Country Public Financial Management System Assessment. Republic of Armenia: Seismic Safety Improvement Program

Transcription

1 Country Public Financial Management System Assessment Project Number: Loan Number(s): June 2015 Republic of Armenia: Seismic Safety Improvement Program

2 ABBREVIATIONS ADS - Armenian Development Strategy BSL - Budget System Law COC - Chamber of Control DLI - disbursement-linked indicator EU - European Union INTOSAI - International Organization of Supreme Audit Institutions IPSAS - International Public Sector Accounting Standards MOF - Ministry of Finance MTEF - medium-term expenditure framework NA - National Assembly PFM - public finance management PIU - project implementation unit PRSP - Poverty Reduction Strategic Program SDP - Sustainable Development Program SHA - State Health Agency SNCOs - state non-commercial organizations SSIP - Seismic Safety Improvement Program TSA - Treasury Single Account UIPFR - unaudited interim program financial statements WB - World Bank

3 Seismic Safety Improvement Program (RRP ARM 49078) A. Introduction 1. This country public financial management (PFM) system assessment intends to determine the degree to which the system will be able to manage fiduciary risks relating to financial management and provide reasonable assurance that program funds will be used appropriately. The assessment has been conducted with reference to the Guidelines for the Financial Management and Analysis of Projects, 1 Financial Due Diligence: A Methodology Note, 2 and Financial Management Technical Guidance Note. 3 As required by ADB s policy paper on Piloting Results-Based Lending for Programs, 4 it focuses on accountability and transparency and covers (i) policy based budgeting, (ii) budget execution and cash/debt management; (iii) internal controls, (iv) accounting and financial reporting, (v) independent audit, and (vi) funds flow and disbursement arrangements. 2. The proposed arrangements for the program, a results-based lending modality, encourage use of the country PFM systems and, as ADB policies on financial management and procurement will not apply, it is relevant to assess the strength of government systems to determine whether additional assurances and/or institutional capacity building measures should be required. The assessment includes a review of the Republic of Armenia government s PFM system, which was conducted through a combination of review of relevant laws and regulations, and latest assessments of the PFM system. B. Review of the Government System of Budgeting, Execution, Internal Control, Accounting and Reporting, and Auditing 1. Policy Based Budgeting 3. The general provisions of implementation of the annual budgetary process are defined by the Budget System Law (BSL), which in turn in the Constitution. The process begins with the passage of the Prime Minister s decree on starting the budget process for the coming year. The decree identifies the calendar to be followed by the government agencies in the development of both the 3 years rolling medium-term expenditure framework (MTEF) and the draft state budget. 4. Preparation of the budget is in two stages. The first stage (strategic phase) starts early in the year, through the Ministry of Finance (MOF) providing instructions to government agencies for preparing MTEF submissions. The instructions are provided about 2.5 months before the deadline for presenting the submissions to MOF. The approved MTEF forms the basis for preparing the draft state budget (second stage). 5. Under the second stage, government agencies are required to file their budget submissions with MOF about a month later. The main decisions on expenditure levels and priorities underlying the budget submissions have already been approved during the first stage as part of the MTEF process, thereby simplifying the detailed budget estimation process. The draft state budget is presented to the government for review. The government must submit the draft state budget to the National Assembly (NA) at least 90 days prior to the start of the next budget year. 1 ADB Guidelines for the Financial Management and Analysis of Project. Manila. 2 ADB Financial Due Diligence: A Methodology Note. Manila. 3 ADB Financial Management Technical Guidance Note. Manila. 4 ADB Piloting Results-Based Lending for Programs (approved 6 March 2013). Manila.

