Financial Management Assessment Report

Second Decentralized Public Service and Financial Management Sector Development Program, Subprogram 1 (RRP CAM 52145-001)

Financial Management Assessment Report

Project Number: 52145-001 August 2020

Proposed Project Loan

Kingdom of Cambodia: Second Decentralized Public Service and Financial Management Sector Development Program

Asian Development Bank EXECUTIVE SUMMARY The Asian Development Bank (ADB) plans to support the Government of Cambodia (GOC) construct and operationalize the National School for Local Administration (NASLA) within the Ministry of Interior (MOI). The Training Department of the General Department of Administration (TD) is appointed as the transitional governing body of the NASLA. The NASLA will be the executing agency (EA) and the NASLA Project Management Unit (PMU) will be the implementing agency (IA). A Project Steering Committee (PSC), chaired by the Permanent Secretary of State, MOI will be established to oversee project implementation. A financial management assessment (FMA) has been carried out to review the capacity of the MOI as regards its financial management (FM) system and procedures. This is directly relevant for NASLA since, once established, the present TD staff will become NASLA staff, i.e. the assessment of FM capacity of MOI and any identified FM risks to project implementation, will be the same for NASLA. This report provides the observations and recommendations of the FMA. The FMA overall finds the project FM risk, pre-mitigation, to be substantial. This results from the following specific FM weaknesses:

• Entity-specific: The Training Department does not have experience with the FM procedures and requirements of externally financed programs/projects, including management of disbursements, and has not familiar with the GOC’s Standard Operation Procedures (SOP) or Financial Management Manual (FMM).

• Planning and budgeting: Program budgeting has been only recently implemented, and related procedures thus remain to be fully developed and institutionalized.

• Staffing: Capacity in some entities is limited in terms of skills and staff numbers. The Training Department does not have a project management or FM function.

• Accounting and internal control: The accounting system is manual, which increases the risk of errors. Some entities do not adhere to the eligibility requirements for payment requests. The process of liquidating advances is in some cases protracted.

• Internal audit: Not all staff of the Internal Audit Department (IAD) have received training on internal audit policies, standards and procedures.

• Financial reporting: Financial reports are produced manually and are occasionally delayed, which limits the possibilities for undertaking proactive budget management.

• Information systems: The MOI does not have a computerized FM system, which increases the risk of manual errors as well as processing time.

• External audit: The audit of project financial statements by a private firm contracted by the Ministry of Economy and Finance (MEF) does not include an opinion on the ‘true and fair’ presentation of the financial position.

The Project Management Unit (PMU) will be responsible for day-to-day management of the project and will be established within and overseen by the NASLA PMU. It will be staffed by a seventeen-member team from the Training Department, including one staff who will be assigned as Finance Officer, as well as national and international consultants. Both NASLA PMU and

consultants will receive training on the RCG’s SOP and FMM as well as ADB’s FM procedures and requirements. The engagement of consultants by the NASLA will be linked to the planned capacity development training to be provided to NASLA staff (component 3 under the project) and will be financed using loan proceeds. The NASLA PMU furthermore expects procedural support to be provided on an ad hoc basis by other MOI entities as well as the National Committee for Sub-National Democratic Development Secretariat (NCDDS). While the PMU will provide an administrative structure that functions with a number of safeguards against fiduciary risks, the following additional mitigation measures are proposed to address the identified specific FM weaknesses:

• Planning and budgeting: The MOI will request the MEF for additional support to further develop and strengthen program budgeting procedures.

• Accounting and internal control: The NASLA must maintain separate project accounts and carry out the project-related FM in accordance with the FMM and SOP as well as ADB procedures and requirements.

• Internal audit: The MOI will request the MEF’s General Department of Internal Audit (GDIA) for training to be provided to all internal auditors of the IAD.

• Financial reporting: The NASLA must apply the financial reporting formats provided in the FMM and as required by ADB.

• Information systems: The MOI will continue preparations for the implementation of the GOC’s Financial Management Information System (FMIS), including ensuring that training will be provided to all identified users.

• External audit: ADB and the MEF will define and agree on aligned accounting standards, which will be incorporated into a new Standard TOR. Also, the Training Department will develop and implement an approach for in-year monitoring of the implementation of audit recommendations.

On the basis of the PMU being established and its staff/consultants provided with training, and that the above-mentioned proposed risk mitigation measures are implemented, the residual project FM risk is considered to be moderate and the planned project FM arrangements thus satisfactory.

A. INTRODUCTION 1. The Asian Development Bank (ADB) plans to support the Royal Government of Cambodia (GOC) construct and operationalize the National School for Local Administration (NASLA). National School for Local Administration (NASLA) sits within the Ministry of Interior (MOI). The Training Department of the General Department of Administration (TD) is appointed as the transitional governing body of the NASLA. The NASLA will be the executing agency (EA) and the NASLA Project Management Unit (PMU) will be the implementing agency (IA). A Project Steering Committee (PSC), chaired by the Permanent Secretary of State, MOI will be established to oversee project implementation. This financial management assessment (FMA) report provides a due diligence review of the systemic and procedural capacity of the Ministry of Interior (MOI) in planning and budgeting, accounting and internal control, internal audit, financial reporting, information systems, and external audit. On this basis recommendations are made to address identified deficiencies. The FMA also reviews the proposed funds flow arrangements and disbursement procedure of the project. 2. The assessment was conducted in June–July 2019, including a due diligence mission during 1-5 July 2019, and follows ADB’s FMA guidelines.1 The applied FMA Questionnaire (FMAQ) was filled-in by the MOI and reviewed by the assessor, and subsequently further developed based on consultations with MOI officials. The FMA report was drafted by the assessor and selected parts shared with the MOI for information and verification. All findings and recommendations are based on available documentation and consultations with MOI officials as well as with other relevant stakeholders. 3. The FMA is provided in chapters 2–8 below. Appendices A-E include organizational charts of the MOI, the Training Department and the Department of Logistics and Finance (DLF), funds flow chart, documents reviewed, persons consulted, and the FMAQ. B. PROJECT DESCRIPTION 4. The NASLA will be the executing agency (EA) and NASLA Project Management Unit (PMU) will be the implementing agency (IA). The NASLA PMU will thus manage the implementation of the proposed project, including the financial management (FM). Establishing the NASLA will support the GOC’s efforts for sustainable, structured skills development for sub-national administration (SNA) staff to meet their mandates for expanded service delivery. The project will have three outputs:

