FINANCIAL MANAGEMENT ASSESSMENT I. Objective and ...

Improving the Quality of Basic Education in the North Pacific (RRP REG 49456)

FINANCIAL MANAGEMENT ASSESSMENT

I.

Objective and Purpose

1. The primary objective of the financial management process is to optimize the financial and economic benefits of an investment. Financial management encompasses financial planning, programming, accounting, reporting, auditing, funding, organization and personnel of a project, Executing Agency (EA) or Implementing Agency (IA). Both the EA and IA should plan, develop and maintain financial management systems that can provide timely and reliable information suitable for monitoring the project's EA's and IA's progress towards ADB agreed objectives.

2. As a project financier, ADB is governed by its Charter which requires that; (i) in making a loan or grant it shall take necessary measures to ensure that the proceeds of any loan or grant shall only be used for the intended purpose with due attention to considerations of economy and efficiency. In the case of a loan, the Charter requires that borrower will be able to meet its obligations under the loan agreement.

3. To meet the requirements of the Charter, it is necessary to demonstrate that the project is financially viable and sustainable, in the case of a revenue generating project or financially sustainable in the case of a non-revenue generating project. Furthermore, it is necessary to assess from the borrower/grantee's perspective that its financial management systems and controls are in place to ensure that the funds will be utilized for the intended purpose and support monitoring and supervision of the project.

4. The financial management assessment (FMA) has been carried out of the EA and IA in accordance with ADB's Financial Management and Analysis of Projects, 2005, Financial Management Technical Guidance Note, 2015 and Financial Due Diligence, A Methodology Note, 2009. The Financial Management and Analysis of Projects, 2005, state that "the FMA is not an audit but a review designed to determine whether the entity's financial management arrangements are sufficient for the purposes of project implementation".

5. The FMA was undertaken as follows: (i) the financial management assessment questionnaire (FMAQ) contained in the above ADB guidelines was administered to the EA and IA to elicit information and responses; (ii) analysis of the responses and potential risks; (iii) identify ways of mitigation of risks (if any).

II. Public Financial Management (PFM) Initiatives in the FSM and RMI

6. FSM/RMI public financial management (PFM) is based on the basic legislative framework under the FSM and RMI Code/s. The Code in each jurisdiction covers basic executive, legislative and judicial procedures and has a separate chapter on financial management, also referred to as the Financial Management Acts of FSM and RMI.

7. PFM reviews have been done by PEFA1 for FSM in 2013 and RMI in 2012. PEFA is methodology for assessing public financial management performance. The reviews are carried

1 Under the PEFA framework, performance is assessed in relation to seven dimensions of public financial management: credibility of the budget; comprehensiveness and transparency; degree to which the budget is prepared with due regard to government policy; predictability and control in budget execution; accounting, recording and reporting; external scrutiny and audit operations; appropriateness of development partner practices in country; and intergovernmental fiscal relationships.

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out by the PEFA Secretariat, which is part of the World Bank. The PEFA program is managed by seven international development partners; World Bank, IMF, European Commission and the governments of France, Norway, Switzerland and the U.K.

8. PEFA reports for FSM and RMI were issued in 2013 and 2012 respectively. The conclusions reached for both countries are similar and are as follows. (i) budget credibility. The budget is the mechanism for controlling expenditure and estimating income and implementing the budget as planned is important in delivering the government's policy objectives. The PEFA report concludes that on average, budgeted revenues have been conservative and actual revenues have exceeded the budget. (ii) accounts payable settlement. Although both FMIS report outstanding payables by 30, 60, 90 days, there is evidence that this information is not used systematically resulting in payment of bills exceeding 30 days in some instances. The FSM/RMI Code requires settlement within 30 days, (iii) fiscal risk from SoE, other States and local government. In both FSM and RMI, there is no central agency or central agency that provides oversight on Shoes and potential fiscal risks. The same holds true for each State in the FSM which have separate Constitutions and are entitled to borrow without informing the national government. In practice, FSM national government does not actively monitor the State's fiscal position. In RMI, local governments are not required to send fiscal information to the national government and therefore no monitoring is done. (iv) lack of multi-year fiscal perspective. In FSM, the Strategic Development Program contains sector goals, strategies, outcomes and activities but is not updated nor costed. In RMI, the MediumTerm Budget and Investment Framework (MTBIF), covering a 5-year period into the future is prepared by the Economic Policy, Planning & Statistics Office (EPPSO) under the Office of the President. The MTBIF is not used during the budget process. (v) effectiveness of payroll controls. In FSM line departments maintain personnel records and employees submit timesheets to the DoFA payroll office although these three sets of databases are not reconciled. The same is true for RMI. The public sector payroll is maintained by the MoF, the personnel records by the line ministries and structure for all posts by the Public Services Commission (PSC). Since the three databases are separate changes to employee records take time to be done on all three. The internal control environment at the payroll section of MoF has not been tested and there are issues regarding lack of segregation of duties. (vi) Inadequacy of the account reconciliation process. The discipline of regular reconciliation, clearing of suspense and advance accounts is not prevalent in both countries. Often reconciliations are left till the year end which delays the finalization of accounts. (vii) inadequacy of periodic reporting. Although the FMIS produces budget versus actual variance reports these are not reported to the line departments/ministries either DoFA or MoF. The State finance does not report to the State departments either.