4 2 6. In each year of the period under consideration, a clear calendar for the preparation of the annual state budget was in place and, overall, it was followed. The calendar gave sufficient time to prepare their budget submissions for the next year. 7. The methodological instructions issued to government agencies on the preparation of budget submissions for the next year include the policy priorities and the indicative expenditure financing limits for the coming year based on the provisions of the government program approved by the NA, the long-term programs of the government, and the most recent formally approved MTEF. 8. The involvement of public administration bodies, political officials, and powers in the process of preparing the MTEF is noteworthy. More specifically, in Armenia, the steering committee and the coordination group for the preparation of MTEF are functional. The political representation in the MTEF process is very high, and the MTEF policy decisions are made at this level. The political level involvement exists not only at the final approval of the MTEF document but also at different stages of the process such as the discussion of the underlying macroeconomic indicators, approval of expenditure limits, etc. The MTEF and budget processes successfully combine the top-down and bottom-up information flows. 9. The quality of the MTEF process has improved significantly since 2008, due to line ministries being better informed and better able to engage in a constructive two-way dialogue with MOF during the discussions on MTEF submissions and thus being in a better position to rigorously justify new spending. 10. A program budgeting framework was prepared during recent years (as a successor to the MTEF development project), the purpose being to further strengthen the linkage between policy objectives and budgets. Line ministries have been preparing budgets according to a program classification and have been presenting these to NA in parallel with the official budgets. Presentation of program budgets to NA is now mandatory under the revised BSL with effect from the submission of the 2014 budget to NA. 11. The official budgets continue to be prepared and executed on a traditional administrative, functional, and detailed line item economic classification basis. MOF uses a mapping table that automatically connects the programmatic information with the functional and economic classification databases, ensuring consistency between the program and official budgets. The mapping table also enables monitoring and reporting systems to use the program budget classification as well as the official budget classification. 12. In conformity with the requirement of the BSL, each year the MTEF is prepared and approved by the government for the next three years and submitted to the NA. A new third year is added each year. The MTEF presents forecasts of macro-economic and aggregate fiscal indicators (with expenditures presented by program based on the main economic, functional and administrative classifications). In the event of variances between indicators for the coming year under the approved MTEF and the draft state budget for the coming year, these variances and their underlying causes must be presented in the draft state budget. 13. The MTEF contains not only fiscal information on revenues, expenditures, and deficit but also the fiscal principles, risks and macroeconomic forecasts, sector analysis, the announced sector priorities for the concerned period, expenditure drivers influencing projected expenditures in terms of both volume and prices, and detailed information on programs and their objectives

5 3 across sectors. The MTEF represents a strong, robust, and integrated system. It has come a long way since its introduction several years ago and has scope for further improvement through the ongoing program budgeting reforms. 14. As a rule, MTEFs build on long-term strategic plans with a year strategic perspective. The first such plan was the Poverty Reduction Strategic Program (PRSP), covering , followed by the Sustainable Development Program (SDP), covering the horizon). A third strategic plan, the Armenian Development Strategy (ADS), covers In conjunction with the International Monetary Fund and World Bank, the MOF conducts an annual debt sustainability analysis for external and domestic debt. The conclusions of the analysis are reflected in the Fiscal Risks section of the MTEF. Staff in MOF were trained by the International Monetary Fund and World Bank in the use of the debt sustainability analysis, the methodology having originally been prepared by these two institutions. 16. The sector strategies, the government approved strategic plans for the concerned sector forming the basis for the preparation of both long- and medium-term programs, do not completely cover the sector or are not costed. Financial forecasts are informative by nature in individual sector strategies. The strategic planning for all sectors and their aggregate financial forecasting are covered by the long-term strategic papers (PRSP (2003), SDP (2008), ADS (2013, draft)), and they are later moved to the three-year MTEF planning processes. Costing is conducted, however, as part of the MTEF process, and is more realistic as the costs can be estimated with much greater precision than is possible under long-term planning. For example, they can include the future recurrent costs implied by committed capital investments. 17. Most of the major investments are identified based on the appropriate sector and longterm development strategic plans but their implications for recurrent expenditures are not always taken into account in preparing the draft budgets. The economic and financial assessment of public investments is performed by the relevant line ministry, and reviewed and concluded by MOF. Reviews of the reasonableness of recurrent and investment expenditures take place separately, but in the course of planning they are supposed to be reconciled. 18. The level of the quality and accuracy of the interrelation of recurrent and investment expenditures depends on the level of planning and budgeting capacities of the responsible sector agencies and the extent of integration between these capacities. In practice recurrent and capital budgeting units still tend to operate separately from each other in MOF, even after several years of reform of planning and budgeting processes. Current accounting processes do not separate out the recurrent costs implied by capital investments. In light of the above, the MOF plans to implement a technical assistance project with World Bank support aimed to clarify and describe a unified system for planning investment and recurrent expenditures which will be used in the State planning and budgeting processes. 2. Budget Execution and Cash / Debt Management 19. After adoption of the respective Law on State Budget and approval of the government decision on the state budget quarterly allocations (which identifies the quarterly payment limits for each budgetary institution), the Treasury, located in the MOF, prepares a cash flow forecast for the new budget year on a quarterly, monthly, and weekly basis. The forecasts can be adjusted weekly, taking into account the actual receipts and outflows of cash. The cash flow is monitored by the Budget Commission, which meets every Thursday in the MOF.

