Executive Board Two hundredth session

Transcription

1 Executive Board Two hundredth session 200 EX/20.INF PARIS, 23 August 2016 English & French only Item 20 of the provisional agenda NEW AUDITS BY THE EXTERNAL AUDITOR AUDIT REPORT ON COST RECOVERY FROM VOLUNTARY CONTRIBUTIONS SUMMARY Pursuant to Article 12.4 of the Financial Regulations, the External Auditor submits his audit report on cost recovery from voluntary contributions. The short form of this report and the comments by the Director- General are contained in document 200 EX/20 Part I.

2 200 EX/20.INF EXTERNAL AUDIT OF THE UNITED NATIONS EDUCATIONAL, SCIENTIFIC AND CULTURAL ORGANIZATION AUDIT REPORT ON COST RECOVERY FROM VOLUNTARY CONTRIBUTIONS External Auditor reference: UNESCO

3 200 EX/20.INF TABLE OF CONTENTS Page I. OBJECTIVES AND SCOPE OF THE AUDIT... 1 II. LIST OF RECOMMENDATIONS... 1 III. THE RECOMMENDATIONS FROM THE 2011 REPORT ON COST RECOVERY HAVE BEEN IMPLEMENTED OR ARE IN THE PROCESS OF BEING IMPLEMENTED... 2 A. Review of the principles of the cost-recovery policy... 2 B. Analysis of the implementation of the recommendations from the 2011 External Auditor s report Recommendation No. 5 on restoring the financial balance of FITOCA Recommendation No. 6 on the streamlining and reliability of cost-recovery arrangements IV. THE COST-RECOVERY RULES MUST BE REFORMED A. Reminder of the written cost-recovery rules B. Weaknesses in the rules Lack of recovery of fixed indirect costs The risks of vague rules for cost recovery C. Possible reform of regulations V. THE DISTRIBUTION OF FITOCA FUNDS SHOULD BE REVIEWED A. Practices for the distribution of funds and posts financed by FITOCA B. The necessary updating of practises used to distribute funds and posts The distribution of funds between Headquarters and field offices should be updated The distribution of posts among Headquarters offices should be updated The use of FITOCA funds by field offices must comply with the principles of the cost-recovery policy More flexibility regarding the practice of not carrying over FITOCA funds Non-allocation of FITOCA funds to field offices managing projects with support cost waiver rates should become moot as part of the upcoming reform Each year, field offices should be informed of the method for calculating the allocation of FITOCA funds VI. INFORMATION FOR MEMBER STATES SHOULD BE IMPROVED VII. CONCLUSION VIII. ACKNOWLEDGMENTS ANNEX ANNEX

4 200 EX/20.INF I. OBJECTIVES AND SCOPE OF THE AUDIT 1. In accordance with the notification letter of 14 January 2016, two external auditors carried out an audit at UNESCO from April to June The purpose of the audit was to examine the modalities of the recovery for the regular budget of the costs of managing voluntary contributions, so as to update the findings of the External Auditor s 2011 Audit report on the general conditions of implementation of the Complementary Additional Programmes ( ) in that connection and to ensure follow-up to the corresponding recommendations. 2. The audit was conducted within UNESCO s Bureau of Financial Management (BFM). The auditors also interviewed the Bureau of Strategic Planning (BSP) and 15 field offices. 3. The audit was conducted in accordance with the International Standards of Supreme Audit Institutions, 1 established by the International Organization of Supreme Audit Institutions 2 and in accordance with applicable texts, in particular Article 12 of the UNESCO Financial Regulations and the Annex on the Additional Terms of Reference Governing the Audit. 4. The preliminary observations were discussed at an exit meeting with UNESCO s Bureau of Financial Management (BFM). Its observations were taken into account as warranted. II. LIST OF RECOMMENDATIONS Recommendation No. 1. The External Auditor recommends adapting the Organization s financial management software (SISTER and FABS) so as to facilitate and automate cost-recovery operations for extrabudgetary projects under way. Recommendation No. 2. The External Auditor recommends that training sessions continue to be held for those responsible for preparing and implementing the budgets for extrabudgetary projects. Recommendation No. 3. The External Auditor recommends that the Guidelines on the Cost Recovery Policy be rewritten, formalizing practices in force, integrating forthcoming reforms and providing more examples of how to apply the rules properly. Recommendation No. 4. The External Auditor recommends: (i) updating the amount of extrabudgetary project management costs to be recovered, according to the project size and complexity; (ii) based on the results of the update, proposing a reform of the cost-recovery method to improve UNESCO s position in relation to organizations competing with it for voluntary contributions, thanks to a reduced support cost rate, while avoiding the risk of overcharging projects by making a clear distinction between indirect variable costs recovered by the support cost rate and FITOCA, on the one hand, and direct costs recovered by charging to project budgets or through the special account for cost recovery on the other; (iii) quickly implementing the reform to avoid accumulating unproductive FITOCA reserves. Recommendation No. 5. The External Auditor recommends a two-year trial to base the calculation of costs recovered by charging project budgets or through the special account for cost recovery on simplified set rates. Recommendation No. 6. The External Auditor recommends: (i) updating the distribution of FITOCA funds between Headquarters and field offices based on the results of a study into the work time that various offices actually spend on managing voluntary contributions and extrabudgetary funds, and (ii) updating the distribution of FITOCA-funded posts at Headquarters among the various offices at Headquarters based on the results of a study similar to the one in the first part of the recommendation. Recommendation No. 7. The External Auditor recommends reserving the use of FITOCA by field offices, save exceptions authorized by Headquarters, for the reimbursement of expenditure paid 1 2 ISSAI. INTOSAI.