• Output 1 – Design, construction and installation of the physical infrastructure of NASLA. This will include the detailed engineering design, procurement of the civil works contractor and the construction supervision team, construction of the academic building and a dormitory, and provision of furniture and equipment;

• Output 2 – NASLA curriculum development to ensure high-quality teaching and training; and

• Output 3 – NASLA staff professionalized and core operations established.

1 ADB. 2015. Financial Management Assessment – Financial Management Technical Guidance Note; ADB. 2005.

Financial Management and Analysis of Projects (the ‘Knowledge Management Addendum’, p. 4, provides information on FMAs); and ADB. 2009. Financial Due Diligence – A Methodology Note (p. 3 provides information on FMAs).

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5. The project will be implemented during 2020–2026. A Project Steering Committee (PSC), chaired by the MOI, will oversee project implementation. It will comprise representatives from the MOI, Ministry of Economy and Finance (MEF) and Ministry of Women Affairs. 6. The project is estimated to cost $11.05 million of which ADB will finance $9.35 million from its ordinary capital resources (OCR) and the GOC will provide $1.70 million as counterpart funding that is expected to cover curriculum development activities.

7. The NASLA PMU will have overall responsibility for project implementation, including procurement and consultant recruitment, and advising on technical and sector issues. The NASLA will establish a PMU that will be responsible for day-to-day management of the project, including financial management (FM), disbursement,2 procurement, contract administration, monitoring and reporting. The NASLA will assign seventeen counterpart staff to the PMU, including one staff to function as Finance Officer, who will be supported by national and international consultants (financed by the NASLA using loan proceeds). The consultants will carry out technical and managerial tasks as well as undertake capacity development training of NASLA staff under Output 3 of the project. 8. It is furthermore expected that the NASLA will receive procedural support on an ad hoc basis from other MOI entities, including the DLF, and the National Committee for Sub-National Democratic Development Secretariat (NCDDS). 9. The NASLA PMU will apply the GOC’s Standard Operation Procedure (SOP)3 and Financial Management Manual (FMM)4 in implementing the project. The MEF is presently in the process of updating the manuals, including the Procurement Manual,5 to ensure that they remain relevant for implementing development partner-funded projects. C. COUNTRY FINANCIAL MANAGEMENT ISSUES 10. Country-level issues that potentially impact the FM of the project include weaknesses in budget planning, transparency, budget execution, accounting and internal control, internal audit, financial reporting, and external audit.

a) Public Financial Management (PFM) 11. Country-level PFM assessments using the Public Expenditure and Financial Accountability (PEFA) framework were prepared in 2011 and 2015. The results for the six high-level PFM dimensions are shown in Table 1,6 including the trajectory of change.7

2 This includes the following tasks: (i) preparing disbursement projections; (ii) requesting budgetary allocations for

counterpart funds; (iii) collecting supporting documents, and, (iv) preparing and sending withdrawal applications to ADB with a copy to the Department of Logistics and Finance (DLF).

3 GOC. 2012c. Standard Operating Procedures for All Externally Financed Projects/Programs in Cambodia. Volume I and II. Updated Version, May.

4 GOC. 2012a. Financial Management Manual for All Externally Financed Projects/Programs in Cambodia. Updated Version, May.

5 GOC. 2012b. Procurement Manual for All Externally Financed Projects/Programs in Cambodia. Volume I and II. Updated Version, May.

6 GOC. 2015. Report of the Evaluation on the Public Financial Management System of Cambodia. 31 December. 7 It is mentioned in the 2015 PEFA assessment (on page 6 and in Table B) that some performance indicators are not

comparable between 2011 and 2015 because (i) the indicator structure and/or scoring criteria were changed for some indicators in 2011, and (ii) some scores were not established on the same basis in both years due to lack of

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Table 1: PEFA-based PFM Assessments, 2011 and 2015

Dimensions Average Scores Trajectory of

Change 2011 2015

A Credibility of the budget B B

B Comprehensiveness and transparency C+ C

C Policy-based budgeting A A- ()

D Predictability and control in budget execution C C

E Accounting, recording and reporting C C- ()

F External scrutiny and audit D B

Overall Average Score C+ C+

PEFA = Public Expenditure and Financial Accountability, PFM = public financial management. Note: Calculated based on the PEFA assessment performance indicator (PI). PEFA scores range from “A” (highest) to “D” (lowest).

12. The average dimensional scores are relatively low in both years, which reflect the challenges faced by the GOC’s as regards PFM. While some changes have taken place from 2011 to 2015 – in terms of improvements (‘external scrutiny and audit’) as well as deteriorations (mainly ‘comprehensiveness and transparency’) – the overall score has remained unchanged. The PEFA assessments indicate that the fiduciary risk level associated with the GOC’s PFM system is ‘substantial’. 13. The main observations made in the 2015 PEFA assessment,8 many of which remain valid, are summarized below for the six high-level performance areas:

• Credibility of the budget – Budget credibility was strong at the aggregate level for both revenue and expenditure. However, the variance in expenditure composition at the level of administrative budget heads was high (ranging between 25% and 38%), hence the budget was not a useful statement of policy intent. Also, expenditure arrears were high and the stock of payment arrears was not being regularly monitored.