6 4 Representatives of Central Bank and the Government State Revenues Committee are invited to participate in the meetings. 20. Line ministries, government agencies, and other spending units can program and commit expenditures at the beginning of the new budget year consistent with the state budget quarterly allocations. Budget agencies have been able to plan and commit expenditure according to a full year s time horizon. The government typically has enough resources in its Treasury Single Account (TSA) to fund the expenditures envisaged by the state budget, thus ensuring sufficient flexibility to meet expenditure commitments according to the expenditure schedule, whether original or revised. 21. MOF approved an action plan for public debt management reform in March 2010 to increase the efficiency of public debt management with the following measures: (i) introduction of a debt registration and recording system; (ii) improvement and reinforcement of the institutional structure for debt management; (iii) improvement in the quality of annual and semiannual reports on public debt; (iv) steps aimed at the development of a primary market; and (v) development of a medium-term debt strategy. 22. All applications for loan disbursements from external sources must be approved by MOF, in addition to approval by the program implementing body, and registered. After creditors approve the disbursement applications, the relevant information (in paper or electronic form) is submitted to MOF, where it is recorded in Debt Management and Financial Accountability System on a daily basis and summarized on a monthly basis. The World Bank Client Connection and Asian Development Bank LFIS/GFIS/LAS internet software enable the debtor to follow on-line the process of approval of the submitted disbursement applications. Disbursements made in by these two organizations comprised 37%, 44%, and 55% of overall disbursements. The information about actual disbursements made by other creditors is provided by or regular mail. 23. The transactions on treasury accounts opened for project implementation units (PIUs) are also a source of information about actual disbursements. The accounts of 25 out of 37 operating loan programs during 2012 were held in the central treasury; the accounts of 3 programs were held in commercial banks prior to their completion in early 2014, the remaining account balances program being transferred to the central treasury, and disbursements for 9 programs have been made in the form of direct disbursements directly paid to the beneficiary by development partners, the debt management unit being immediately notified electronically. Any data errors are rectified through correspondence with creditors and PIUs. 24. Creditors submit payments advice notifications (interest, amortization, and other payments) in electronic or paper form to MOF, which checks the correctness of these against its own data. The MOF then prepares the schedule of debt service payments for the next month and provides this to the Budget Commission in MOF and to the Central Bank. The information on actual payments is recorded and summarized on a daily basis. 25. Information about the internal debt structure (government bonds, in terms of value, composition and operations) is available on a daily, weekly, monthly, quarterly, and annual basis. 26. All cash balances are calculated daily and consolidated under the TSA, which contains the entire state budget, extra budgetary, deposit and monetization accounts. The TSA is an account opened in Armenian dram in the Central Bank in the name of the Central Treasury in