5 200 EX/20.INF page 2 from the regular budget for extrabudgetary projects, in accordance with the purpose of the costrecovery policy. Recommendation No. 8. The External Auditor recommends authorizing FITOCA funds to be carried over from one year to the next by field offices for extrabudgetary projects with annual expenditure rates of almost 100%. Recommendation No. 9. The External Auditor recommends providing field offices, each year, with a detailed written explanation of the calculation of the annual allocation of the FITOCA funds they receive. Recommendation No. 10. The External Auditor recommends that, each year, Member States should be provided with information on the distribution of FITOCA funds between Headquarters and the various field offices, the distribution of FITOCA-funded posts among Headquarters offices and the income collected by the special account for cost recovery. III. THE RECOMMENDATIONS FROM THE 2011 REPORT ON COST RECOVERY HAVE BEEN IMPLEMENTED OR ARE IN THE PROCESS OF BEING IMPLEMENTED A. Review of the principles of the cost-recovery policy 5. UNESCO extrabudgetary projects are those not funded from the regular budget (which is financed by compulsory contributions of all Member States), but rather from voluntary contributions paid by some Member States, multilateral organizations (such as the World Bank), other United Nations agencies, the European Union or private agencies (foundations, associations or companies). 6. The aim of the policy of the regular budget recovering the management costs of extrabudgetary projects is to avoid favouring extraordinary projects to the detriment of the work programme funded by the ordinary budget. 7. Indeed, according to the Guidelines on the Cost Recovery Policy and Budgetary Aspects of Extrabudgetary Projects, if the regular budget subsidized extrabudgetary projects This can give the erroneous impression that the management of extrabudgetary projects is more efficient than the regular programme; which in turn can make extrabudgetary projects more attractive to donors and in the long run can endanger the Organization s regular programme funding. These 2008 Guidelines are still in force, but have been supplemented by a decision from the 195th session of the Executive Board (see paragraph 38 below) and by the annual guidelines of the Bureau of Financial Management (BFM) that consider any changes in cost recovery policy direction from the working group on support costs for extrabudgetary activities (which was set up in 2003 by the United Nations High-Level Committee on Management (HLCM)). 8. The Guidelines thus recommend charging direct costs and indirect variable costs from extrabudgetary projects to the budget of each project using the following methods (summarized in table 1 below): Direct costs, which are costs incurred by the Organization which can be traced in full to a specific project, 3 must be directly charged to the budget of each extrabudgetary project. They include the remuneration paid to staff recruited exclusively for the project, rent and charges for premises used exclusively for the project and the proportion of the general costs (information technology, premises maintenance, travel and so forth) of a service at Headquarters or a field office associated with the project; In the specific case of direct expenses for personnel costs (salaries and expenses) of UNESCO staff members paid by the Organization s regular budget but spending some of 3 This and the following definitions are taken from Item 5.9 of the Administrative Manual.

6 200 EX/20.INF page 3 their work time on extrabudgetary projects, 4 the costs are charged to the budget of each extrabudgetary project; 5 the corresponding revenue is credited to the Special Account for the Recovery of Staff and Other Costs from Extrabudgetary Projects and then refunded to the Headquarters service or field office that pays the staff concerned; Indirect variable costs, which are also known as support costs or general administration expenses, are costs incurred by the Organization in support of projects, but which cannot be easily traced directly to a specific project. They are charged to each project s budget using a Programme Support Cost (PSC) rate (a percentage of the project s total expenditure - usually 13%). 6 The corresponding revenue is paid into the Funds-in-Trust Overhead Cost Account (FITOCA), with funds distributed to corporate services and field offices the following year according to non-formalized customary rules: field offices receive 40% of the FITOCA funds they generated by applying the previous year the standard support cost percentage of 13% to project budgets they manage, with Headquarters receiving the rest; in principle, no FITOCA credit is allocated 7 for extrabudgetary projects that have benefited from a support cost percentage of less than 13%, with Headquarters alone receiving funds generated the previous year through the application of the lower percentage. Indirect fixed costs are costs incurred by the Organization regardless of the scope, level or funding source of activities, and which typically include the top management of an organization, its corporate costs and statutory bodies not related to service provision. These costs relating to senior management and statutory bodies implicitly also cover any rent and service charges for UNESCO buildings not exclusively allocated to extrabudgetary projects 8 that are paid from the regular budget and Special Accounts relating to the management of Headquarters offices 9 and field offices. They are not paid by extrabudgetary projects, in accordance with a 2007 recommendation (that has been subsequently updated) from the working group on support costs for extrabudgetary activities set up by the United Nations High-Level Committee on Management (HLCM) These costs were considered as indirect variable costs in the External Auditor s report of The classification that has now been adopted by the Secretariat in accordance with the latest United Nations guidelines is the one used herein. A Certificate of Time Spent and a Request for Journal Voucher Creation must be produced by the Headquarters service or field office managing the extrabudgetary project, according to Annex 1, section 11.1, of the Guidelines on the Cost Recovery Policy and Budgetary Aspects of Extrabudgetary Projects. Those documents show the budget code for the relevant Headquarters service or field office so as to ensure that the personnel costs charged to the Special Account are actually refunded to them. There are other percentages and potential waivers from them (see below). Only the Office in Brazil receives FITOCA credits in such cases (see below). The rent for buildings used by field offices for extrabudgetary projects are considered to be direct costs charged to the project budgets. The relevant Special Account for Headquarters is mainly funded by rents paid by delegations for their offices in the rue Miollis.