• Comprehensiveness and transparency – The budget and accounts classification system was at a basic level, but the ongoing efforts to add functional and program classifications were noted. The comprehensiveness of information included in budget documents was somewhat low and the public’s access to key fiscal information was limited.9 The extent of unreported government operations was relatively high (between 5% and 10% of total GOC expenditure), and the MEF’s oversight of aggregate fiscal risk from public enterprises and public administrative entities was incomplete. However, the transparency and predictability of inter-governmental transfers was high as they were rules-based, and the indicative estimates were provided well in time and were reliable.

• Policy-based budgeting – Performance in preparing the annual budget was strong due to a comprehensive and well-organized process with appropriate involvement of line ministries as well as the political level. However, the medium-term aspects of policy-based budgeting were performing less well as sector

data or different interpretation of data requirements. However, the indicators that were deemed comparable show developments similar to those outlined in this report (paragraph 10).

8 The assessment was carried out in 2015. The applied quantitative data covered the period 2011–2013 (and in some cases also 2014 based on revised budget estimates), while the qualitative data covered up to mid–2015.

9 While four of six essential elements of information were being published, this happened with significant delays.

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strategies were not costed in line with fiscal aggregates, recurrent and capital project expenditures were budgeted separately, and changes in multi-year forecasts were not explained from year to year.

• Predictability and control in budget execution – Tax administration was deemed overall ineffective, especially as regards taxpayer registration, tax assessment, and tax collection. However, cash flow forecasting was performing well although in-year reallocations of budget appropriations were frequent and significant. Debt management was relatively well-functioning. Internal controls had a number of shortcomings, including a lack of clear guidelines for capital expenditure and asset management, and frequent non-compliance with rules. Also, no payroll audits were being carried out. The internal audit function was recently established as a result of which coverage and quality was low, and with internal audit focusing mainly on transactions.

• Accounting, recording and reporting – Reconciliations of bank accounts managed by the MEF’s General Department of National Treasury (GDNT) were done monthly within two weeks, but reconciliation and clearance of advances generally took more time. The timeliness of in-year budget execution reports was good, although they only captured the payment stage. However, the annual financial statements were significantly incomplete as they did not include bank account balances or financial assets/liabilities. Also, no comprehensive information on resources received by service delivery units (e.g. primary schools and health centers) was available.

• External scrutiny and audit – While the National Audit Authority (NAA) completed and submitted audit reports in a timely manner, the institutional coverage of audit was low and international auditing standards were not fully applied. The scrutiny of audit reports by the National Assembly was good as regards timeliness, extent of hearings on key issues, and issuance of recommendations. However, the legislature’s oversight function in the budget process was limited in terms of scope as well as time available.

14. The weaknesses in comprehensiveness and transparency noted in the PEFA assessment are likewise seen in the Open Budget Survey,10 which for 2017 scored the GOC’s budget transparency at 20%.11 While this was an improvement compared to 2015 (when the score was 8%), it is low in absolute terms as well as in a regional perspective (average of 39%) and an international perspective (average of 42%). Cambodia’s score for public participation in budgeting was very low (4%), but budget oversight was deemed to be somewhat better functioning with a “limited” rating for the legislature and an “adequate” rating for external audit (NAA). 15. As regards fiscal decentralization, there has in recent years been good progress in developing the political, institutional and legal aspects. This provides the foundation from which targeted outcomes can be realized over time, including the architecture for an inter-governmental transfer system with conditional and unconditional transfers.12 In an international comparison, however, Cambodia has achieved only low levels of decentralization with expenditures that are imbalanced between (vertical) and within (horizontal) the four levels of administration. Also, SNAs

10 International Budget Partnership. 2018. Cambodia, Open Budget Survey 2017. 11 While the GOC does produce all eight documents covered by the Open Budget Survey, two are produced only for

internal use (Executive’s Budget Proposal and Year–End Report). Three documents contain only “minimal” information (Citizens Budget, Mid–Year Review and Audit Report). The information in the remaining three documents is assessed as “limited” (Pre–Budget Statement), “substantial” (In–Year Reports), and “extensive” (Enacted Budget).

12 ADB 2018b. Fiscal Decentralization Reform in Cambodia – Progress over the Past Decade and Opportunities. Manila, Executive Summary.

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continue to have limited FM autonomy and require significant capacity building. The GOC is currently reviewing the possibility of reassigning the functions and resources of district and municipal offices from provincial departments to SNAs, but a shared vision between stakeholders as well as a stronger consensus on the direction of fiscal decentralization will be required going forward.13 16. Recent FMAs undertaken by ADB for project loans have identified several shortcomings regarding PFM (both generic and entity-specific):14 weak internal control procedures; inadequate record keeping procedures; weaknesses in the internal audit function, including regarding capacity and the quality of reports; incomplete and late submission of in-year financial reports as well as of audited project financial statements; FM capacity gaps among GOC as well as PMU staff; and, GOC as well as PMU staff not familiar with ADB procedures and requirements. These findings are, in the relevant areas, broadly similar to those at the country-level and as identified for this project. 17. The GOC (MEF and EAs/IAs) together with ADB, the World Bank and the Japan International Cooperation Agency (JICA) conduct an annual joint country portfolio performance review (JCPPR) that focuses on systematic portfolio bottlenecks in implementing externally financed projects. The latest JCPPR found that while progress had been achieved on a number of previously agreed actions, several key issues remained.15 The 2019 Joint Action Plan (JAP) includes the following FM-related actions: Improved information in Withdrawal Applications (WAs) for disbursement, improved quality of audit reports, integration of the GOC’s new chart of account into project FM systems, and (better) compliance with GOC rules for taxes on goods, works and services. 18. Reform initiatives implemented in the past few years to improve the functioning of the PFM system include:

• A medium-term fiscal framework is being developed to improve macro-economic and fiscal forecasting, while a medium-term budgeting framework is being prepared to provide a better basis for setting budget ceilings for the annual budget;

• Program budgeting, with some integration of capital and recurrent budgets, has been implemented by all ministries; the MEF has updated the program budgeting guidelines;

• The budget preparation circulars have been updated to improve the quality of Budget Strategic Plans (BSPs) as well as to support the program budgeting approach;16

13 Different views on the development of fiscal decentralization are, in particular, held by the MEF and the NCDDS/MOI,

while many line ministries are not (yet) fully committed to decentralization. This is likely linked to a reluctance of giving up influence and resources as well as concerns regarding the capacities of SNAs to take over central functions [ADB 2019. Kingdom of Cambodia: Sector Assessment and Roadmap (Public Sector Management). Manila, p. 9].

14 Second Greater Mekong Subregion Corridor Towns Development Project (46443–002); Second Upper Secondary Education Sector Development Program (47136–006); Provincial Water Supply and Sanitation Project (48158–002); Climate–Friendly Agribusiness Value Chains Sector Project (48409–002); Strengthening Public Financial Management Program, Subprogram 1 (49041–002); and, Second Integrated Urban Environmental Management in the Tonle Sap Basin Project (50102–002).

15 GOC. 2019c. 2016–2017 Joint Country Portfolio Performance Review (JCPPR) of Loans/Grants funded by the Asian Development Bank/World Bank and Japan International Cooperation Agency – Memorandum of Understanding. February.

16 A review of the coherence between the three–year BSPs and the annual Program Budgets is planned for the MEF and six–line ministries, including the MOI, between November 2019 and April 2020 with TA from the European Union.

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• A Budget System Reform Strategy (BSRS) for 2018–2025 has been prepared and an Action Plan is being implemented to move towards performance-informed budgeting.17

• Revenue management and performance has been strengthened with the implementation of the Medium-Term Revenue Management Strategy (MTRMS) 2014–2018;

• A new budget classification and chart of accounts has been prepared and applied;18

• Preparatory activities for introducing cash-based International Public Sector Accounting Standards (IPSAS) have been undertaken,19 including for Financial Management Information System (FMIS)-generated reports;

• The regulatory framework for internal audit has been strengthened and an internal audit manual has been launched;

• Public debt management has been further developed and a Public Debt Management Strategy (PDMS) for 2019–2023 is under preparation;

• The FMIS has been fully operationalized in the MEF and provincial treasuries and is now being rolled out in stages across line ministries; and

• NAA audit manuals, including for financial and compliance audits, have been updated, and new manuals for performance-based and sub-national auditing are being prepared.

19. With support from development partners the GOC has since 2004 implemented the PFM Reform Program (PFMRP) as a framework for strengthening the functioning and performance of the PFM system. The PFMRP was designed as a comprehensive and long-term reform process with four phases covering a 20-year period.20 The PFMRP governance structure consists of a GOC Steering Committee, Development Partner Technical Working Group, GOC-Development Partner Working Group, and the General Secretariat placed within the MEF, which provides administrative and technical support. The PFMRP is implemented based on multi-year Consolidated Action Plans and detailed annual Ministerial Action Plans.21 Some specific initiatives have separate implementation plans (e.g. the BSRS, MTRMS and PDMS). Internal monitoring of implementation progress is done monthly, quarterly and annually, while independent reviews are carried out every few years by the External Advisory Panel. The GOC calculates implementation progress scores for each entity under the MEF as well as all line ministries,22 and in 2018 initiated an incentive schedule to further promote PFMRP implementation.23

17 Royal Government of Cambodia. 2018. Budget System Reform Strategy (2018–2025) – “Effectiveness,

Accountability and Transparency”. Adopted by the Council of Minister’s Plenary Session on 12 January 2018. 18 There are now seven budget classifications: Economic, administrative, functional, geographical, program, source of

budget, and project. 19 This work involves the National Accounting Council (NAC), which is responsible for regulating the accountancy

profession in Cambodia under MEF’s direction. NAC’s responsibilities include: (i) setting accounting and auditing standards; (ii) issuing and withdrawing professional licenses to offer accounting services; (iii) establishing mechanisms to investigate violations (investigation and discipline); (iv) supervising the activities of the professional body of accounting and auditing; and, (v) setting ethical requirements for professional accountants.

20 Stage 1 (2005–2008): Budget credibility; Stage 2 (2009–2015): Financial accountability; Stage 3 (2016–2020): Budget–policy linkages; and, Stage 4 (2020–2025): Performance–based management.

21 While the NAA has its own Strategic Plan 2017–2021, some selected external audit aspects are included in the CAP. 22 The score is calculated by based on weights for each activity, objective and part, and places MEF entities and line

ministries into five groups: Excellent (96%–100%), Good (86%–95%), Above Average (71%–85%), Average (61%–70%) and Poor (0%–60%). The line ministry scores for 2018 were as follows: Poor – 1, Average – 1, Above Average – 3, Good – 12, and Excellent – 24. The MOI (General Administration) score for 2018 was 96%.