7 5 MOF. All the resources at the disposal of the Republic of Armenia and communities are deposited in it, and all the payments are made out of it. 27. Starting 2011, the government has brought all the special accounts of foreign-financed loan and grant programs into the Central Treasury. These accounts are foreign currency subaccounts opened in the name of the respective PIU under the TSA. Prior to 2012, disbursements under some foreign-financed programs were made in the form of direct payments to the beneficiary. Starting 2012, however, the disbursements and expenditures made under these programs were also recorded through the Central Treasury, using the Treasury s Operational Day software. 3. Internal Controls 28. Internal control for payroll controls is less effective due to lack of timely reconciliation between payroll and personnel records of public entities, mainly as the manual linkage between the two make reconciliation process very time consuming. 29. Procurement related internal control is strong in the dimensions of legal and regulatory framework, public access to complete, reliable, and timely procurement information, and existence of an independent administrative procurement complaint system, but weak in using competitive procurement methods. The method of procurements conducted through the negotiation procedure without prior announcement of the proposed procurement is considered as a non-competitive procurement method. The majority of contracts were awarded in 2011 and 2012 (66% in 2011, 72% in 2012, by value, 54%, in 2011, 82% in 2012 by number) using noncompetitive procurement methods on the basis of special or exclusive rights. 30. Internal control for non-salary expenditure is strong in the dimension of expenditure commitment control, but less effective in the dimensions of comprehensiveness, relevance, and understanding of other internal control rules and procedures, and degree of compliance with rules for processing and recording transactions. Internal controls are observed and bypassing them is not frequent, but nevertheless audits conducted by internal audit units in public bodies and by Chamber of Control (COC) identify regular violations of internal control processes and the unjustified use of simplified procedures. Violations include (i) inadequate authorization of decision making; (ii) violations of asset management, technical and other control rules, established procedures and norms; (iii) acceptance of incomplete works and payments thereof; (iv) wrong accounting of transactions; and (v) many other cases of inadequate and incomplete application of controls and the bypassing of controls. 31. Internal audit function exists in almost all public bodies. Standards, rules of conduct, and manuals have been adopted based on internal audit international standards and independence has improved. However, audit standards are not fully observed, and capacity constraints limit the pace of establishment of the internal audit function. It was a mandatory requirement for line ministries to submit internal audit reports to MOF. However, as the internal audit information system is only partially working, there is no reliable way for MOF to know the extent to which public bodies observe the rules stipulated for the submission and distribution of audit reports. Though recommendations are not always implemented or even prepared, the extent of followup continues to improve. Overall the internal audit is less effective.

8 6 4. Accounting, Recording and Reporting. 32. Debit and credit transactions shown daily in the TSA held by the government in the Central Bank are electronically reconciled daily (using the Treasury Operating Day software) with Treasury transactions records held in MOF. A nostro reconciliation is conducted in line with debit and credit transactions. Reconciliation differences are settled the following day. All disbursements under foreign-financed programs/projects and expenditures made under these disbursements have been reflected in the TSA, starting in Prior to 2012, such disbursements and expenditures were not reflected in the TSA but in changes in balances of bank accounts outside the TSA. 33. All state non-commercial organizations (SNCOs) in all sectors, including secondary schools having SNCO status, prepare and submit quarterly and annual reports to their authorized bodies (e.g. Ministry of Education) and then to the MOF on the planned and actual state budget resources received as well as other resources (i.e. own revenue) received in accounts held by them in commercial banks. Most hospitals and polyclinics having closed jointstock company status, submit to State Health Agency (SHA) the data on budgetary resources allocated to individual hospitals and polyclinics. SHA summarizes these data and publishes them on the agency s webpage. 34. The quality of data is strengthening mainly due to the advent of the client-treasury system and inclusion of financial flows related to development partners financed projects and programs implemented through PIUs. 35. Contrast to the above strong performance, Quality and timeliness of annual financial statements remains weak, as the absence of modern accounting standards hinders the preparation of meaningful auditable annual financial statements. 36. A consolidated government report is prepared annually. The report consolidates the budget execution statements of central government budgetary agencies (i.e. excluding community governments and autonomous central government agencies that have budgeting and accounting systems outside the central government s budgetary system; in the context of Armenia, SNCOs are also excluded). Annual budget execution reports are prepared according to a consistent format, which, however, is not consistent with International Public Sector Accounting Standards (IPSAS). Public bodies are guided by the Soviet-era accounting instructions (order No 61 of Armenian SSR Ministry of Finance dated March 10, 1987), but the accounting standards are not disclosed. 37. Due to the absence of modern accounting standards, the government is unable to prepare auditable annual financial statements. The COC is unable to provide an opinion about the fair presentation of the financial position and results of operations. The annual budget execution statements submitted to COC omit much of the accounting information that typically appears in financial statements: statements of financial assets and liabilities. 5. External Audit and Legislative Scrutiny 38. A high quality external audit is an essential requirement for creating transparency in the use of public funds. Though independence increased, the COC still lacks sufficient independences in terms of staffing, budget, entitled oversight, and annual action plan.

