Draft Financial Management Assessment

Melamchi Water Supply Development Board (MWSDB)

14 June 2013 I. INTRODUCTION

1. This Financial Management Assessment (FMA) has been prepared in accordance with ADB’s Guidelines for the Financial Management and Analysis of Projects1 (the Guidelines) and the publication Financial Due Diligence A Methodology Note2 And focuses on fund flows, staffing, accounting policies and procedures, internal controls, financial reporting and monitoring and internal and external audit. This FMA incorporates the Financial Management Internal Control and Risk Management Assessment required by the Guidelines. A Financial Management Assessment Questionnaire was prepared and used for completing the FMA (refer Appendix-1). 2. The FMA considers the Ministry of Urban Development (MOUD) as the Proposed Executing Agency (EA) and the Melamchi Water Supply Development Board (MWSDB) as the Implementing Agency (IA) for the proposed Project. This assessment has been carried out for MWSDB as well as Khathmandu Upatyaka Khanepani Limited (KUKL) to the extent relevant for the purposes of the proposed additional financing. 3. This assessment has been prepared during a fact-finding mission in June 2013. Preparation activities included reviewing documents and interviewing personnel in MWSDB. 4. For the purpose of country level public financial management risk assessment, this assessment has also considered the study by the World Bank in 2007 on Public Sector Accounting and Auditing Standards, Public Expenditure and Financial Accountability (PEFA) Report by the World Bank on Nepal in 2008 and Nepal’s Country Partnership Strategy (CPS) Risk Assessment, DFID Fiduciary Risk Assessment for Nepal (2008) and Governance Risk Assessment Report, ADB (2009). The assessment also draws lessons from the Compliance Review Report (December 2004) and the Briefing Paper from the Integrity division of the Office of the auditor General ADB (July 2005) relating to this Project. This assessment updates the assessment made in 2008 for MWSDB at the time of the approval of the Major changes in Scope for the MWSDP as well as the assessments done for KUKL in recent ADB projects. 3 5. Although many areas are considered satisfactory and improvements are ongoing, certain financial management weaknesses have been identified. These include weak management capacity of KUKL and possible delays in submission of audited project financial statements. Although there continues to be a risk that project may be further delayed, if cost estimates are later deemed inadequate due to more difficult rock conditions than anticipated, this risk has been partially mitigated by leaving a small cushion of unallocated funds. . In addition, the GON has assured ADB that it is fully committed to completing this project, and 1 Financial Management and Analysis of Projects. ADB. 2005.

2 Financial Due Diligence A Methodology Note. ADB. 2009.

3 Loan 3000-NEP: Kathmandu Valley Wastewater Management Project, Loan 2776-NEP: Kathmandu Valley Water

Supply Improvement Project

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would provide extra financial resources from its own funds, if required, without requesting for any further financial support from ADB for this project in the future. In the wake of the recent contract termination, and commercial Nepali banks defaulting on their counter guarantee, there is also a possibility that for future contracts MWSDB and its contractors will have difficulty in securing guarantees. MWSDB intends to take this up with the Nepal Central bank, and there would likely be other candidates for providing guarantees. Risk mitigation measures are proposed to partially manage some of these issues which include: (i) detailed statement of audit needs will be provided to ensure that audited financial statements are more closely aligned with Nepal Public Sector Accounting Standards and Nepal Government Auditing Standards; and (ii) recommendations have been made for strengthening capacity of KUKL. In addition, the project coordination and implementation units’ staff will include a financial specialist well versed in the government’s financial and procurement rules and ADB’s procurement and consulting service guidelines; Recently, GON has also agreed to provide KUKL with a grant to cover its taxation. This will also contribute to strengthening the financial situation of KUKL. II. EXECUTIVE SUMMARY OF FINDINGS AND CONCLUSIONS

A. Project Description

6. Melamchi Water Supply Project (MWSP) – Loan 1820-NEP (SF): was approved on 21 December 2000 and became effective on 28 November 2001. The MWSP is a comprehensive water supply project that aims to improve the health and well-being of the people in Kathmandu Valley by diverting water from the Melamchi River to the Kathmandu Valley and alleviating the shortage of potable water. Melamchi tunnel is a key component of the MWSP, and its performance impacts the pace and progress of several downstream water supply and wastewater projects in Nepal. 7. In 2008, major change in scope and implementation arrangements in Loan 1820-NEP and associated projects was approved by ADB to restructure the project design, optimize the available funding resources and correspond to the changed institutional environment.4 The restructuring of the projects allowed for the initiation of tunnel construction works, which had been on hold from 2000 to 2008. The changes in scope did not alter the projects' development benefits or impact of improving the health and well-being of the inhabitants of Kathmandu Valley by alleviating the chronic shortage of potable water. Moreover, the MWSP was divided into two subprojects, with two distinct implementing agencies that enhanced the implementation efficiency and outputs of the two subprojects. Melamchi Water Supply Development Board (MWSDB) continued to implement subproject 1, which included the Melamchi tunnel. The newly established water utility Kathmandu Upatyaka Khanepani Limited (KUKL) became the implementing agency for subproject 2, which included distribution network improvement in the Kathmandu Valley. Unfortunately, the contractor hired was unable to complete the work satisfactorily and the contract was terminated, resulting in further delays. 8. A new contract has been awarded in July 2013 for the Melamchi tunnel for approximately $100 million while the actual contract amount of the previous contract was $66 million. The proposed additional financing of $25 million as a loan from ADB’s special fund resources will supplement the original project funding and meet cost overruns that will arise due to higher amount of the new contract for the Melamchi tunnel. This additional financing is important to ensure that the Melamchi tunnel is completed and the outcomes envisaged in the original project are achieved. The proposed additional financing will not change the scope of the original project or the original financial management assessment. Since the contract has already been awarded, cost overruns are less likely.