23 The incentive scheme in 2018 amounted to $2.7 million, which was 18% of the total PFMRP implementation budget.

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20. ADB is actively supporting the GOC in implementing the PFMRP, presently through the Strengthening Public Financial Management Program, Subprogram 1 (2016–2020), which focuses on strengthening the GOC’s: (i) policy and regulatory framework for expenditure and revenue management; (ii) procedures and capacities of selected line ministries to implement budgeting and expenditure management reforms; and (iii) capacity of the external audit function. ADB is also providing technical assistance (TA) for capacity development of SNAs, including on PFM, through the Second Decentralized Public Service and Financial Management Program, Subprogram 1 (2016–2019), and supporting fiscal decentralization through the Decentralized Public Service and Financial Management Sector Development Program, Subprogram 2 (2016–2022). 21. Other development partners providing support for PFM reform include the European Union (BSRS for SNAs and M&E of SNA performance), France (legislative and regulatory framework), IMF (FMIS, IPSAS and capacity development), Sida (taxation, statistics and external audit), UNICEF (M&E of SNA performance), United States Department of Treasury (program budgeting), and the World Bank (public expenditure review and support to the GOC’s on-going PEFA self-assessments at the national and sub-national levels).24 D. PROJECT FINANCIAL MANAGEMENT SYSTEM 22. This chapter presents the main strengths and weaknesses of NASLA’s FM system and procedures. The focus is on those elements that have particular relevance for project implementation in terms of resource management. Also, the proposed funds flow and disbursement arrangements for the planned project are outlined.

a) Overview 23. Organization and staffing – The Training Department of the MOI was established in 2014 as one of six entities under the General Department of Administration. Its core task is to undertake training and capacity development for other MOI entities and SNAs. According to the ‘Updated Structure Civil Servant List’, the Training Department has 67 staff and five organizational units: Administrative Office, Planning and Curriculum Office, Human Resource Development Office, Research and Governance Development Office, and Information and Dissemination Office. An organizational chart is provided in Appendix A. 24. MOI’s Department of Logistics and Finance (DLF) (General Admin),25 which is one of eight entities under the General Department of Logistics and Finance (GDLF), has 66 staff and six organizational units: Planning and Finance Office, Accounting Office, SNA Budget Office, State Property Management Office, External Aid Management Office, and Administration Office. An organizational chart is provided in Appendix A. According to the DLF, it needs an additional 15 staff in order to be able to properly manage its tasks. DLF’s staff turnover is low (generally below 5% per year). DLF’s Accounting Office has 21 staff of which some have an accounting- and finance-related education, but none are Certified Public Accountants (CPA). 25. The MOI does not have a training policy. Civil servants are appointed based on an entry exam and undergo a one-year internship within a General Department before being assigned to a specific Department. A total of 100 MOI staff, including from the DLF, underwent a three-month

24 The MEF plans to finalize the national–level PEFA assessment in 2019 and the sub–national PEFA assessment in

2020. 25 There is a separate Department of Logistics and Finance for the public security entities of the MOI.

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part-time training program in PFM and procurement provided by the MEF in 2017 and 2018. MOI representative had, as a general comment on training, noted that this is often general in nature rather than specific and that the training does not include checks of the participants understanding of the subject matter before and after the sessions (i.e. it is unclear to which extent the training helps to develop staff capacity). 26. Information management – The MOI has no computerized accounting system in place. Hence DLF’s Accounting Office carries out its tasks manually using paper-based records and spreadsheets. The lack of computerization results in time-consuming registration and reporting procedures and increases the risk of errors. 27. The MOI is scheduled to implement the GOC’s FMIS in 2020. Preparatory activities (including identification of users, assessment of training needs and installation of equipment) are currently on-going. 28. The MOI retains financial records for ten years as required by the MEF. The GOC’s FMM similarly requires that financial records are stored for ten years.26 29. Planning and budgeting – The GOC, and thus also the MOI, has historically applied a dual budgeting system with a recurrent budget and a capital budget. The three-year rolling BSP, which was introduced into the budget preparation process through the Law on State Budget System (2008),27 among other things aimed to integrate the recurrent and capital budgets. The policy objectives, programs, sub-programs developed for the BSP helped the MOI prepare for and implement program budgeting when it was introduced in 2018 (MOI was among the last three out of 39-line ministries to introduce program budgeting). However, the procedures to be applied in managing program budgeting still need to be fully developed and institutionalized, including for preparing the semi-annual and annual performance report that must be submitted to the MEF. 30. Accountability measures – As civil servants, MOI’s staff have to abide by the Common Statute of Civil Servants (Royal Kram 06/NS/94), which covers conflict of interest. According to the Anti-Corruption Law (2010), senior civil servants are required every two years to declare assets and liabilities (Article 17).28

b) Strengths 31. The following main strengths of MOI’s FM arrangements have been identified:

• The NASLA is establishing a dedicated team to manage project implementation, which will be supported by other MOI entities as well as the NCDDS;

• The NASLA PMU will include a staff member assigned as Finance Officer who has a relevant educational background and appropriate professional experience;

• The GOC’s SOP and FMM provide clear and comprehensive guidance on project FM, including with specific procedures and templates, for the PMU to apply;

• The Internal Audit Department (IAD) provides on-the-job training to new staff as well as participation in the internal audit training that is provided by the MEF most years;

26 Royal Government of Cambodia. 2012. Security and Safe Keeping of financial records. Section 21.3. 27 The law is sometimes also referred to as the Law on Public Finance System. 28 Senior civil servants are, according to the Law, “Civil servants, police, military personnel and other public servants

appointed by Royal Decrees or Sub–Decrees”.

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• The IAD can include the project in its annual work program and has initial experience in this regard from an on-going externally financed project; and

• The DLF and other MOI entities are strongly supportive of the PFMRP activities in which the MOI is involved in, including program budgeting and the preparations for the FMIS.