9 7 39. According to the Constitution, the COC provides oversight over the use of budgetary resources and the use of public and community property. However, according to other laws enforced in Armenia, COC is not entitled to provide oversight over the use of non-budgetary revenues earned by state and community non-commercial organizations and over the use of loans and grants received from external sources. 40. The process of planning the audit and presenting an opinion on the quality of the budget execution report needs to be improved, as it is not fully consistent with International Organization of Supreme Audit Institutions (INTOSAI) standards. An issue is that the COC s opinion does not fully reveal the standards used by the government in preparing its budget execution reports and does not reveal its own standards that it uses to audit these reports. 41. With on-going and planned support from WB, GIZ, and EU, the work of the COC will improve in the near future to (i) strengthen conformity with INTOSAI standards through training, receipt of relevant handbooks, and pilot audits; (ii) strengthen the quality of the COC s opinion on the budget execution report; (iii) prepare a draft revision of the RA Law on COC, aimed at ensuring and maintaining the independence of the COC; (iv) strengthen the toolkit of the performance audit carried out by the COC, with particular focus on controls in the public procurement system, through education and training courses and pilot audits; and (v) build capacity in general. 42. Legislative scrutiny of the annual budget law was weak, as rules for in-year amendments to budget without ex-ante approval by NA, though with considerable flexibility on the basis of efficiency gains, allow in a somewhat non-transparent way to change budget allocation. Legislative scrutiny of external audit reports was also weak due to no mandatory force for proposals on resolution of issues raised in the report of COC. 6. Overview of Public Expenditure and Financial Accountability Assessment 43. A public expenditure and financial accountability assessment has recently been completed in May 2014 at country-level. The latest report indicates that overall PFM system of Armenia scores very well for some of the functions, 5 shown in Table 1. Strong performance was found for budget credibility (PI 1-4), and for comprehensiveness and transparency (PI 5-8, and 10), but weak in the dimension of oversight of aggregate fiscal risk from other public sector entities (PI 9). Policy-based budgeting (PI 11-12, budget execution and cash/debt management (PI 16-17) performs well. Revenue Administration has strong performance (PI 13-14), but weak in the dimension of effectiveness in collection of tax payments (PI 15). Areas which were found to be weaker include overall internal control (PI 18-21), accounting, recording, and reporting (PI 22-25), and external scrutiny and audit (PI 26-28). Table 1: Summary of Performance Indicator Ratings, 2008 and 2013 PEFA Assessments Indicators PI-1 PI-2 Dimension A: BUDGET CREDIBILITY Aggregate expenditure out-turn compared to original approved budget Composition of expenditure out-turn compared to original approved budget 5 B and above rating given for these indicators. PEFA Score Risk Rating 2014 B A Low A B+ Moderate