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9. The MWSP was designed to finance four major components: (i) infrastructure development, mainly comprising a 27.5 km Melamchi tunnel and access roads; (ii) social and environmental support; (iii) institutional reforms; and (iv) project implementation support. Additional financing will be used to finance the civil work of the Melamchi tunnel. 10. There are no changes proposed for the implementation arrangements. As with the original project, the Ministry of Urban Development (erstwhile Ministry of Physical Planning and Works) will continue to be the executing agency, and MWSDB will be the implementing agency. MWSDB is currently being supported by a project management consultant (PMC), and a design and construction supervision consultant (DSC), and will continue to be supported by the same consultants. The consulting firms will be engaged in accordance with ADB’s Guidelines on the Use of Consultants (2010, as amended from time to time). Procurement of Civil Works will be carried out in accordance with ADB’s Procurement Guidelines (2010, as amended from time to time). Loan proceeds will continue to be disbursed in accordance with ADB’s Loan Disbursement Handbook (as amended from time to time). 11. The organizational structure of the entities managing Kathmandu Water is based on earlier ADB recommendations and consists of: Melamchi Water Supply Development Board (MWSDB)which is responsible for the

implementation of the Sub Project 1 , i.e. construction of the Melamchi Tunnel Project Implementation Directorate (PID) – which is responsible for the implementation of Sub Project 2 Kathmandu Valley Water Supply Management Board (KVWSMB) – who will be the owners of the asset upon its completions Kathmandu Upatyaka Khanepani Limited (KUKL) is the operator of the assets. It is an autonomous legal body with representation from the public and private sector as well as all municipalities. The Melamchi tunnel and all other related assets will be leased and transferred to KUL upon their completion. KUKL currently operates all the water assets in Kathmandu and is responsible for distribution to the municipalities. Water Supply Tariff Fixation Commission (WSTFC) – They are responsible for setting the water tariff, based on proposals from KUKL Both the MWSDB and KVWSMB work under the mandate of the Ministry of Urban Development (MOUD)

12. As the key implementation agency for Sub Project 1, the FMA has been updated for MWSDB. In addition, since KUKL was newly established at the time of the Scope Variation in 2008, and is critical to the Project delivering on its intended outcome, KUKL financial management assessment’s4 done recently have been updated. There is no need for further assessment of, which relates to Sub Project 2, or for KVWSMB, who operate on a skeleton staff primarily as intermediaries. The WSTFC is also fulfilling its mandate and has only recently on June 12, 2013 disseminated a proposal for increasing the tariff from Rs 55 / 10 m3 to Rs 125/ 10 m3. This is expected to be effective from the FY July 15, 2013. 13. At the end of the Project, it is expected that MWSDB staff will be transferred amongst the other entities.

4 See footnote 3

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B. Country Issues

14. Country issues that potentially impact the financial management of the Project include a weak public financial management (PFM) environment, management and skills capacity issues, and ADB country portfolio issues. 15. The 2009 ADB Country Performance Assessment (CPA) exercise assigned Nepal an overall rating of 14.6 – more than the South Asian (DMC) average. The CPA portfolio performance rating for 2009 was 3.5 (out of 6). The 2010 Country Portfolio Review Mission (CPRM) showed that ADB projects in Nepal in recent years have performed satisfactorily. Historically, however, the major portfolio implementation issues have included: (i) delays in endorsement of contracts; (ii) counterpart funds not being provided in a timely manner; and (iii) delays in the submission of audited annual project financial statements. Nepal is ranked at 139th position out of 176 countries, with a score of 27 in the 2012 Corruption Perceptions Index (CPI) of the Transparency International. Although this is an improvement from 2011, when Nepal was ranked 146th, this is still amongst the lowest in the region.

1. Public Financial Management Environment

16. Nepal's PFM arrangements have improved in the past several years, albeit from a low base. The Government has pursued a PFM reform, when Nepal was emerging from adverse political conditions and public finances were under strain due to poor fiscal discipline, and weak expenditure management. 17. ADB has carried out a governance risk assessment at the country level and the sector levels for both urban development and rural infrastructure, in line with ADB’s Second Governance and Anticorruption Action Plan (GACAP II) issued in August 2009. Nepal’s performance in Public Financial Management (PFM) suggests a system that is generally well designed but unevenly implemented. The budget is viewed as a credible policy tool with clear links to policies in priority sectors. The government has control over at the aggregate level and has reasonable control framework at the transaction level. However, there are gaps in the control framework, constraints on implementation, and large fiscal activities outside the scope of the central government budget. On PFM, ADB assessment and other studies done by various development partners show that: (i) the overall risk related to public expenditure management in Nepal is high; (ii) the overall risk of corruption impacting on PFM systems is also judged to be high; and (iii) the overall fiduciary risk is, therefore, also high. 18. Country PFM arrangements were assessed in 2008 using the Public Expenditure Financial Accountability (PEFA) PFM Performance Measurement Framework. The assessment identified overall PFM improvements. Macroeconomic stability improved and fiscal discipline has been maintained, with the debt burden significantly lower. Despite these improvements, PFM remains weak, which impedes the Government's ability to control expenditures, disburse the budget as approved, and provide essential services. There are several related challenges that have emerged, which need to be handled with urgency: (i) risk of reversal of PFM reforms due to the current political transition; (ii) significant weaknesses in the implementation of the MTEF and budget formulation process affecting realism and overall credibility of the budget; (iii) lack of a credible monitoring system in the PEFA; and (iv) growing need for enhancing capacity at various levels of all accountability institutions to align capacity with new initiatives in PFM reforms. While fundamental arrangements are in place, implementation weaknesses mean that the systems and procedures for expenditure and control cannot be relied upon to ensure appropriate accountability. Oversight has been weakened by delays in preparing and releasing