9. In May 2016, the Graduate School, U.S.A fielded a team of Consultants to carry out a broad level assessment of MoF. The report is still in Draft form but it is pertinent to highlight the three highest risks that they have identified in terms of PFM at MoF;

Management deficiencies, staff turnover/vacancies and staff morale; Compelling need for acquisition of FMIS, as the new owners do not seem in

supporting the product or improving it; Slipping deadlines for the completion of audit.

III. Financial Management Assessment of the Executing Agencies (EA)

10. The Department of Finance and Administration (DoFA) of FSM and the Ministry of Finance (MoF) of RMI are the executing agencies (EA) for the project. The Secretaries of Finance of DoFA and MoF are the chief accounting officers and are responsible for the

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collection, disbursement and accounting of public funds. They are accountable to their respective Ministers of Finance. The EAs are responsible for the management of all government funds including the General Fund, grant funds and the Compact Trust Fund (CTF). The General Fund comprises of tax and non-tax revenue collections and budget appropriations for government expenditure. Grant funds comprise of U.S Federal grants, Compact sector grants and grants from other donors. The CTF is a fiduciary fund with restricted use until 2023 when the Compact ends.

11. In the FSM, reporting to the Secretary of Finance are assistant secretaries heading the departments of (i) budget and economic management; (ii) treasury; (iii) customs and tax; (iv). investment; and (v) personnel. The treasury division oversees accounting and reporting and consists of separate sub-divisions for accounts payable, accounts receivable, payroll, reconciliation, travel advances, IT and three field offices in the States of Chuuk, Kosrae and Yap.

12. In RMI, reporting to the Secretary of Finance are four assistant secretaries for; (i) accounting and administration; (ii) budget and procurement; (iii) treasury, taxation, revenue and customs; (iv) Ebeye MoF office and (v) international development. The accounting and administration department is comprised of two main sections, the Chief Accountant's section and the IT/FMIS administrator. The Chief Accountant has Accounts receivable and accounts payable sections in addition to the payroll sections reporting to him. In addition, there is a separate "reconciliation" section which undertakes bank reconciliations and other general ledger reconciliations with subsidiary ledgers. The international development (previously grant writing office) is responsible for a coordinating role with bi-lateral and multi-lateral agencies for funding assistance.

A. Findings of the Financial Management Assessment (FMA)

13. Financial system. DoFA in FSM (including States) uses the FundWare financial management information system (FMIS) and in RMI, MoF uses the 4Gov FMIS for recording and reporting transactions. Both FundWare and 4Gov are windows-based modular FMIS which have been used for the past ten years or so and both FSM and RMI are considering the migration in to more advanced and user-friendly FMIS. The FMIS uses the U.S Government Accounting Standards2, is a double entry based general ledger system with accompanying subsidiary ledgers. The FMIS is in effect a modified double entry accounting system with receipts being posted on an actual basis when received and payments based on accrual accounting. It is not possible to accrue receipts hence the modified double entry system in operation. The FMIS consists of several modules for accounts payable, procurement (purchase requisitions and purchase orders), payroll, inventory, cash receipts and budget. Reports can be produced of at any time of the budget and cumulative spend to date. The cumulative spend cannot exceed the budget. Certain modules which should be used such as bank reconciliation and fixed assets are used due to the lack of knowledge on their use and the functions are being done manually, off-system which is inefficient and error-prone.

14. DoFA and MoF do not have active vendor support for the FMIS software as it once did in the past due to staffing changes at the vendor. Many staff have not been trained in using the FMIS's functions to the fullest and therefore, much time and effort is spent on off-system work. Given the age of the systems, DoFA and MoF are considering replacement. MoF is taking account of the recommendations from the US Graduate School Report of 2016, is considering replacing the FMIS which requires careful planning and continued assistance to ensure that

2 A requirement by the U.S due to substantial grant funding under the Compact.

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hardware is purchased, staff properly trained and current FMIS data carefully transferred to the new system.

15. Many hundreds of Journal entries are posted on an annual basis. Journal entries are used to make corrections and account for items such as bank charges or depreciation and should be few. This large number of journal entries indicates that there is an issue in incorrect data entry postings. The chart of accounts is lengthy and alpha-numeric (in the case of MoF) which too may be contributing to the number of errors.

16. Financing reporting. The FMIS can produce periodic budget and expenditure to date by each type of fund such as General Fund, Compact etc. However, this information is not regularly extracted and given to the various ministries and discussed as part of routine management meetings. Instead each ministry is allowed one fourth of the annual budget on a quarterly basis. Periodic progress financial reporting to management is minimal. At the end of the Financial Year (FY), a Trial Balance is obtained from the FMIS and once all reconciliations are complete is handed over to Deloitte who does the preparation and audit of the final government financial statements. This is unusual as the auditor prepares as well as audits the financial statements, but has been the practice for many years.