7 200 EX/20.INF page 4 Table 1. Cost recovery rules Costs Definition Example Recovery method Use of funds Direct costs Costs that can Salaries of staff Costs charged to project budget. Costs paid by be traced in full and rents of the funds of to an premises that each extrabudgetary are exclusively extrabudgetary project 10. used for the project (from extrabudgetary the voluntary project. The contributions proportion of a funding the field office s project). capital expenditure allocated for an extrabudgetary project. Specific case of The share of A few hours Hours are estimated, recorded in the Hours credited direct costs of staff costs paid worked by a budget and charged to the project; to the special staff paid from by the regular Headquarters they are then credited to the Special account for the regular budget for the expert on Account for cost recovery. cost recovery budget and time worked by extrabudgetary are then paid assigned part those staff projects or a to the relevant time to an extrabudgetary project members on the extrabudgetary project. field office s IT technician on an extrabudgetary Headquarters service or field office. Indirect variable costs Indirect fixed costs Expenses incurred by the regular budget for the extrabudgetary project that are difficult to quantify with any accuracy. Costs independent of the value of each project. project. Any expenditure not included in direct costs Senior management costs or property expenses for UNESCO Set percentage of 13% of the budget for the extrabudgetary project (standard rate) or a waiver rate (such as 7% or 10%) is applied to the project s expenses in favour of FITOCA. Not recovered. FITOCA funds are distributed among the Headquarters and field offices on the basis of customary rules. Headquarters Sources: External Auditor, based on the Guidelines on the Cost Recovery Policy and Budgetary Aspects of Extrabudgetary Projects. 9. The cost recovery policy was reviewed in the 2011 External Auditor s report on the planning of voluntary contributions ( Audit Report on the General Conditions of Implementation of the Complementary Additional Programmes ( ) ), in which recommendations 5 and 6 related to cost recovery. 10. The present report first examines the implementation of these recommendations, provides a full analysis of the cost-recovery system and then formulates new recommendations. B. Analysis of the implementation of the recommendations from the 2011 External Auditor s report 1. Recommendation No. 5 on restoring the financial balance of FITOCA 11. Recommendation No. 5: restore the financial balance of the Funds-in-Trust Overhead Costs Account (FITOCA) in such a way as to ensure that its balance amounts to at least the equivalent of 18 months of the salaries that it pays: 10 EXB.

8 200 EX/20.INF page 5 (i) (ii) (iii) (iv) by amending its regulations in order to reduce the number of cost-recovery rates below the single standard rate of 13%; failing that, by reducing the number of waivers granted from the statutory cost recovery rates; by using FITOCA to fund only Headquarters or field posts that provide administrative support for extrabudgetary projects; and by continuing its efforts to rationalize the account in Brazil. 12. The aim of the recommendation to restore financial balance to FITOCA has been achieved, and efforts have been made in the four areas suggested. (a) Recovery of FITOCA accounts 13. The FITOCA accounts, which posted a $5.7 million deficit in 2008 and a $2.3 million deficit in 2009, recovered strongly between 2010 and 2015 thanks to a 10.62% increase in revenues and a % reduction in expenditure from the fund (which recorded a $5.634 million surplus at the end of 2015). This progress is even more significant if the negative results from Brazil resulting from the fall in the value of the real against the dollar since 2010 are excluded. Table 2. Evolution of all FITOCA accounts, 2010 to 2015 (Thousands of United States dollars) FITOCA (overall) Revenues Expenditure Balance Sources: External Auditor, based on data communicated by the Secretariat. Table 3. Evolution of FITOCA accounts (excluding Brazil) (Thousands of United States dollars) FITOCA (without Brazil) Revenues Expenditure Balance Sources: External Auditor, based on data communicated by the Secretariat. Table 4. Evolution of FITOCA accounts (Brazil only) (Thousands of United States dollars) FITOCA (Brazil) Revenues Expenditure Balance Sources: External Auditor, based on data communicated by the Secretariat.