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audit reports. Statutory authority monitoring and accountability in KUKL is particularly weak. More active engagement by the Auditor General's Office is important indicator in improving financial accountability.

2. Management and Skills Capacity

19. In common with many Developing Member Countries (DMCs), Nepal has a shortage of skills in general management, financial management, financial analysis, and management accounting. In particular, few accounts staff poses practical skills beyond basic bookkeeping. The impact of these skill shortages on Government operations is amplified by high demand for financial skills from the private sector, which pay higher remuneration and, in most cases, provide better conditions.

3. Audit and Financial Reporting

20. Although some delays in the timely submission of audited annual project financial statements remain, the OAG has made significant progress in this regard. Barring one, all APFS for ADBs Nepal portfolio for the FY 2011-2012 have been submitted on time.. The World Bank is implementing a number of ongoing reforms at the OAG including reviewing and updating their guidelines, moving towards risk-based audit approach, enhancing performance audit capabilities, and introducing electronic working papers and improved audit practices. Although independence remains an issue for the Auditor General as a result of receiving their budget allocation through the Ministry of Finance and lack of a Public Accounts Committee and being staffed through the Civil Service Cadre, the OAG has shown great improvement. Time for submission of audited financial statements to Parliament has reduced from 17 to 9 months, and the relevance of their observations is also improving, Despite the shortage of staff which remains an issue, the OAG experiences less turnover than other government departments 21. . There is also a move towards the approval of Nepal Public Sector Accounting Standards (NEPSAS) which will include approved standards for cash-basis of accounting. C. Risk Analysis

22. A Financial Management Internal Control and Risk Assessment was conducted.5 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.

1. Inherent Risk

23. Inherent Risk is summarised in the Table below:

5 Refer page 24 of Financial Management and Analysis of Projects (Knowledge Management Addendum). ADB.

2005.

6

Risk type Risk Asst

6

Risk Description Mitigation Measures

1. Country-Specific Risks

H Inadequate financial management, including accountability and corruption perceptions

The ADB and WB are working on PFM reforms at a country level

2. Entity-Specific Risks

M The Project has been plagued by delays and cost allegations of corruptions primarily relating to procurement

Close collaboration between ADB and all stakeholders to ensure that recently awarded contract for the Tunnel flows smoothly. High commitment by ADB as well as MOUD to ensure that there are no further delays. The PMU and the DSC for the Project now have significant experience with ADB funded projects More robust procurement procedures applied for award of the new contract

3. Project-Specific Risks

L Inadequate skills in financial management.

ADB is providing support for enhanced accounting and billing systems, institutional capacity development and monitoring and information systems for KUKL to ensure that assets which will be constructed under the Project will be utilised properly by the asset operating entity. PMC has been set up at MWSDB which includes a financial management specialist to ensure that record keeping, progress reporting and financial reporting is adequate.

M Reputational Risk – Upon default by banks on the previous counter guarantee for the terminated contract, there is a risk of unavailability of bank counter guarantees for new contract. There has also been related bad press in local newspapers.

MWSDP will take up the issue of commercial banks not honouring their guarantees with the Central Bank. It expects that there many other commercial organisations that would be happy to issue a Bank Guarantee

M Mafia of tankers and alternate water suppliers may try and jeopardise the Project

There is a high level of commitment by the government. Also, Melamchi cannot meet 100% of the water demand, and hence other suppliers may likely not be too threatened.

Overall Inherent Risk

H

6 S= Substantial, H = High, M = Medium, L = Low.

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2. Control Risk

24. Control Risk is summarised in the table below:

Risk type Risk Asst

7 Risk Description Risk Mitigation Measures

1. Implementing Entity - staffing

S KUKL is facing difficulties in achieving its mandate. They are understaffed, have not been able to hold their AGM for approving FY 2008 financial statements or hold MOUD mandated workshop on a timely basis.

Recommended that MOUD to appoint an external GM for KUKL as well as to appoint senior municipal representatives to the Board.

2. Funds Flow L Deficiencies and misinterpretation of ADB guidelines in disbursement and withdrawal of program funds.

MWSDB already has significant experience with ADB procurement and disbursement guidelines. PMC includes a financial management specialist

3. Accounting Policies and Procedures

L No significant risk

4. External Audit L MWSDB may not be able to meet the 6 month submission deadline

Provision of a time bound action plan, detailed statement of audit needs and close collaboration with IA and OAG during implementation.