10 8 PEFA Score Risk Rating Indicators Dimension PI-3 Aggregate revenue out-turn compared to original approved A A Low budget PI-4 Stock and monitoring of expenditure payment arrears B+ A Low B. KEY CROSS-CUTTING ISSUES: Comprehensiveness and Transparency PI-5 Classification of the budget A A Low PI-6 Comprehensiveness of information included in budget A A Low documentation PI-7 Extent of unreported government operations A B+ Moderate PI-8 Transparency of inter-governmental fiscal relations B A Moderate PI-9 Oversight of aggregate fiscal risk from other public sector D+ D+ High entities. PI-10 Public access to key fiscal information A A Low C. BUDGET CYCLE C (i) Policy-Based Budgeting PI-11 Orderliness and participation in the annual budget process A A Low PI-12 Multi-year perspective in fiscal planning, expenditure policy B B Moderate and budgeting C (ii) Predictability & Control in Budget Execution Revenue Administration PI-13 Transparency of taxpayer obligations and liabilities C+ B+ Moderate PI-14 Effectiveness of measures for taxpayer registration and tax B B Moderate assessment PI-15 Effectiveness in collection of tax payments B+ D+ High Budget Execution & Cash/Debt Management PI-16 Predictability in the availability of funds for commitment of A A Low expenditures PI-17 Recording and management of cash balances, debt and A A Low guarantees Internal Controls PI-18 Effectiveness of payroll controls B+ D+ High PI-19 Transparency, competition and complaints mechanisms in A B Moderate procurement PI-20 Effectiveness of internal controls for non-salary expenditure C+ C+ Substantial PI-21 Effectiveness of internal audit D+ C Substantial C (iii) Accounting, Recording and Reporting PI-22 Timeliness and regularity of accounts reconciliation A A Low PI-23 Availability of information on resources received by service C A Low delivery units PI-24 Quality and timeliness of in-year budget reports C+ B+ Moderate PI-25 Quality and timeliness of annual financial statements D+ D+ High C (iv) External Scrutiny and Audit PI-26 Scope, nature and follow-up of external audit D+ C+ Substantial PI-27 Legislative scrutiny of the annual budget law A C+ Substantial PI-28 Legislative scrutiny of external audit reports D+ D+ High D. Donor Practices

11 9 PEFA Score Risk Rating Indicators Dimension D-1 Predictability of Direct Budget Support D+ C+ Substantial D-2 Financial information provided by donors for budgeting and A A Low reporting on project and program aid D-3 Proportion of aid that is managed by use of national procedures D B Moderate C. Fiduciary Risk Assessment and Risk Mitigation Measures 44. The risk assessment approach is based largely on International Standard on Auditing 400 Risk Assessment and Internal Control. The following risk assessments are based on existing circumstances, staffing and procedures, and include recommendations for risk mitigation measures. 45. Inherent Risk. Inherent Risk is the susceptibility of the project financial management system to factors arising from the environment in which it operates, such as country rules and regulations and entity working environment. Risk Type 1. Policy based budgeting and execution 2. Internal controls Table 2: Overall Inherent Risk Risk Risk Description Rating Annual state budget and 3-year rolling L MTEF are prepared and approved annually, while the MTEFs are prepared based on long-term strategic plans with a year strategic perspective. Line ministries, government agencies, and other spending units can program and commit expenditures at the beginning of the new budget year consistent with the approved state budget. Internal control is less effective for S payroll controls and non-salary expenditure. Overall procurement related internal control is strong, however, the majority of contracts were awarded in 2011 and 2012 using non-competitive procurement methods. Risk Mitigation Measures Capacity building and information system development are essential to improve international control. Monitor and follow-up of external audit observations. 3. Accounting and financial reporting Standards, rules of conduct, and manuals have been adopted based on internal audit international standards, but not fully observed due to capacity constraints and only partially working of information system. Internal audit is less effective. Annual budget execution reports are prepared according to a consistent format, which, however, is not H An IA will be established to ringfence the implementation of the ADB-funded program applying