9 200 EX/20.INF page The account recovery swelled the FITOCA reserves by 64.45% between 2010 and This easily pushed FITOCA beyond 18 months of the staff costs it pays (see table 5) from In 2014, reserves were 69.54% higher than 18 months of staff costs; in 2015, the reserves were 96.82% higher than 18 months worth and would cover 36 months of staff costs. This significant level of reserves, which may appear surprising, is due to the Secretariat s wish to create a buffer in case the reform of the cost-recovery system (which is being studied by a working group see below) results in reduced FITOCA revenues. Table 5. Evolution of FITOCA reserves (Thousands of United States dollars) FITOCA (without Brazil) FITOCA (Brazil) FITOCA (overall) Sources: External Auditor, based on data communicated by the Secretariat. Table 6. Evolution of staff expenditure funded by FITOCA and share of that expenditure in total annual FITOCA expenditure (Thousands of United States dollars) FITOCA (without Brazil) % % % % % % FITOCA (Brazil) % % % % % % FITOCA (overall) % % % % % % Sources: External Auditor, based on data communicated by the Secretariat. (b) Increased revenues in the special account for cost recovery 15. The recovery in the FITOCA accounts has been accompanied by a rise in revenues in the special account for cost recovery, 11 through which transit the payments for the direct costs of staff paid from the regular budget but spending some of their work time on extrabudgetary projects. Indeed, the revenues of this special account soared between 2010 and 2015, whereas the sum received by the Organization in voluntary contributions rose by only 3.52% during the same period. 16. This development can be attributed to the following three factors: the special account was significantly underused previously, and the extrabudgetary project managers did not charge major project staff costs to the project budgets; the Secretariat has made considerable efforts to train staff involved in managing such projects and to check that the relevant budgets are drawn up; 11 To be precise, there are two such accounts: the Special Account for the Recovery of Staff and Other Costs from Extrabudgetary Projects and the Special Account for the Recovery of Security Costs from Extrabudgetary Projects.

10 200 EX/20.INF page 7 lastly, Member States intervened by requesting at the 195th session of the Executive Board, held in November 2014, that recovery of staff expenditure relating to extrabudgetary project management amount to 2% of the total cost of such expenditure (rather than the 1% it had been previously). 17. Having said that, the sum of revenues collected by the special account in 2015 was still only 1.2% of the total staff costs linked to extrabudgetary projects and not the 2% requested by the Executive Board. Table 7. Evolution of revenues paid into by the special account for cost recovery (United States dollars) Sources: External Auditor, based on data communicated by the Secretariat. Table 8. Evolution of voluntary contributions received by UNESCO (Thousands of United States dollars) Voluntary contributions received by UNESCO (not including Brazil) Voluntary contributions received by the Office in Brazil Voluntary contributions received by UNESCO institutes Total voluntary contributions Sources: External Auditor, based on data communicated by the Secretariat. (c) The FITOCA financial regulations have not been changed but a working group has been set up to review them 18. Contrary to subparagraph (i) of Recommendation No. 5 of the 2011 External Auditor s report, the FITOCA financial regulations have not been amended to reduce the number of cases where the percentage taken from each extrabudgetary project s budget is less than the standard 13%, with rates (programme support costs 12 ) remaining as follows: standard rate: 13%; special accounts funded by donors: 10%; activities where the main activity is equipment procurement: 8%; 12 PSC.

11 200 EX/20.INF page 8 United Nations joint programmes, multi-donor funds-in-trust, European Union, World Bank, UNAIDS: 7%; minimum contribution to FITOCA of $6,500 for small extrabudgetary projects equal to or less than $50, However, an internal working group in the Secretariat was set up in November 2012 to review the entire cost-recovery system, and the support cost percentages in particular. This group is not working with a view to reducing the number of percentages applied that are lower than the 13%, but rather is studying the possibility of applying a single lower rate and removing waivers by aligning if possible on the rates of 7% or 8% used in several United Nations agencies. This would prevent UNESCO from being disadvantaged in seeking voluntary contributions in competition with other United Nations agencies (see the section below on reform of current regulations). (d) Maintaining exemptions to standard support cost percentages 20. Given the unchanged FITOCA financial regulations, authorised waivers to the standard programme support cost rate (provided they are approved by the Director-General on the basis of specific justifications) 13 have continued to be granted. Furthermore, the European Union has set a support cost percentage of 7% for projects it funds, while the governing bodies of certain international conventions hosted by UNESCO have also set support cost rates under 13%. 21. There were nine new projects with rates below 13% in 2010, 11 in 2011, four in 2012, three in 2013, three in 2014 and two in Despite the downward trend, the number of older multiyear projects with rates below the standard means that 49.61% of extrabudgetary projects managed in 2015 ($58.4 million out of $117.7 million) have support cost rates below 13%. (e) The proportion of FITOCA used to fund support posts at Headquarters or field offices has increased considerably 22. The total number of posts funded by FITOCA fell from 107 to 63 between 2010 and 2015 as part of the aforementioned account recovery policy. In accordance with the External Auditor s recommendation, the share of administrative support posts increased (from 58.87% to 80.95%) in proportion with a reduction in operational posts: support posts went from 63 to 51 and operational posts reduced from 44 to The policy of account recovery and increased reserves is in accordance with the auditors recommendations and in keeping with the Secretariat s precautionary concern about possible income reductions related to forthcoming reform to the cost-recovery system. 13 According to the Guidelines on the Cost Recovery Policy and Budgetary Aspects of Extrabudgetary Projects, requests must provide evidence of the need for the derogation, when possible; provide evidence to BB that the support costs which would have normally been covered via the PSC rates are budgeted as direct costs to the project; have a balanced FITOCA account before requesting a waiver (i.e. the requesting unit should have generated sufficient FITOCA revenue to cover its FITOCA posts, if any).