5. Reporting and Monitoring

L Quality of the APFS can be improved

Detailed Statement of Audit Needs and Template Financial Statements to be provided

Overall Control Risk

M

H= High, S= Substantial, M=Moderate, L=Low D. Implementing Agency Capacity

25. The governing body of MWSDB is independent. The organizational structure of MWSDB is appropriate for the needs of the project. The statutory reporting requirements are as per provision of Financial Procedural Rules and Act of the office of the Financial Comptroller General. Personnel in MWSDB are deputed by the Government of Nepal and have adequate experience and knowledge of GON financial rules and regulations. 26. However, the most significant issue highlighted during the assessment has been the management capacity of KUKL. Although KUKL is not involved in the construction of the Melamchi Tunnel, it will in 2016 be handed over the lease of the assets and will be expected to operate and run the water assets efficiently. Hence it is imperative to the ultimate success of the Project, that KUKL streamlines its operations at the latest by 2016. KUKL was established with representation from all municipalities and the private sector with an aim to introducing private sector knowledge, efficiency into its activities. Although KUKL is tied down by a lack of budget, which will only be increased after the Melamchi tunnel, there are a number of areas which can be addressed.

7 H = High, M = Moderate, L = Low.

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27. The audited financial statements of KUKL for the FY 2008 have only recently been approved by the Board of Directors, and have not yet been endorsed at the AGM. Financial statements for the FY 2009, 2010, 2011 and 2012 have not yet been approved by the Board of Directors. 28. A Workshop requested by the MOUD has also not yet been held, despite many reminders. The NRW Strategic Plan, a key target output of KUKL , has not yet been drafted. 29. Although a copy was not made available to us as it was still considered to be a working draft, we were informed by the Capacity Building Technical Assistance Team (CBTA) that 20 year projections could indicate cash flow problems. 30. KUKL is required to pay WSTFC and KVWSMB fees, which are paid late as well as short of full amounts due. 31. Although an Internal Audit Department is stated to exist, there is no evidence of any of the work that they have performed to date. 32. Senior Level positions remain unfilled, and KUKL is unable to hire quickly. This is currently due to lack of funds, and inability to attract talent. This may change when Melamchi water is able to be sold. 33. Although the Board of Directors meet often, this has not contributed to improvement. Rather, lack of authority by key management personnel has possibly hindered progress. In addition, municipal representatives on the Board may not have adequate seniority. 34. It is recommended that the MOUD consider assigning more senior government representatives to the Board of KUKL. It is also recommended that KUKL take steps to hire an external GM as soon as possible, or that one is assigned to KUKL by the GON. MOUD can also consider increasing the operational budget of KUKL until Melamchi construction is complete. 35. KUKL’s projected profit and loss account as provided by KUKL are summarised in the Financial Analysis. E. Disbursement and Fund Flow Mechanisms

36. There is no change in proposed disbursement and fund flow mechanism from the existing loan. The funds from the government, ADB and other funding agencies are reflected in yearly budget (red book). Based on the approved budget as per the annual program, Ministry of Urban Development delegates its authorization to MWSDB to spend the approved budget. The MWSDB will pre-finance the ADB share of funds, particularly for project implementation support costs. The District Treasury Office Kathmandu transfers one third of the project budget (ADB share of funds excluding funds to be used by direct payment disbursement procedure and Government Counterpart) to the project account (operated and maintained by MWSDB) in the beginning of each fiscal year after the approval of the budget by the Government. 37. An imprest account has been opened in Nepal Rastra Bank, the government bank for the transfers of the funds. Flow chart of the prevailed fund flow mechanism is presented below. The arrangement of the transfers so far is satisfactory.

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38. The Government will provide counterpart funds from the Government Treasury to the project. Since the MWSP is the Priority 1 project, the Government will transfer one third of the project budget to the MWSDB account from the Treasury after the beginning of each FY. 39. The MWSDB has good experience in the management of disbursements from ADB and has sound capability in managing foreign exchange risks. Funds are arranged and accessed by the government. 40. All payments for Design and Construction Supervision consultant shall be made by GON. ADB shall only fund the construction of the tunnel, which is the only remaining output under the Project. 41. PMU will be responsible for preparing its disbursement projections, preparing withdrawal applications to ADB, and requesting budgetary allocations for ADB and counterpart funds. The existing imprest account will be continued to be used exclusively for subproject 1. The imprest accounts will be managed, administered, replenished, and liquidated in accordance with ADB’s Loan Disbursement Handbook (2007, as amended from time to time). The advance initial or outstanding, to each imprest account will be 6 months of estimated expenditure, to be financed by the ADB loan, or 10% of the subproject loan amount, whichever is lower. The ADB’s statement of expenditure procedures will be used to liquidate and reimburse the imprest account for individual payments not exceeding $100,000.

Fund Flow Chart

Melamchi Water Supply Project

F. Personnel

42. The staffs deputed in the finance section are as follows:

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a) Finance and Account Chief : 1 b) Account Officer : 1 c) Assist. Account Officer : 2 d) Computer Operator : 1

43. The responsibilities and required educational background and professional experience of the staffs are clearly mentioned in Civil Circular / Directives of Government of Nepal. The existing number of staffs and their qualifications and experience are currently adequate for normal functioning of the finance section. However, the staffs are partially trained in ADB financial procedures and require some hands on trainings in the skills. There is provision for nominating training to the staffs regularly but the office rarely does such nominations. 44. Financial Comptroller General’s Office (FCGO) transfers the staffs after every two years. This process has been creating problems as newly transferred personnel many times do not know financial procedures of donor agencies. G. Accounting Policies and Procedures

45. In addition to the standard accounting procedure of Government of Nepal general guidelines and accounting procedures of related donor agencies are followed. The Government accounting procedure reflects the periodical expenditures according to the governments’ standard accounting code and is not suited to the requirement of donors. Hence, separate accounting systems have been maintained to suit requirements of the donors.