32. These elements are thus relevant for ADB during project implementation.

c) Weaknesses 33. The following weaknesses of the MOI’s FM arrangements have been identified:

• The MOI functions within the generally weak PFM environment of the GOC (in terms of systems, procedures and skills), which will also affect project-level activities;

• The IA does not have prior experience in managing externally financed projects, and is not familiar with the GOC’s SOP and FMM, or ADB’s FM procedures and requirements;

• Bookkeeping is manual and the MOI does not yet have a FMIS;

• Some MOI entities do not fully adhere to procedures for payment requests and liquidation of advances;

• Many staff in the DLF and the IAD lack a relevant educational background and professional experience;

• The MOI does not have a training policy in place; and

• The NAA does not audit the MOI, and audit of project financial statements does not presently include an opinion on the ‘fair and true’ presentation of the financial position.

34. ADB cannot rely on these elements for project implementation, and they should hence be improved, or the associated risks mitigated.

d) Personnel, Accounting and Internal Control, Internal Audit and External Audit

35. This section reviews specific elements of MOI’s FM systems and procedures as presently set up and applied. 36. Personnel – The MOI’s NASLA will establish a PMU that will be responsible for day-to-day management of the project, including FM. As per current plans, the PMU will have two full-time staff (international and national consultants to be financed from the loan proceeds) – Project Team Leader/Procurement Specialist and Finance and Administration Expert29 – who will be supported by seventeen counterpart staff assigned by the NASLA, one of whom will be designated as Finance Officer.30 Safeguards and Gender experts will also be engaged and will form part of the detailed engineering design and construction supervision firm. The PMU staff and consultants will carry out technical and managerial tasks as well as undertake capacity

29 Recruitment of positions will need to take into consideration the availability of FM capacity on the market and duration

of recruitment process in the Cambodian market. 30 The staff holds a B.A. in Accounting, Diploma in Taxation, and master’s in public administration, and has previously

worked for two years with a local non–governmental organization (NGO) as Finance Officer managing externally financed projects.

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development training of NASLA staff related to Output 3 of the project. 37. As the NASLA staff do not have previous experience with managing GOC projects financed from external sources, it is necessary that they receive training on the RCG’s SOP and FMM. It is planned that guidance and training will be provided on ADB procedures and requirements (as per the Loan Disbursement Handbook) before project start (effectiveness). This should include advance fund management, statement of expenditure (SOE), withdrawal applications (WAs), financial reporting, and external audit. 38. It is furthermore expected that the NASLA, on an ad hoc basis, will receive procedural support from other MOI entities, including the DLF, and the NCDDS. 39. Accounting and internal control – Chapter V of the Law on State Budget System (2008) defines the accounting framework of the GOC. Financial operations and public accounting are centralized at the MEF’s GDNT and undertaken by public accountants (Article 73) who are in charge of revenue collection and spending execution (Article 82).31 According to Sub-Decree No. 81, managers (ministers and heads of institutions) cannot approve proposals for expenditure commitments as these require approval of the Financial Controllers placed by the MEF in line ministries. Also, while managers issue payment orders and supporting documentation, only public accountants can process these and make payments. 40. The basis for accounting is modified cash for accounting and reporting. The MEF plans to implement the cash based IPSAS by 2025. 41. Accounting policies and procedures are set by the National Accounting Council (NAC), which is established under the MEF. All relevant guidance – including laws, royal krams (decrees), sub-decrees and prakas (detailed orders or regulations) – are distributed to the relevant MOI entities. The exception is the SOP and the FMM, which only those entities that have been directly involved in implementing externally financed projects have used (the DLF, for example, is not familiar with the SOP and the FMM). 42. The MOI uses a manual bookkeeping approach that is paper-based and supported by spreadsheets. Since the payment function is centralized at the MEF’s GDNT, the MOI does not keep a general ledger and does not prepare financial statements (trial balance of accounts, etc.), but prepares reports on its financial transactions during the relevant period. The DLF undertakes regular reconciliation between its records and the payment reports that it receives from the GDNT. 43. Segregation of duties and controls are in place for financial transactions, which involve the MEF both as regards the authorization to execute transactions and the recording of transactions of the GDLF. Invoice-processing procedures involve different entities so as to provide adequate controls.32 Internally the MOI has limited financial delegation.33 The MOI has an account with the GDNT that is used for payments and petty cash. The procedure for using cheques follows the

31 Only public accountants are authorized to handle treasury funds, which makes the GDNT the sole institution in charge

of paying suppliers and government personnel (i.e. salary payment). 32 (i) Copies of purchase orders and receiving reports are obtained directly from issuing departments by DLF’s Financial

Affair Office; (ii) Comparison of invoice quantities, prices and terms with those indicated on the purchase order and with records of goods actually received is done by DLF’s Accounting Office; (iii) Comparison of invoice quantities with those indicated on the receiving reports is done by the MEF Financial Controller; (iv) Checking the accuracy of calculations is done by the MEF Financial Controller; and, (v) Checking authenticity of invoices and supporting documents is done by the MEF’s GDNT.

33 Transactions below KHR 100 million are approved by a Secretary of State, while transactions above this threshold must be approved by the Minister.