12 10 Risk Type 4. External audit 5. Sector or Program Risk Description consistent with IPSAS or national standards consistent with IPSAS. Public bodies are guided by USSR-era accounting instructions (order No 61 of Armenian SSR MOF dated March 10, 1987), but the accounting standards are not disclosed. Due to the absence of modern accounting standards, the Government is unable to prepare auditable annual financial statements. The COC is unable to provide an opinion about the fair presentation of the financial position and results of operations. The annual budget execution statements submitted to COC omit much of the accounting information that typically appears in financial statements: statements of financial assets and liabilities. According to the Constitution the COC provides oversight over the use of budgetary resources and the use of public and community property. However, according to other laws enforced in Armenia, COC is not entitled to provide oversight over the use of non-budgetary revenues earned by state and community noncommercial organizations and over the use of loans and grants received from external sources, which are later provided to the commercial banks and financial organizations and circulated by those organizations. The process of planning the audit and presenting an opinion on the quality of the budget execution report needs to be improved, as it is not fully consistent with INTOSAI standards. An issue is that the COC s opinion does not fully reveal the standards used by the Government in preparing its budget execution reports and does not reveal its own standards that it uses to audit these reports. Construction code / building standard to be updated in line with international Risk Rating H H Risk Mitigation Measures international standards on accounting, reporting, and auditing - not full use of country PFM systems. Training on financial reporting and auditing should be provided. Regular review of external audit reports and management letter should be used to update financial management action plan as required. Monitoring tools including variance analysis of actual vs budgeted financial and physical targets shall form part of the program monitoring. The Program will audited annually by independent auditors whose qualifications, experience and terms of reference are acceptable to ADB, in accordance with international standards on auditing or the national equivalent acceptable to ADB With on-going and planned support from WB, GIZ, and EU, the work of the COC will improve in the near future to (i) strengthen conformity with INTOSAI standards through training, receipt of relevant handbooks and pilot audits; (ii) strengthen the quality of the COC s opinion on the budget execution report; (iii) prepare a draft revision of the RA Law on COC, aimed at ensuring and maintaining the independence of the COC; (iv) strengthen the toolkit of the Performance audit carried out by the COC, with particular focus on controls in the public procurement system, through education and training courses and pilot audits; and (v) build capacity in general. Update and approval of the building codes and development

13 11 Risk Type specific risks Risk Description standards and best practices. Guidelines for school building strengthening to be developed. Risk Rating Risk Mitigation Measures and approval of guidelines in line with international best practices is a disbursement linked indicator in year 2 (DLI 4). Overall S inherent risk ADB = Asian Development Bank; COC = chamber of Audit; DLI = disbursement-linked indicator; EU = European Union; GIZ = Deutsche Gesellschaft für Internationale Zusammenarbeit/ German International Cooperation; IA = implementing agency; INTOSAI = International Organization of Supreme Audit Institutions; IPSAS = International Public Sector Accounting Standards; MOF = Ministry of Finance; MTEF = Medium-Term Expenditure Framework; PFM = Public Finance Management; RA = Republic of Armenia; USSR = Union of Soviet Socialist Republics; WB = World Bank Source: Asian Development Bank. D. Program Financial Reporting and Auditing 46. Review results do not recommend using the country PFM system on financial reporting and auditing. Audit on all ongoing projects financed by ADB in Armenia have been conducted by private audit firms. 47. To ring-fence the implementation of the ADB-funded program, a program implementing agency shall maintain separate accounts and records for the program, and prepare annual program financial statements for the program in accordance with accounting principles acceptable to ADB, that is, following cash basis IPSAS, or national standards consistent with cash basis IPSAS. The annual program financial statements should reflect all sources of funds for the program. 48. The annual program financial statements will be audited annually by independent auditors whose qualifications, experience and terms of reference are acceptable to ADB, in accordance with international standards for auditing or the national equivalent acceptable to ADB. The auditors will prepare a report (which includes the auditors opinion on the financial statements, use of the loan proceeds, and compliance with the financial covenants) and a management letter (which sets out the deficiencies in the internal control of the Program that were identified in the course of the audit, if any). The audited financial statements in English should be received by ADB within 6 months of the end of the fiscal year. 49. ADB shall disclose the annual audited financial statements for the program and the opinion of the auditors on the financial statements within 30 days of the date of their receipt by posting them on ADB s website. 50. The executing agency and implementing agency for the SSIP will provide the auditors with full access to the related documents and records. The government will provide evidence to ADB of the course of action to resolve issues in the audit report and management letter within 6 months after the date of the audit report. ADB will monitor the timely resolution of any issues identified in the audit reports. 51. ADB will reserve the right to commission supplementary financial and compliance audits, if required. Any irregular expenditure will be followed up through the government s own accountability procedures.