46. There is good control over the preparation and approval of transactions. The chart of accounts is quite adequate to properly account for and report on project activities and disbursement categories. Cost allocations to the various funding sources are made accurately and in accordance with established agreements. For the easy access to authorised users all accounting and supporting documents are retained in a defined system on a permanent basis. General Ledger and subsidiary ledgers are reconciled and in balance. 47. Functional responsibilities such as authorization to execute a transaction, recording of the transaction and custody of assets involved in the transaction are performed by different units with good coordination. The responsibility of different activities such as ordering, receiving, accounting for, and paying for goods and services are rest with separate units. 48. Budgets are prepared on the yearly basis representing physical and financial targets. Budgets are prepared by the Executive Director with the help of Planning Unit and Finance & Account Unit. MOF and NPC approve the Budget. Budgets are prepared for all significant activities in sufficient details as prescribed by the National Planning Commission (NPC) & MoF. Reporting / Monitoring of physical works and expenditures are done on monthly basis. Major Deviation in regard to allocation of budget requires advance approval. Collection of information for preparation of budget is commenced well in advance (in January) under prescribed format developed by MOF / NPC. Budgets are prepared on realistic basis considering availability of resources and requirements. 49. All invoices made are stamped PAID, dated, reviewed and approved, and clearly marked with account codes. 50. There is a proper authorization for controlling preparation and changes of payrolls.

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51. There are policies and procedures manual in place to guide activities and ensure staff accountability. They also clearly define conflict of interest and related party transactions to provide adequate safeguards to protect the organization. The policies and procedures manual were updated as required by the project and distributed to appropriate personnels. 52. There exist well established policies and procedures covering all routine financial management. However, the office of auditor general and FCGO have authority to alter or establish a new accounting principle, policy or procedure to be used by the entity. 53. Executive Director or Deputy Executive Director and Head of Account Unit or Accounts officer are the authorized signatories in the bank accounts of MWSDB. 54. The board maintains adequate, up-to-date cashbook, recording receipts and payments. Bank and cash are reconciled on monthly basis and all receipts are deposited on a time. 55. There is already a system of adequate safeguards to protect assets from fraud, waste and abuse. Subsidiary records of fixed assets and stocks are kept up to date and reconciled with control accounts. All major assets are sufficiently covered by insurance policies. H. Internal Audit

56. The MWSDB has proposed to conduct Internal Audit through external competent auditor but the District Treasury Comptroller Office (DTCO) has advised to do through Financial Comptroller Office (FCO). The Board is arranging internal audit from the current fiscal year through District FCO. The internal auditor will be responsible for reporting to the FCO, office of Auditor General, MOUD & MWSDB. I. External Audit

57. Office of the Auditor General (Constitutional Body) carries external audit every year. Normally, audit reports are issued in the month of March every year. The audit is conducted according to the International Standards. Coordination with the donors all recommendations are implemented. 58. Interim Audit report is submitted as un-audited Project Account on request to AGO and ADB, and Audited Project Account is submitted by AGO on or before due date of 15 April each year. 59. The annual audit report shall include a separate auditor’s opinion on the use of the imprest account, statement of expenditures, compliance with loan covenants and use of loan proceeds in accordance with loan agreement. The government and MWSDB have been made aware of ADB’s policy on delayed submission, and the requirements for satisfactory and acceptable quality of the audited accounts. ADB reserves the right to commission a supplementary audit of the project's financial statements to confirm that the share of ADB’s financing is used in accordance with ADB’s policies and procedures. J. Financial Reporting & Monitoring

60. All government agencies currently prepare entity financial reports in accordance with the Finance Procedures Act (1999) and Finance Procedures Rules (2007). The Chart of Accounts is largely consistent with International Accounting Standards and existing cash-based accounting

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practices are generally well-established and accounts are frequently reconciled with the exception of revenue accounts (PEFA 2008). However, incomplete computerization has weakened the timeliness and quality of accounting. Annual reporting and financial statements are of acceptable quality but there are some gaps in the content and some delay in submission. 61. Implementation of Nepal Public Sector Accounting Standard corresponding to the cash basis IPSAS has now been elevated on top of the government accounting reform agenda. The Government of Nepal entrusted the Accounting Standards Board, Nepal (ASB) with the responsibility to develop accounting standards for public sector in 2007. Nepal Public Sector Accounting Standards (NPSAS) have been prepared in line with Cash Basis the International Public Sector Accounting Standards (IPSAS) and submitted to Nepal Government for approval and adoption by ASB in 2009. Policy Decision by Government of Nepal for adoption of Cash Basis NPSAS and final approval of Cash Basis NPSAS has also been completed in 2009. The Government has agreed to adopt NPSAS on 2009/09/16. However, necessary policy and guidelines for adoption are still in process. ICAN has a good working relationship with government bodies and there is good awareness about the IPSASs. As at October 2012, Public Expenditure & Financial Accountability (PEFA) is in the process of translating NPSAS into language and a first draft is already submitted by the consultant. The draft is reviewed by various regulators and government officials and accordingly resubmitted to the consultant for finalization. It is planned that the government will implement NPSAS on phase wise basis. 62. The Government Auditing Standards Part 3: Segment Audit Guidelines – Project Financial Statements – October 2005 also provide a template for the preparation of Project Financial Statements. 63. The existing reporting system is quite sufficient thus additional reporting systems are not necessary. The existing reporting system is capable to link the financial information with the project's physical progress. Financial information are linked with the physical progress component wise in the reporting system. One register (Ledger) is maintained by the project unit and financial information are reconciled with the account figures. 64. A financial management information system (FMIS) has been implemented and the reporting is specified in accordance with the requirement of FMIS. 65. The PMU MWSDB (for subproject 1) shall maintain separate records and accounts for all expenditure under Sub project 1. This will include expenditure under the original loan as well as the additional financing. The project accounts and related financial statements will be audited annually in accordance with Nepal auditing standards by the Auditor General’s Office. The PMU MWSDB will submit annual audited reports and related financial statements to ADB within 6 months of the end of each fiscal year. The PMU MWSDB will also prepare and submit to ADB, within 1 month of the end of each relevant period, quarterly progress reports Within 3 months of physical completion of the projects, the PMU MWSDB will prepare project completion reports, including details on costs and compliance with the loan covenants. This is an amendment to the previous loan agreement which required submission within 9 months. K. Information System

