghanistan, is undergoing liquidation through which its viable assets and technically
qualified staff will be transferred to DABS. In February 2009, Comprehensive
Agreement on a medium-term plan to reduce government subsidies was signed between
DABS and the Ministry of Finance. Whether or not to transfer some of DABM liabilities
awaits further agreement between MoF and DABS. In addition, as Government
continues to divest state electricity assets and the roles and responsibilities of
Government ministries and agencies will change to focus on policy-making and
regulatory functions. As part of this restructuring, Government encourages wider private
sector participation and improved design and implementation of a legal and regulatory
framework. The progress of the restructuring of DABM/S is delayed due to momentarily
reduced political commitment. A Memorandum of Understanding that specifies the
functional roles between DABS and the Ministry of Energy and Water (MEW) has been
drafted but pending for approval, impinging upon the transfer of assets and personnel
from DABM to DABS.

15. DABS, as the overseer of energy infrastructure of the country would be the
executing agency for the project. Newly established in 2008, DABS is currently
Supplementary Appendix C 5
developing their internal control systems from scratch. As DABM’s accounting and
management was virtually non existent, no FM system can be inherited. Currently, World
Bank (WB) is working with DABS in computerizing their accounting and management,
but WB's support is expected to end in December 2009. The Tranche 1 project has
included components for establishing and training DABS staff through PMO which is
intended to manage the project. The Tranche 2 project will provide support to continue
management assistance after WB's support comes to an end. Issues with respect to the
financial management of DABS can be summarized as follows:

(i) The financial management capacity of DABM/DABS is very limited. Only
treasury offices exist working on a cash movement basis. As mentioned
above, a WB TA is supporting improvements, however, more time and
resources are needed;
(ii) Auditing is still a new concept in the country, where DABM does not even
have proper financial statements or accurate cash ledgers to be audited
in the first place. Financial statements of 1385(2006/07) and 1386
(2007/08) were audited by external auditors under World Bank funding.
However the auditors refused to give any opinion as the financial
statements were not complete/ready for audit and that accounting policies
and procedures used in the preparation of the financial statements were
not stated. WB TA is assisting DABM's effort to reconcile its accounts
from all of its field offices for the past few years;
(iii) Scattered and uncoordinated projects can raise uncontrollable fiscal
accountability issues at the local level involving spending of money on
other than the intended purposes; and,
(iv) The approval procedure by the Government on the tariff proposed by
DABS remains to be decided. The ability for DABS to set an appropriate
level of tariff is critical for its financial sustainability.

16. Considering the central role of the PMO for ensuring the sound financial
management arrangements acceptable to the ADB, specific measures would be
required to be taken for the FM institutional development and capacity building of the
PMO including hiring of professional FM staff and implementation of reliable financial
management systems. Simultaneously, continued support for financial and accounting
capacity building is necessary at the EA level, as WB TA support is expected to end
toward the end of 2009.

E. Fund Flows Arrangement

17. The overall control over movements of the project’s funds and provisions of the
appropriate financial and economic data related to the project will be carried out by the
PMO. ADB funds will directly flow from ADB to the suppliers of equipment and to the
contractors. Further, ADB funds would be released to an imprest account to be operated
by the Project Director. The member of PMO who deals with accounting issues would
carry out the overall control of all receipts and payments made through the Impress
account.

18. All procurement procedures during the project utilization will be maintained by the
Project Implementation Consultants under direct supervision of DABS’s management
and should be fulfilled in accordance with ADB procurement guidelines.
6 Supplementary Appendix C
19. It is assumed that the following fund flow chart should be adopted during the
project utilization:

Chart A3.1: Funds Flow Chart of the Project
ADB
(Financier)
Direct Payment Imprest Fund Procedure
Procedure (Statement of
and Expenditure)
Commitment Grant
Procedure Agreement
IRoA MOF
(Recipient)
Subsidiary Project
Loan Agreement
Agreement
Repayment

DABS DABS
(Borrower) Imprest Account
Contracts
Contract Agreement
Fund Flow (major)
Fund Flow (minor)
Repayment

F. Personnel

20. Based on the additional work required to ensure the timely and accurate
processing, accounting, and reporting of the financial and related activities of the project,
staffing requirement of one professionally qualified Project Finance Manager (PFM) and
his deputy assisted by six staff is necessary The PFM should have qualifications at least
Supplementary Appendix C 7
equivalent to Chartered or Cost and Management Accountant. His major responsibilities
will include overseeing the budgeting, accounting, and reporting of all financial
transactions relating to the implementation of the project under the overall supervision of
the Project Director. The following is the FM organogram of the Project (PMO):

Chart A3.2: Financial Management Organogram (PMO)

Project
Director
Project Finance
Manager and
Deputy
Accounts Accounting Finance
Officers (2) Assistants (2) Officers (2)

21. The Finance Officers would be at least an intermediate/ part-qualified accountant
whereas an Accounts Officers would be seconded from the Accounting Department of
DABS. The Accounting Assistant, who would assist the FM staff in record keeping and
data entry, should preferably be a finance graduate. The Project Implementation (PI)
Consultants will assist the EA in the development of job-description of the FM staff. Due
to scarcity of qualified FM resources in Afghanistan, the FM personnel budget of the
Project should be based on reasonably competitive rates and initially funded by the PI
Consultancy Budget. The FM staff except the Accounts Officers would be recruited
through the PI Consultants and a local accounting firm ensuring that finance and
accounts staff would be adequately qualified and experienced. The lack of FM expertise
in Kabul warrants engagement of qualified accountant from other provinces thereby
increasing the likelihood of staff rotation. However, contracting a local accounting firm for
recruitment / replacement of staff would ensure quicker replacements. Advance
recruitment will be initiated so that contracting can be done shortly after loan
effectiveness.