12 200 EX/20.INF page 9 Table 9. Evolution of posts funded by FITOCA Year Operational posts Administrative posts Total 2010 Headquarters Field offices Total Headquarters Field offices Total Headquarters Field offices Total Headquarters Field offices Total Headquarters Field offices Total Headquarters Field offices Total Sources: External Auditor, based on data communicated by the Secretariat. 24. Other FITOCA expenditure ranged from 24% of the annual total in 2010 to 21% in 2015 (see the share of staff costs in the total in table 5). The annual FITOCA accounts and the questionnaire replies from field offices indicate that some of the costs correspond to external services (which include other kinds of staff costs such as consultant recruitment or contracting for a few months of services) (see section on allocation of FITOCA funds below). (f) Recovery efforts for the Brazil account 25. The UNESCO Office in Brazil implements a significant portfolio of activities covering all areas in which UNESCO is active and amounting to over 100 million reais of expenditure in The activities are almost entirely funded by voluntary contributions from local partners (70% by the Brazilian Government, federal States and cities, non-governmental organizations and the private sector - particularly the Globo television channel that renewed its partnership agreement for six years in 2012). FITOCA accounts for Brazil, which are always presented separately in the FITOCA annual accounts owing to the scale of voluntary contributions funding them, have been rebalanced in recent years from a deficit of $276,000 in 2010 to a surplus of $1.25 million in 2014 and $263,000 in 2015.

13 200 EX/20.INF page The scale of the recovery in dollars is masked by the depreciation of the real. In Brazilian currency, the Brazil FITOCA reserves stood at million reais 14 (BRL 15 ) at the end of 2015 (representing 20 months of staff costs). 27. The situation in Brazil with regard to the cost-recovery policy is unique. Indeed, a Brazilian Government decree prohibits the charging of direct staff costs to the budget of projects funded by the Government s contribution. The Office in Brazil is therefore unable to apply the standard support cost FITOCA rate of 13% (instead applying a 5% rate established by the aforementioned decree), as well as being unable to apply the special account mechanism for cost recovery to charge to State-funded projects (which are 70% of the total) the costs of working hours spent by the five staff members funded from the UNESCO regular budget for the projects concerned. 28. The Office does, however, effectively apply the cost-recovery policy to other extrabudgetary projects funded by non-governmental sources (particularly the private sector). This enables it to use extrabudgetary resources to fund about one third of the costs of posts at the Office. 29. Given the significance of the extrabudgetary projects it manages, the Office in Brazil is the only field office to benefit from Headquarters allocating it FITOCA funds even for projects having a support cost rate of below 13% : FITOCA provides it with 80% of the sums taken for the account from projects funded by the Brazilian Government. 2. Recommendation No. 6 on the streamlining and reliability of cost-recovery arrangements 30. Recommendation No. 6: streamline procedures for the recovery of time spent by regularprogramme staff on extrabudgetary projects; and (ii) build the Organization s accounting and budgeting information system s capacities for reliable calculation of indirect variable costs and, thus, for equally reliable statutory recovery rules and rates. 31. In accordance with information provided by the Secretariat during the 2011 audit on the planning of voluntary contributions, the Budget for UNESCO (B4U) online tool was launched in to prepare the budgets for extrabudgetary projects. It is compulsory to use this tool to gain Headquarters approval on new extrabudgetary project proposals and their budgets. 32. Five field offices (out of the 15 to have received the External Auditor s questionnaire) would also like a computer tool to facilitate budget application in terms of cost recovery. Although B4U can be used to draw up a budget, charging direct costs from an extrabudgetary project under way (using the special account for cost recovery) involves laborious manual operations that would ideally be automated. This suggestion seems particularly relevant at a time when the Organization is reforming its information systems. It would be desirable to supplement the Organization s financial management software (SISTER and FABS) 16 so as to facilitate and automate the cost recovery operations for extrabudgetary projects under way. Recommendation No. 1. The External Auditor recommends adapting the Organization s financial management software (SISTER and FABS) so as to facilitate and automate costrecovery operations for extrabudgetary projects under way. (a) Organization of training sessions 33. To develop the skills of staff members responsible for extrabudgetary project preparation and budgets, training sessions were held by BFM and BSP in March 2015 in Beirut for the seven field offices in Arab countries; by BFM in June 2015 in Dakar for the eight field offices in French $3.865 million. Brazilian real. SISTER (System of Information on Strategies, Tasks and Evaluation of Results) and FABS (Finance and Budget System).