66. Due to traditional recording system the information system has become complicated and time consuming. The financial management system is partially computerized and able to produce financial reports with slow pace.

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67. The staffs are partially trained in computer accounting. Hence they may benefit from some training. 68. The management and the processing units safeguard the confidentiality, integrity and the data very well. L. Procurement Arrangements

69. Procurement related issues have been the main reason for delays and problems in the Project so far. However, this time around, there were no pre qualified bidders, a two-envelope procedure was used and the technical review by the DSC team was much more robust, in light of experience, ADB guidelines are followed and there is strong coordination between the Procurement & Finance sections. 70. Mitigation measures include (i) use of ADB’s guidelines for procurement and use of consultants, (ii) establishment of PMU with dedicated staff to deal with procurement; (iii) training of PMU staff in government and ADB rules and procedures for procurement 71. Procurement methodologies are identified the Project Administration Manual III. FINANCIAL MANAGEMENT ACTION PLAN

72. Summary of the actions to be taken Detailed financial statements template, Statement of Audit Needs and Time Bound Action Plan to be provided to MWSDB Continuation of disbursement arrangement Continuing the use of ADB procurement guidelines Continuing inclusion of an FMS at the PMU Requirement for KUKL to provide complete financial projections prior to loan effectiveness

73. The following two issues are already covenanted in the loan agreement for the Waste Water Management Project by KUKL (Loan 3000), and hence do not need to be addressed separately for the additional financing. Recommendation of structural changes at KUKLs BOD Requirement for holding the AGM of KUKL

14 Appendix 1

Financial Management Assessment Questionnaire MWSDB

Topic Response Remarks

1. Implementing Agency

1.1 What is the entity’s legal status / registration? Government of Nepal (GoN), Ministry of Urban Development (MOUD), Melamchi Water Supply Development Board (MWSDB)

Melamchi Water Supply Development Board established through formation order of the Government.

1.2 Has the entity implemented an externally-financed project in the past (if so, please provide details)?

Yes. It has implemented Engineering loan to MWSP and Loan 1820-NEP.

1.3 What are the statutory reporting requirements for the entity?

MWSDB reports to MUD and its Board which is chaired by MUD and ADB in relation to MWSP. The MWSDB prepares reports based on guidelines provided by the Financial Administration Regulation and according to the reporting manuals provided by donors.

1.4 Is the governing body for the project independent?

Yes

1.5 Is the organizational structure appropriate for the needs of the project?

Yes. MWSDB has total 74 staff and central coordination office has been established in Kathmandu and field office has been established in Melamchi Valley.

2. Funds Flow Arrangements

2.1 Describe (proposed) project funds flow arrangements, including a chart and explanation of the flow of funds from ADB, government and other financiers.

MWSDB has established project account in commercial bank and receives funds from treasury of the Government as reflected in the approved annual budget. GoN will pre-finance the ADB share of funds. In order to ease the cash flow of the Government with regards larger works, direct payment disbursement procedures wil be used for the payment to civil works.

2.2 Are the (proposed) arrangements to transfer the proceeds of the loan (from the government / Finance Ministry) to the entity satisfactory?

Yes

2.3 What have been the major problems in the past in receipt of funds by the entity?

No

2.4 In which bank will the Imprest Account be opened?

Nepal Rastra Bank Central Bank of the Government of Nepal.

Appendix 1 15

Topic Response Remarks

2.5 Does the (proposed) project implementing unit (PIU) have experience in the management of disbursements from ADB?

Yes MWSDB has implemented Loan 1820-NEP and gained experience to manage the disbursements from A

2.6 Does the entity have/need a capacity to manage foreign exchange risks?

Yes MWSP is the priority 1 project of the Project and MOF will support the MWSDB to manage the foreign exchange risks.

2.7 How are the counterpart funds accessed? MWSDB has established project accounts and treasury transfers the fund to the project account to meet the counterpart requirements.

2.8 How are payments made from the counterpart funds?

Payments to the works and goods based on the invoice submitted by the contractor, suppliers and vendors. Civil works are certified by the construction supervision consultants.

2.9 If part of the project is implemented by communities or NGOs, does the PIU have the necessary reporting and monitoring features built into its systems to track the use of project proceeds by such agencies?

No. SUP activities are implemented under Loan 1820-NEP: MWSP.