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rules established by the National Bank of Cambodia (NBC). Revenue collection and cash handling procedures follow MEF rules, and cash on hand is reconciled monthly with the cashbook. 44. Payroll is managed as per the system for civil servants. The MOI prepares and submits required documentation to the Ministry of Civil Service and, once approved, submits payment requests to the MEF. Timesheets are used for internal administrative purposes, but not directly in relation to payroll preparation. 45. The MOI has a Fixed Assets Register that is updated annually as required by the MEF. All assets, inventories and stocks are labeled. However, assets are not covered by insurance. 46. FM-related challenges noted by the GDLF include that some entities within the MOI on occasion submit payment requests, which are outside the originally established budget or do not fulfill eligibility criteria and therefore are not approved by the MEF’s GDNT. Also, the liquidation of advances can be a lengthy process, especially in cases where staff, who originally processed the advance in the receiving entity, have moved to another department. In response to the latter issue, the GDLF plans to establish a rule whereby the issuance of a new advance requires that all previous advances have been liquidated. 47. The NASLA will apply the FMM in managing the implementation of the project. That will imply maintaining separate accounts and records for all project-related expenditures. The basis of accounting will be similar to that of MOI, and reports to the MEF and ADB will be prepared on the same basis. The reporting currency to the MEF will be Cambodian Riel (KHR), and the reporting currency to ADB will be US Dollar. It will be important to ensure that the chart of accounts applied by the NASLA PMU for registering the financial transactions of the project is consistent with the GOC’s new chart of accounts.34 48. Internal audit – MOI has an Internal Audit Department (IAD) with 339 staff (66 civil servants and 273 police personnel). It was established as a ‘Department’ in 2006 based on Sub-Decree No. 22 (2006) on the Establishment of Internal Audit Department and upgraded to a ‘General Department’ in 2015 based on Sub-Decree No. 109 on the Establishment and Functioning of the Ministry of Interior. There is no audit committee. 49. Most of the IAD’s staff have been transferred from other ministries or from other General Departments within the MOI and have generally not had prior experience with internal audit. Also, the educational background of the staff is varied and includes accounting and finance, but none have formal qualifications in internal audit. Hence although new staff receive on-the-job guidance (mentor approach) and many staff have participated in the MEF’s internal audit training (see below), the IAD’s work is affected by limited staff capacity. 50. IAD’s staff participate in internal audit training provided by the MEF’s General Department of Internal Audit (GDIA). This included 87 staff in 2016 and 120 staff in 2017. There was no training in 2018. A training course for 100 IAD staff was conducted in September 2019. 51. The IAD reports to the Minister of Interior. All reports, including summaries, are provided to the Minister’s Office and prior-reviewed by the Secretary of State.35 Some of the IAD’s reports

34 This relates to the issues noted in Chapter 3 on the JCPPR action points regarding the chart of accounts as well as

the updating of the GOC’s SOP and FMM. 2019c. 2016–2017 Joint Country Portfolio Performance Review (JCPPR) of Loans/Grants funded by the Asian Development Bank/World Bank and Japan International Cooperation Agency – Memorandum of Understanding. February.

35 The MOI has 22 Secretaries of State, each of whom is assigned specific organizational responsibilities.

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are shared with the NAA. 52. The IAD’s annual internal audit program is compliance-based and the IAD’s purview covers all entities under the MOI’s supervision, both at the national and sub-national levels, including civil administration, police and correctional affairs. The program is prepared based on the internal audit findings of the previous year (i.e. it is risk-based) and takes into account the available staffing and budgetary resources. The program is approved by the Minister. 53. The IAD holds exit meetings with the auditees to inform about the internal audit findings and recommendations. Monitoring of the implementation of recommendations is done as part of the following year’s internal audit. According to the IAD, the auditees generally implement the recommendations in a timely manner. Issues about the availability and completeness of records have occasionally been observed by the IAD at the level of communes/sangkats, but it is not a general problem. 54. The IAD can include externally-financed projects in its annual work program, and it is currently in the process of preparing to undertake an internal audit of a World Bank-funded project being implemented by the MOI.36 It is yet to be decided by ADB and the MOI, if the planned ADB-financed project shall be subject to annual internal audit by the IAD. 55. External audit – According to Article 2 of the Audit Law (2000, as amended), the NAA has the mandate to audit all government institutions, including sub-national governments, and other entities such as public enterprises. The NAA prepares an annual audit plan that covers 50-60% of all ministries and is purportedly risk-based.37 However, according to the MOI, it has not been subject to external audit by the NAA.38 56. Annual project financial statements are subject to external audit. ADB requires that the audit is undertaken in accordance with International Standards on Auditing (ISA) by an independent auditor acceptable to ADB. The requirement stated in the Terms of Reference (TOR) used by the MEF in the tender for the ‘audit of the annual project financial statements of multiple development projects in Cambodia (bundled annual audit)’ is the application of the Cambodian International Standards on Auditing (CISA). 57. The audit of project annual financial statements is in Cambodia undertaken by a firm contracted by the MEF for all externally financed projects and for which a standard TOR is used. Contracts are awarded for three years, and the MEF’s current contract covers 2017–2019 (i.e. a new contract is to be agreed this year or in early 2020). ADB has recently reviewed the applied TOR to ensure alignment with ADB requirements as outlined in legal agreements,39 and on that

36 The 2017 Project Appraisal Document (PAD) of the World Bank–funded Livelihood Enhancement and Association

of the Poor (LEAP) project states: “The Internal Audit Department (IAD) of MOI is encouraged to carry out the project’s internal audit activities based on risk–based approach at least once per year. The findings resulting from the internal audit shall be discussed with the project’s management. The Director of IAD will issue the final audit report to the project’s management and to the Minister of MOI according to his/her responsibilities. After getting the final internal audit, the project shall send a copy to the Bank no later than 15 days after receipt. If the internal audit reports are not submitted to the Bank or the IAD is unable to carry out internal audit on the project’s activities, the Bank may request the project to engage a consulting firm to build capacity of the IAD and to work with the IAD to perform an internal audit of the project.” (page 65).

37 Royal Government of Cambodia. 2015. op. cit., p. 91. 38 The MOI is subject to regular checks by the MEF’s Inspection Department. However, the financial inspection of

payment transactions is an inherited practice that is not equivalent to, or a replacement for, external audit. 39 Project Administration Instruction (PAI) 5.07 on Financial Reporting and Auditing of Loan– and Grant–Financed

Projects.