G. Accounting Policies and Procedures, and Financial Reporting and
Monitoring

22. The existing AFM used by MEW for management of outstanding ADB loan
implementation and monitoring would be transferred to DABS and applied to originate an
effective financial management and reporting system for the project. The PFM will
ensure that any additions required in the AFM be timely effected to reflect the project
specific requirements and the proposed FM structure. The FM capacity building is seen
as one key dimension of the three pronged approaches for capacity building articulated
under this project. It would involve implementation support for the AFM in a
computerized environment and related training of staff.
8 Supplementary Appendix C
22. DABS has bought automated accounting system package which will be
customized and installed shortly after DABS becomes operational. A commercial –
based Chart of Accounts have been developed and different cost centers have been
identified. The system will provide the financial reporting within DABS; the financial
reporting for the project has to be developed with assistance of Implementation
consultants.

23. The Project would adopt the cash basis of accounting. Notes to the financial
statements showing the outstanding commitments at the period end would augment the
financial reporting. The financial statements will be compiled in accordance with IPSAS
Cash Basis standards following all the mandatory requirements with an attempt to
present the optional disclosures as per good practice. Although the preparation for
adopting accrual accounting is on the way, the capacity is too premature and unrealistic
for the immediate introduction of accrual accounting.

24. The Project financial statements would be kept separate from the entity /
government financial statements. DABS accounting department would consolidate the
summary project financial statements into the company accounts in compliance with
local accounting standards. Simultaneously, the management assistance to be provided
under Tranche 2 will strengthen the accounting and financial management capacity of
DABS.

H. Internal Audit

25. Auditing is still a new concept in the country, where DABM does not even have
proper financial statements or accurate cash ledgers to be audited in the first place.
DABS has no internal controls unit yet in the Opening Team (OT, responsible for running
DABS till end of Year 1 operations), but it is under development and the recruitment
process has already started. DABM, primarily involved in audit of recurrent expenditure
does not audit the expenditure incurred on various capital works projects. Reports of this
DABM unit are entirely in Dari.

26. Despite DABS staff members have undergone certain training courses at MOF,
their level of experience, the scope, approach and methodology is limited and requires
improvement. There is inadequate focus on the use of up to date and advanced audit
techniques. The staff are also constrained by non availability of computer hardware and
software and limited knowledge of English.

27. Existing staff at DABM/S are not qualified in internal audit and lack training;
considerable effort is required to build capacity.

28. The MOF has also established an Internal Audit Division (IAD-MOF) with the
purpose of conducting regular internal audits of all ministries, government departments
and state owned enterprises. IAD-MOF, to date, has not undertaken any internal audits
at MEW or DABM. An international advisor assists the Director General of IAD-MOF.
MOF is expected to recruit over 300 staff members and additional international
consultants/ experts to strengthen this division.

I. External Audit
Supplementary Appendix C 9
29. It is also noted that, the external auditors are a limited liability firm. This is not
ordinarily the practice in the accounting profession and as such may require and
consideration prior to the execution of future external audit engagements.

30. DABM’s financial statements for Years 1385 (2005/06) and 1386 (2006/07) were
to be audited by an independent auditor. However the recruited auditor refused to give
an opinion stating that the financial statements were incomplete and further the
accounting policies and procedures use were not documented. In the Disclaimer of
Opinion’ issued by the DABM external auditor since the financial statements did not
include notes comprising a summary of accounting policies in order to understand the
impact of different financial transactions.

J. Budgeting System

31. Due to very weak baseline data from DABM, DABS budget lines have to be
developed after the transfer of assets from DABM to DABS. During the course of
transition, DABS, as a transitional entity under the MOF, will require a budget
appropriation directly from the MOF, not MEW.

32. All procedures are in place to plan project activities, collect information from the
units in charge of different operations/components and prepare the budgets.
Accordingly, the DABS Senior Management Group (SMG) will prepare the DABS budget
and the Board of Directors will approve it; the subsequent department/unit/location
budgets are approved by the SMG. DABS will have a system of review of monthly
financial reports including variances.

K. Information System

33. The financial information system (FIS) that the PMO would implement should
have the capacity to provide accurate reporting as per requirement in a timely manner.

34. These financial reports in accordance with the Manual will include, but not be
limited to - sources and application of funds, physical progress, procurement status
reports.

35. DABS is developing a new up-to-date computerized system for which DABS has
acquired MS Dynamics software but still need to customize it to cater to their
requirement. For the Project itself, similar software will be acquired which should match
the DABS system. Accounting software would be acquired as part of the FM capacity
building separately kept under the Project. Extensive training will be required for DABS
and PMO.

36. The FM capacity building would include a) licensing and parameterization of
accounting software, b) implementation support for the AFM (approximately 4-5 person
months), c) purchase of IT equipment for the PMO and d) training of FM staff.

L. Procurement Arrangement

37. The PMO will be responsible for procurement of all goods and works. As the
PMU does not have sufficient capacity to procure and manage numerous contracts
required under the MFF, the international consulting firms recruited for the