2.10 Are the beneficiaries required to contribute to project costs? If beneficiaries have an option to contribute in kind (in the form of labour), are proper guidelines formulated to record and value the labour contribution?

No

3. Staffing

3.1 What is the (proposed) organizational structure of the accounting department? Attach an organization chart.

Number of core staff in the finance and account unit of MWSDB is five Organization chart attached

3.2 Identify the (proposed) accounts staff, including job title, responsibilities, educational background and professional experience. Attach job descriptions and CVs of key accounting staff.

FCGO deputes accounts staff to MWSDB and their job descriptions and defined through the directives of the government.

Undertaken through Civil Circular / Directives

3.3 Is the project finance and accounting function staffed adequately?

Yes Five staff are deputed.

16 Appendix 1

Topic Response Remarks

3.4 Is the finance and accounts staff adequately qualified and experienced?

Yes FCGO deputes second class officer as head of finance and account head.

3.5 Is the project accounts and finance staff trained in ADB procedures?

Partially Trained Account Staffs needs advance training for confident building.

3.6 What is the duration of the contract with the finance and accounts staff?

2 years and could be extended.

3.7 Indicate key positions not contracted yet, and the estimated date of appointment.

none

3.8 Does the project have written position descriptions that clearly define duties, responsibilities, lines of supervision, and limits of authority for all of the officers, managers, and staff?

Yes Undertaken through Civil Circular / Directives

3.9 At what frequency are personnel transferred? FCGO transfer personnel after every two year

3.10 What is training policy for the finance and accounting staff?

FCGO is required to nominate personnel regularly for training.

This is undertaken however, rarely

4. Accounting Policies and Procedures

4.1 Does the entity have an accounting system that allows for the proper recording of project financial transactions, including the allocation of expenditures in accordance with the respective components, disbursement categories, and sources of funds? Will the project use the entity accounting system?

Yes

4.2 Are controls in place concerning the preparation and approval of transactions, ensuring that all transactions are correctly made and adequately explained?

Yes, the system is already in place

4.3 Is the chart of accounts adequate to properly account for and report on project activities and disbursement categories?

Yes

4.4 Are cost allocations to the various funding sources made accurately and in accordance with established agreements?

Yes

4.5 Are the General Ledger and subsidiary ledgers reconciled and in balance?

Yes

4.6 Are all accounting and supporting documents retained on a permanent basis in a defined system that allows authorized users easy access?

Yes

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Topic Response Remarks

Segregation of Duties

4.7 Are the following functional responsibilities performed by different units or persons: (i) authorization to execute a transaction; (ii) recording of the transaction; and (iii) custody of assets involved in the transaction?

Yes

4.8 Are the functions of ordering, receiving, accounting for, and paying for goods and services appropriately segregated?

Yes The responsibility of different activities rest with separate units

4.9 Are bank reconciliations prepared by someone other than those who make or approve payments?

Yes

Budgeting System

4.10 Do budgets include physical and financial targets?

Yes Budgets (Programs) are prepared yearly basis representing physical and financial targets

4.11 Are budgets prepared for all significant activities in sufficient detail to provide a meaningful tool with which to monitor subsequent performance?

Yes Budgets are prepared for all significant activities in sufficient detail as prescribed by the National Planning Commission (NPC) & MoF

4.12 Are actual expenditures compared to the budget with reasonable frequency, and explanations required for significant variations from the budget?

Yes Reporting / Monitoring of physical works and expenditures is done on monthly basis

4.13 Are approvals for variations from the budget required in advance or after the fact?

Major deviation in regard to allocation of budget requires advance approval .

4.14 Who is responsible for preparation and approval of budgets?

Executive Director prepares the budget with the help of Planning Unit and Finance & Account Unit.

MOF and NPC approves the Budget

4.15 Are procedures in place to plan project activities, collect information from the units in charge of the different components, and prepare the budgets?

Yes Collection of information for preparation of budget is commenced well in advance (in January) under prescribed format developed by MOF / NPC

4.16 Are the project plans and budgets of project activities realistic, based on valid assumptions, and developed by knowledgeable individuals?

Yes They are on realistic basis considering availability of resources and requirements.

18 Appendix 1

Topic Response Remarks

Payments

4.17 Do invoice-processing procedures provide for: (i) Copies of purchase orders and receiving reports to be obtained directly from issuing departments? (ii) Comparison of invoice quantities, prices and terms, with those indicated on the purchase order and with records of goods actually received? (iii) Comparison of invoice quantities with those indicated on the receiving reports? (iv) Checking the accuracy of calculations?

Yes

4.18 Are all invoices stamped PAID, dated, reviewed and approved, and clearly marked for account code assignment?

Yes

4.19 Do controls exist for the preparation of the payroll and are changes to the payroll properly authorized?

Yes

Policies And Procedures

4.20 What is the basis of accounting (e.g., cash, accrual)?

Cash

4.21 What accounting standards are followed? Government accounting system of Nepal

4.22 Does the project have an adequate policies and procedures manual to guide activities and ensure staff accountability?

Yes

4.23 Is the accounting policy and procedure manual updated for the project activities?

Yes

4.24 Do procedures exist to ensure that only authorized persons can alter or establish a new accounting principle, policy or procedure to be used by the entity?

Yes Office of Auditor General and FCGO has the authority

4.25 Are there written policies and procedures covering all routine financial management and related administrative activities?