14 12 E. Disbursement Arrangements 52. The disbursement arrangement is to promote results-based management by linking disbursements to government s delivery of results. Disbursement by ADB will be subject to achievement of key results of the SSIP result framework presented in the DLI matrix. The DLIs will focus on the results critical to meet the goals of the government s sector development plan. 53. Disbursement by ADB will be subject to the submission of the withdrawal application, attached with the evidence of DLI achievements, and unaudited interim program financial statements (UIPFRs) of the EA/IA. UIPFRs should show that the government expenditures incurred under SSIP is cumulatively more than the sum of ADB s disbursement and other development partners disbursements in support of SSIP over the program period. UIPFRs should be prepared on the basis of latest audited financial statements and subsequent interim unaudited expenditures. 54. For the prior results, the government will provide unaudited financial statements of the IA that show the government s expenditures for SSIP for the period before loan effectiveness but within 12 months before loan signing. Other key results which are not included in the DLI matrix, as well as capacity building improvements, shall be incorporated in the program action plan and monitored by ADB. Expenditure eligible for reimbursement shall be the total expenditure by the government under the SSIP less funding by other development partners and excluding any payments made for goods or services to contractors or consultants from non-adb member countries. 55. The implementation of SSIP will be entirely funded through the consolidated fund with no requirement to identify which transaction or payment is funded from which source: i.e., all transactions are funded from one single source - the consolidated fund of the government. Additional support will be provided to strengthen sector management capacity for the implementation of the SSIP. 56. Total ADB loan of $88.3 million will be disbursed over 5 years. The first disbursement will be made for carefully selected prior results (DLI year 0) after loan effectiveness. Each DLI will be associated with a set amount. If all DLIs are met for the period and the achievements are verified, the total sum of all DLIs will be disbursed. If few DLIs are not met, only the amount for achieved DLIs can be disbursed while the rest of the disbursement can be made at a later period. F. Fund-Flow Mechanisms 57. ADB will be disbursing to the consolidated fund from where the resources will be merged with other revenues. Implementation of SSIP will be financed by regular releases from the consolidated fund. The flow of funds will follow a procedure where ADB disburses directly to one of the government s central revenue accounts in the Central Bank of Republic of Armenia. The funds from the consolidated fund are released entirely in accordance with government procedures.

15 13 Disbursement and Fund Flow Arrangement ADB MOF Designated USD account in Treasury - WAs - Expenditure report - DLI report - UIFS ATDF Contractors Consultants Beneficiaries Documents for disbursement ADB Funds ADB = Asian Development Bank; ATDF = Armenia Territorial Development Funds; DLI = Disbursement link indicator; UIFS = Unaudited interim program financial statements; SSIP = Seismic Safety Improvement Program Source: Asian Development Bank. G. Financial Covenants 58. ADB will contribute to the total government expenditure framework allocated for the SSIP. Sufficient budgetary resource should be allocated by the government for the SSIP. To ensure that ADB s contributions serve to leverage required additional resources to finance the SSIP, rather than substituting government allocations financed from the consolidated fund, the government should agree to a minimum threshold of budget allocations broadly consistent with the resource requirements of the SSIP.

16 14 H. Audit Review and Financial Management Action Plan 59. An annual fiduciary review process is proposed to assess key risk areas identified through annual audits and other sources of information. An overview of main risks and proposed mitigating action are provided in Table 2 above. There would be high risks on financial reporting and auditing in using country PFM in the short term, potentially in the medium term as well, and review results do not recommend using the country PFM system, at least not fully use. To ringfence the implementation of the ADB-funded program, the IA should apply international standards on accounting, financial reporting, and auditing on the Program financial statements.