14 200 EX/20.INF page 11 speaking Africa; by BFM and BSP in September 2015 in Addis Ababa for the 10 offices and an institute in English-speaking countries; and by BFM, BSP and HRM in April 2016 in Montevideo for the 11 offices in Latin America and the Caribbean The courses attended by these participants clearly explain the rules to apply and are supplemented by practical exercises on preparing budgets for extrabudgetary projects using B4U and the implementation of such budgets in terms of cost recovery. 35. Given the fact that field offices are unfamiliar with certain cost recovery rules, as reflected in some of the replies to the External Auditor s questionnaire - see para. 69 below), training sessions should continue to be organized. Recommendation No. 2. The External Auditor recommends that training sessions continue to be held for those responsible for preparing and implementing the budgets for extrabudgetary projects. (b) Controls on the preparation of budgets for extrabudgetary projects 36. Proposals for extrabudgetary projects and the corresponding project budgets drawn up by a Headquarters service or a field office must be validated by BFM (except for projects for an amount less than $250,000). 37. Reading the messages exchanged between project managers and BFM shows that the Bureau is very proactive in encouraging budget amendments that emphasize the recovery of all costs to be charged to projects (either directly or through the special account for cost recovery) in application of the rules of B4U and the choice of the appropriate support costs rate. 38. It is thanks to B4U, the training sessions and BFM s controls that the revenues paid into the special account for cost recovery have increased so considerably. IV. THE COST-RECOVERY RULES MUST BE REFORMED A. Reminder of the written cost-recovery rules 39. The UNESCO cost-recovery system is governed by a few written rules on the recovery methods themselves and the support cost rates, as well as by old customary practices based on the distribution and use of FITOCA funds. 40. The cost-recovery policy is briefly mentioned in the UNESCO Administrative Manual, in which Item refers to the Practical Guide to UNESCO's Extrabudgetary Activities 19 and Item defines direct costs, indirect variable costs and indirect fixed costs and sets out the costrecovery principles, as follows: 41. In line with the United Nations General Assembly Triennial Comprehensive Policy Review (TCPR) principle of full cost recovery, the HLCM-endorsed cost-recovery principles specify that all costs (i.e. direct and indirect variable) incurred in the management and implementation of extrabudgetary projects should be charged to the projects themselves. These costs may be: (a) charged directly to the project, or (b) recovered by applying a programme support cost (PSC) rate Bureau of Financial Management (BFM), Bureau of Strategic Planning (BSP) and Bureau of Human Resource Management (HRM). Item 2.2 Programme and Budget, section 3.3 Main programming principles and approaches, (d) Alignment of extrabudgetary activities with the regular programme. Article 5, paragraph 6 of the Financial Regulations defines special accounts (which include FITOCA and the special account for cost recovery). Item 5.9 UNESCO s Cost Recovery Policy.

15 200 EX/20.INF page The Practical Guide to UNESCO's Extrabudgetary Activities was published in 2012, in accordance with Recommendation No. 3 of the 2011 External Auditor s report to "Compile a single specific document, grouping together all instructions on the preparation and execution of complementary additional programmes". The Guide simply refers back to the 2008 Guidelines on the Cost Recovery Policy and Budgetary Aspects of Extrabudgetary Projects for matters concerning calculation methods for the various costs to recover. 43. The 2008 Guidelines were written for practitioners. The document defines the general principles of the cost-recovery policy and reviews the definitions from the Administrative Manual, while emphasizing the specific list of actions to carry out to prepare a budget (Annex 1) without formalizing the customary practices in the form of clear legal rules. 44. The special account for cost recovery and its operations are therefore only mentioned in three annexes to the Guidelines (Annexes 1, 7 and 8) on Explanation of Cost Elements; Financial Regulations of the Special Account for the Recovery of Staff and Other Costs from Extrabudgetary Projects; and Financial Regulations of the Special Account for the Recovery of Security Costs from Extrabudgetary Projects, respectively. 45. Annex 1 makes a brief reference to the special account under Internal experts, which states that the sums to recover for those experts must be recorded as credit for the special account (with no previous explanation of the role of the account). The other two annexes on the regulations of the special accounts offer no further clarifications on this role. 46. These drafting shortcomings have negative impacts on field offices understanding of recovery rules: seven replies to the External Auditor s questionnaire to 15 offices showed a wish for clarification of the explanations provided. The questions asked by certain offices also show that some significant rules have been misunderstood: several offices wonder whether they should take into account the working hours spent on extrabudgetary projects by their staff members paid under the regular budget. One office asked whether costs other than staff costs should be recovered. 47. It would be desirable to rewrite the Guidelines on the Cost Recovery Policy by formalizing the customary practices in the form of clear legal rules and updating the document to take account of recent innovations (such as the Executive Board s setting of a 2% recovery target for staff costs linked to extrabudgetary projects) and to incorporate rules resulting from the impending reforms. It would also be useful, for educational purposes, to provide more examples of how to apply to costrecovery rules. Recommendation No. 3. The External Auditor recommends that the Guidelines on the Cost Recovery Policy be rewritten, formalizing practices in force, integrating forthcoming reforms and providing more examples of how to apply the rules properly. B. Weaknesses in the rules 48. The cost-recovery regulations may be criticized in terms of the lack of consideration for fixed indirect costs and especially the complexity and risks of the current cost-recovery system. (1) Lack of recovery of fixed indirect costs 49. In accordance with the conclusions of the working group on support costs for extrabudgetary activities (which was set up by the United Nations High-Level Committee on Management 21 ), the Guidelines on the Cost Recovery Policy do not provide for charging indirect fixed costs to the budget of extrabudgetary projects. The costs of senior management, statutory bodies and the buildings of Headquarters and field offices are therefore completely covered by the regular budget of UNESCO, while the property charges are covered by specific special accounts and the 21 HLCM.