Yes Well established policies and procedures exist covering all routine financial management

4.26 Do policies and procedures clearly define conflict of interest and related party transactions (real and apparent) and provide safeguards to protect the organization from them?

Adequate safeguard exists

4.27 Are manuals distributed to appropriate personnel?

Yes

Cash and Bank

4.28 Indicate names and positions of authorized signatories in the bank accounts.

Executive Director or Deputy Executive Director and Head of Account Unit or Accounts officer

Appendix 1 19

Topic Response Remarks

4.29 Does the organization maintain an adequate, up-to-date cashbook, recording receipts and payments?

Yes

4.30 Do controls exist for the collection, timely deposit and recording of receipts at each collection location?

Yes

4.31 Are bank and cash reconciled on a monthly basis?

Yes

4.32 Are all unusual items on the bank reconciliation reviewed and approved by a responsible official?

Yes

4.33 Are all receipts deposited on a timely basis? Yes

Safeguard over Assets

4.34 Is there a system of adequate safeguards to protect assets from fraud, waste and abuse?

Yes

4.35 Are subsidiary records of fixed assets and stocks kept up to date and reconciled with control accounts?

Yes

4.36 Are there periodic physical inventories of fixed assets and stocks?

Yes

4.37 Are assets sufficiently covered by insurance policies?

Yes

Other Offices and Implementing Entities

4.38 Are there any other regional offices or executing entities participating in implementation?

No

4.39 Has the project established controls and procedures for flow of funds, financial information, accountability, and audits in relation to the other offices or entities?

Not applicable

4.40 Does information among the different offices/implementing agencies flow in an accurate and timely fashion?

Not applicable

4.41 Are periodic reconciliations performed among the different offices/implementing agencies?

Not applicable

Other

4.42 Has the project advised employees, beneficiaries and other recipients to whom to report if they suspect fraud, waste or misuse of project resources or property?

Yes The project implementation authorities are clearly defined to whom to report.

5. Internal Audit

5.1 Is there an internal audit department in the entity?

No The internal audit is performed by District FCO.

5.2 What are the qualifications and experience of audit department staff?

Not Applicable

20 Appendix 1

Topic Response Remarks

5.3 To whom does the internal auditor report? FCGO, office of Auditor General, MOUD & MWSDB

5.4 Will the internal audit department include the project in its work program?

No The internal audit program is determine by District Treasury Comptroller Office (DTCO)

5.5 Are actions taken on the internal audit findings? Yes

6. External Audit

6.1 Is the entity financial statement audited regularly by an independent auditor? Who is the auditor?

Yes , Office of Auditor General ( Constitutional Body) Audit every year.

6.2 Are there any delays in audit of the entity? When are the audit reports issued?

No Audit reports are normally issued in the month of March every year.

6.3 Is the audit of the entity conducted according to the International Standards on Auditing?

Yes

6.4 Were there any major accountability issues brought out in the audit report of the past three years?

No

6.5 Will the entity auditor audit the project accounts or will another auditor be appointed to audit the project financial statements?

According to the arrangement with donors.

6.6 Are there any recommendations made by the auditors in prior audit reports or management letters that have not yet been implemented?

All recommendations are implemented.

First auditor issues preliminary reports for response within 35 days within 35 days some issues are written off. After 35 days remaining issues are reported.

6.7 Is the project subject to any kind of audit from an independent governmental entity (e.g., the supreme audit institution) in addition to the external audit?

Internal audit started by FCGO

6.8 Has the project prepared acceptable terms of reference for an annual project audit?

Not applicable Office of Auditor General has TOR.

7. Reporting and Monitoring

7.1 Are financial statements prepared for the entity? In accordance with which accounting standards?

With the accounting standard of GoN's Account System.

7.2 Are financial statements prepared for the implementing unit?

Yes

7.3 What is the frequency of preparation of financial statements? Are the reports prepared in a timely fashion so as to useful to management for decision making?

Yes Reports (Monthly and Yearly) are prepared timely. So, it is useful to management for decision making.

Appendix 1 21

Topic Response Remarks

7.4 Does the reporting system need to be adapted to report on the project components?

Present reporting system is sufficient. So additional reporting systems are not necessary.

7.5 Does the reporting system have the capacity to link the financial information with the project's physical progress? If separate systems are used to gather and compile physical data, what controls are in place to reduce the risk that the physical data may not synchronize with the financial data?

Yes Financial information links with the physical progress in the reporting system component wise accounting is being done. Physical and financial information are being recorded in the program and one register (Ledger) being maintained by the project unit and financial information are being reconciled with account figures.

7.6 Does the project have established financial management reporting responsibilities that specify what reports are to be prepared, what they are to contain, and how they are to be used?

Yes A financial management information system (FMIS) is implemented and the reporting is specified in accordance with the requirement of FMIS.

7.7 Are financial management reports used by management?

Yes

7.8 Do the financial reports compare actual expenditures with budgeted and programmed allocations?

Yes

7.9 Are financial reports prepared directly by the automated accounting system or are they prepared by spreadsheets or some other means?

Mostly using spreadsheets

8. Information Systems

8.1 Is the financial management system computerized?

Yes it is partially computerized

8.2 Can the system produce the necessary project financial reports?

Partially Produce

8.3 Is the staff adequately trained to maintain the system?

Partially Trained Account Staffs needs advance training for confident building.

8.4 Does the management organization and processing system safeguard the confidentiality, integrity and availability of the data?

Yes