17. Fixed Asset Register (FAR). Although the FMIS has a FAR module, the FAR is maintained off-system on MS Excel spreadsheets at both DoFA and MoF, which inevitably results in reconciliation issues with the General Ledger (GL) in the FMIS. In addition, fixed assets are not tagged and annual verification of fixed assets is not carried out at MoF although it is at DoFA.

18. Standard Operating Procedure (SoP). In MoF, Standard Operating Procedures (SoP) was prepared by an external consultant in 2015 and approved by the Minister of Finance. These are specific policies, procedures and controls to be adhered to in processing transactions in accordance with best practice. DoFA has a recently prepared document dated August 2016 on finance office procedures, but in both countries, few of the staff are aware of them.

19. Centralized payment structure. The public sector payroll is maintained and payments made to each employee by both DoFA and MoF. In addition most of the payments of the various government ministries are also made through the DoFA and MoF. The only exception is where the Ministries of Education and Health in RMI make payments for certain items under their budget, excluding payroll which is fully centralized.

20. Budgeting process and budgetary control. The budget preparation cycle commences with the Budget Call Circular usually issued during the third quarter of the preceding FY. The line ministries receive information, formats and timetable for submission of their budget. The budget circular is issued by the Budget Office of the DoFA and MoF after approval from the Budget Coordinating Committee (BCC). Following the submission of budget proposals, the BCC conducts hearings with the line ministries, generally during June and July each year and a draft budget is prepared and submitted to Cabinet for approval. After cabinet approval, the legal counsel prepares the Appropriation Bill which is submitted to the respective Parliaments for approval as an Appropriation Act prior to the commencement of the new FY, i.e., prior to 30 September.

21. Each budget unit has the responsibility to manage their own budget and the DoFA and MoF informs each unit of the budget and actual results (and variance) through quarterly statements. Budget transfers between different budget items are permitted provided they are

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approved by the Secretary of Finance. Supplemental budgets are permitted but the approval process is similar to that of the original budget.

22. Payroll. The entire public sector payroll is handled by the payroll section within the DoFA and MoF. Hours worked by each employee are entered into the FMIS which has masterfile information of all employees to calculate the pay. There is no separate HR section responsible for maintaining and updating employee master file data to ensure integrity of the payroll.

23. Audit. The consolidated FSM and RMI financial statements are audited by Deloitte and in financial statements are prepared in accordance with U.S Government Accounting Standards due to the substantial grant funding from the U.S. Although the financial statements have received an unqualified audit opinion, the 30 June deadline for audit has not been met since FY2010 in the RMI. Therefore, the FY2015 RMI statements have still not been audited. The Management Letter issued by the auditor for RMI contains several accounting and internal control issues many of which have not been addressed for many years.

IV. Financial Management Assessment of the National Department of Education (NDOE), FSM and Ministry of Education (MOE), RMI

24. NDoE and MoE are the implementing agencies (IA) of the project. NDoE consists of the office of the secretary, office of post-secondary education and scholarships, division for basic education systems and accreditation, assessment systems unit, curriculum unit, early childhood program, teacher certification, data and IT systems, special education, career and technical education divisions. As the national policy agency, NDoE has a small staff. Teachers are attached to the State DoEs.

25. The MoE consists of the Public Schools System (PSS), the National Training Centre (responsible for TVET), private schools and the College of Marshall Islands (CMI), all coming under the purview of the Minister of Education. The PSS is headed by a nine-member Board of Education and reporting to the Board the Commissioner of Education. Reporting to the Commissioner are assistant commissioners responsible for primary school, secondary schools, planning / policy / statistics, facility management and administration and human resources. The latter currently oversees the budget and fiscal operations of the MoE. MoE is the largest ministry in RMI employing over 1300 persons.

A. Findings of the Financial Management Assessment (FMA)

26. All payments on behalf of the NDoE are made by DoFA. At MoE, up to FY 2015 all financial functions were centralized at MoF. In FY 2016, the non-payroll budget of the General Fund only (about $100,000) was decentralized to MoE. This means that MoE has the authority to make expenditure (mainly stationary and other sundry expenses).

27. NDoE uses a spreadsheet to monitor budget and cumulative expenditure of the financial year for each section and program. The Fiscal officer attached to the NDoE visits the DoFA from time to time (generally quarterly) to access the DoFA computer and ensure that the balances pertaining to the NDoE at DoFA agree with the balances in the spreadsheet and if not make adjustments as necessary in the spreadsheet and/or the DoFA FMIS.

28. In RMI, MoE is using a windows-based, integrated accounting software package called Abila?MIP, different from 4Gov used by MoF but used in the RMI by CMI, MISSA, EPA and the

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