16 200 EX/20.INF page 13 Organization s regular budget - with no contribution from extrabudgetary project budgets, except where a field office charges to its own budget the direct cost of rent and charges for a building rented exclusively for the needs of an extrabudgetary project). Implicitly, the policy considers that costs that cannot be traced to specific project are only marginally influenced by extrabudgetary projects. 50. This is hardly questionable when the sum of voluntary contributions is but a small proportion of the total resources of an organization. However, it becomes untenable when voluntary contributions represent almost half of an international organization s revenue (as is the case for UNESCO) Some organizations use income from cost recovery to fund new buildings rented for additional staff recruited to manage programmes funded by voluntary contributions It would be to UNESCO s advantage to envisage funding some of the costs of its premises used for both regular budget requirements and extrabudgetary projects using the cost recovery system (rather than just using the regular budget and specific special accounts as per current procedures). (2) The risks of vague rules for cost recovery (a) The risk of improper implementation of the system due to its own complexity 53. The current system provides for two ways of withdrawing funds from the budgets of projects funded by voluntary contributions: charging direct costs to the budgets, or charging support costs that is paid into FITOCA, but there is no mention as to how the two arrangements combine or what the ceiling is for such levies. 54. In fact, the system provides for each project to recover direct costs (by charging them to its budget and using the special account for cost recovery) and to apply the programme support cost rate with no limit on the cumulative effect of the two methods. There is no exhaustive list of expenditure covered by the support cost rate (which would prevent levies for direct costs already on such a list) and there is also no rule on a ceiling for cumulative levies from direct costs and the support cost rate (which would limit cost recovery as a percentage of each project budget) to avoid donors being disadvantaged to the favour of the regular budget. 55. The regulations do, however, make a subtle reference to the accumulation issue in the particular case of support cost rates below the standard rate of 13%: the Guidelines on the Cost Recovery Policy state that the Headquarters service or field office requesting a waiver must provide evidence to BB that the support costs which would have normally been covered via the PSC rates are budgeted as direct costs to the project. This rule demonstrates that considerable recourse to direct costs may cover indirect variable costs that are normally covered by programme support costs. 56. In practice, what has been more typical in the management of extrabudgetary projects has been the under-recovery of direct costs, rather than an overcharging of these costs to projects (as demonstrated by the aforementioned surge of withdrawals transiting through the special account since 2010). The very complexity of the cost-recovery rules (rather than just the aforementioned shortcomings in the Guidelines) probably leads to a poor understanding of the system on the part of some field offices and only a partial application thereof. This in turn leads to a shortfallfor the Organization s regular budget. 57. The Secretariat gives instructions to project managers on a case-by-case basis requesting them not to apply both means of levy at the same time, and controls the application of the According to Note 25 on revenue in the 2015 financial statements, voluntary contributions represented 47.35% of total OECD income in 2014 ( k out of k ). As is the case of OECD.

17 200 EX/20.INF page 14 instructions. The External Auditors has not noted any cases of overcharging. 58. However, there is still a risk of overcharging, even if no case has been noted. This fear held by Member States was demonstrated by an unverifiable case that several delegations reported to the External Auditor As the Secretariat s actions improve the application of recovery rules for direct costs, it is important to specify the scope of each levy method so as to avoid the risk of overcharging these costs to extrabudgetary projects. This is even more of a concern given that UNESCO is in competition with other international organizations in the quest for voluntary contributions to fund extrabudgetary projects. (b) The risk of making UNESCO s extrabudgetary projects less attractive than those of other international organizations 60. The reflections of the working group on support costs for extrabudgetary activities, set up in 2003 by the United Nations High-Level Committee on Management (HLCM), were intended to harmonize the programme support cost rates of all United Nations agencies. The 13% rate adopted by UNESCO was in accordance with the proposals of the group (which was chaired by the Director of UNESCO s Bureau of the Budget). 61. In practice, however, the rates applied by many international organizations are around 7% or 8%: 25 the 7% rate is given in the Guidelines on the Cost Recovery Policy for United Nations joint programmes, multi-donor funds-in-trust, the European Union (which funds several of UNESCO s extrabudgetary programmes), World Bank and UNAIDS. One of the field offices questioned by the External Auditor complained about competition from UNOPS, IOM and OEI. Certain United Nations agencies (UNFPA, UNDP, UNICEF and UN Women), 26 which also applied a 7% rate, agreed to increase it to 8% in Four of the field offices contacted by the External Auditors would like to see the adoption of rates similar to those of the above-mentioned international organizations, or even ad hoc percentages negotiated with donors, so that UNESCO is not disadvantaged by competition with other organizations in its quest for voluntary contributions. 63. This is why the working group set up in late 2012 to review the entire cost-recovery system is studying the possibility of aligning the support cost rate on the 8% rate applied by some other international organizations. This approach is in part legitimized by the risk of overcharging indirect variable costs. C. Possible reform of regulations 64. To streamline the system, eliminate the risk of overcharging and improve UNESCO s position in relation to other agencies competing for voluntary contributions, there seem to be several possible reform options. 65. One option, which it appears necessary to implement in any event, would be to specify the categories of costs recovered by current support cost rates (13%, 10%, 8%, 7% and 5% for Brazil) and only use the charging of direct costs for other cost categories. In other words, certain cost categories would be recovered by FITOCA while other cost In 2005, the UNESCO Secretariat is said to have suggested charging services provided to the Convention on the Protection and Promotion of the Diversity of Cultural Expressions under the principle of direct cost recovery, even though those services were already provided by the Convention s secretariat. Following negotiations, the overcharging seems to have been avoided. See the list of organizations in Annex 2. United Nations Office for Project Services (UNOPS), International Organization for Migration (IOM), Organization of Ibero-American States (OEI), United Nations Population Fund (UNFPA), United Nations Development Programme (UNDP), United Nations Children s Fund (UNICEF) and the United Nations Entity for Gender Equality and the Empowerment of Women (UN Women).

18 200 EX/20.INF page 15 categories would be directly charged to the project budget. 66. Prior to such reform and in the interests of all other possible reforms, it would be useful to identify all cost categories, update the calculation of the amounts they represent for various types of extrabudgetary project of differing size and complexity (as project management is less costly if there is a single donor and economies of scale are possible when managing high-value projects) and grouping together these categories of expenditure by support cost rate (with a support cost rate of 13% covering more categories than a 5% rate). 67. A second option would be to use only a standard programme support cost rate for cost recovery (through FITOCA) and do away with the direct cost recovery system. This would be simple and low cost, as it would avoid the current complex calculation of direct costs by extrabudgetary project managers, the cost of BFM checking such calculations and the costs of training in cost recovery. 68. However, this method would probably involve applying a support cost rate of over 13%, which would place UNESCO at a disadvantage compared to its rivals. 69. A third option would be to recover the maximum level of costs as direct costs and to adopt an extremely low programme support cost (such as 3%) so that UNESCO is at much less of a disadvantage in relation to its competitors. However, the Secretariat does not consider such reform to be feasible as the working group on support costs for extrabudgetary activities, set up by the United Nations High-Level Committee on Management (HLCM), is strongly in favour of harmonizing the rates of the various agencies. 70. A fourth option put forward by two field offices in their replies to the External Auditor s questionnaire would be to enable extrabudgetary project managers to negotiate an ad hoc support cost rate with the donor(s): the rate would be based on their estimate of direct costs that could not be charged to each project s budget for whatever reason. All cost categories not included in this support cost rate would be charged to the project as direct costs. 71. While this solution appears very sensible, it requires a very high level of training of those in charge of project budgets, as well as intensified BFM controls on the preparation and implementation of extrabudgetary project budgets. The Secretariat is not in favour of this option, as it would run the risk of creating competition among field offices for donors and would make UNESCO s cooperation policy fragmented and incoherent. 72. The fifth option, which is the direction currently preferred by the working group, would be to align the support cost rate for FITOCA on the rate envisaged by the abovementioned group of international organizations (8 %), prohibit waivers from the rate and recover the maximum level of direct costs (as today). To avoid the risk of overcharging, this arrangement studied by the working group would have to be accompanied by the aforementioned reform (to identify cost categories covered by the support cost rate for FITOCA and to reserve direct cost recovery for other cost categories). 73. The Secretariat is concerned that the reform being considered by the working group will result in a shortfall for the Organization of between $1.4 million and $3.3 million in relation to the 27 budgets of extrabudgetary projects under way. This risk explains the Secretariat s aforementioned wish to maintain a high level of FITOCA reserves. 74. The risk must not be exaggerated for two reasons: Training sessions held to date have increased the skills of staff members and have rapidly increased the sums recovered by the special account (which have risen tenfold since 27 See document 197 EX/5, Follow-up to decisions and resolutions adopted by the Executive Board and General Conference at their previous sessions. Part IV.B of 26 August 2015 on management issues (para. 49).