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basis proposed to the MEF the following changes: (i) provide special auditor’s opinion on use of loan proceeds, and (ii) include opinion on true and fair presentation of project’s financial position into the audit report.40 The first proposal has been agreed. However, the second proposal is still being discussed due to issues with the accounting standards applied to financial reporting of projects financed by development partners.41 ADB is presently consulting with the MEF on addressing these issues and aligning accounting standards with either the GOC’s national accounting standards or international standards. For the time being, the auditor will therefore be unable to provide an opinion on ‘true and fair’ presentation of the financial positions of projects. 58. The audit report for the project financial statements and the management letter must be presented to ADB within six months from fiscal year-end by the EA. ADB will disclose the audited project financial statements (APFS), but not the management letters, no later than 14 days after ADB’s confirmation of their acceptability by posting them on ADB’s website. 59. The requirements and procedures for external audit for externally financed programs/projects are set out in the FMM (Section 20.2), but the descriptions are general rather than specific. Hence detailed guidance on the procedures to be followed by the Training Department, including regarding ADB’s requirements as well as the process involving the MEF, will need to be provided.

e) Financial Reporting Systems, including Use of Information Technology 60. Reporting and Monitoring Mechanisms – All General Departments of the MOI are required to provide regular financial reports to the DLF (monthly, quarterly, six-monthly and annually). The DLF prepares monthly, six-monthly and annual financial reports for the Minister as well as quarterly financial reports for the MEF.42 Given that the payment function is centralized with the MEF’s GDNT,43 the DLF does not prepare ordinary financial statements. 61. Financial reporting for the project will be carried out in line with the procedures stated in the FMM and as per the requirements of ADB. The applicable financial reporting formats are provided in the FMM’s Chapter 19 as well as in Appendix 1 (Accounting documentation) and Appendix 4 (Samples of financial reports). 62. Information Systems – As noted above, the MOI does not have a computerized accounting system in place, and DLF’s Accounting Office therefore carries out is tasks manually using paper-based records and spreadsheets. The DLF is using a USB flash drive to make back-

40 Before that, audit opinions on projects stated only that the accounts were prepared in accordance with the basis of

accounts described in the notes to the financial statements. 41 Despite the GOC’s FMM referring to cash basis accounting, the financial statements of externally financed projects

are currently prepared based on the basis of modified cash accounting. Furthermore, modifications are not applied consistently across projects and, also, the modified cash basis differs from international accounting standards as well as the GOC’s national accounting standards, which thus does not comply with "fair presentation framework" as defined in the ISA 700.7.

42 This follows from Article 71 of the Law on the State Budget System (2008), which requires that “ministers, heads of institutions, heads of similar public entities, and governors of the sub–national level administration shall have the duties to prepare for and provide to the Minister of Economy and Finance a report on budget execution, a report on the implementation of projects pertaining to borrowings, issuance of state securities, guarantees and financial commitments, acceptance of financial grants and report related to revenue from investments on financial fixed assets, and other necessary information as required by the Minister of Economy and Finance.”

43 This follows from the requirement stated in Article 72 of the Law on the State Budget System (2008) that only state public accountants are authorized to handle treasury funds, which thus makes the GDNT and provincial government treasuries the sole institutions that can undertake manage payments to suppliers and salaries to government personnel.

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ups of relevant files, but the procedure is not done regularly. 63. It is expected that the MOI will implement the GOC’s FMIS in 2020 for which preparatory activities are currently on-going (as mentioned above). 64. Given the disbursement arrangements that will be applied for the project (see below), it would seem that the application of a spreadsheet should suffice for the purpose of registering and tracking project financial transactions. In order to facilitate this, however, all required accounting documentation and financial reports (as per the FMM) should be prepared as templates and uploaded on the computers that will be used by the Training Department team. 65. The Training Department will be trained in financial reporting and monitoring as per the FMM as well as based on ADB procedures and requirements.

f) Funds Flow Mechanism and Disbursement Arrangements 66. The proposed funds flow arrangement for the project is shown in Appendix B. 67. The loan proceeds will be disbursed in accordance with ADB’s Loan Disbursement Handbook (2017, as amended from time to time), and detailed arrangements agreed upon between the GOC and the ADB. ADB funds will be managed by the NASLA PMU in using the advance fund and SOE procedure of disbursement as well as the direct payment procedure for selected categories. 68. The loan will use the direct payment procedure for civil work and service contracts as well as other high-value payments. These payments will thus be made directly by ADB, based on the payment requests of the Training Department – in the form of WAs along with the necessary supporting documents – submitted to ADB. 69. The MEF will, on behalf of the NASLA, will establish a separate pass-through account for the ADB loan at the NBC to receive funds from ADB. An advance account in US dollars will be set up in a commercial bank proposed by the MEF and acceptable to ADB and maintained by the NASLA. The advance account will be used for incremental administration costs of the ADB loan (consultants, training, publications, etc.) and will be used exclusively for ADB’s share of eligible expenditures. The ceiling of the advance will be $100,000. The NASLA will be accountable and responsible for the proper use of advances to the advance account. 70. The loan will be disbursed based on advance six-month projections over the course of the project implementation period. Supporting documents are to be submitted to ADB or retained by the NASLA in accordance with ADB’s Loan Disbursement Handbook (2017, as amended from time to time) when liquidating or replenishing the advance account.44 All WAs will be sent to ADB for processing.

71. The FMA shows that the MOI has some FM weaknesses, and the overall fiduciary risk (pre-mitigation) is assessed as substantial. The GOC has a high level of variance in expenditure composition at the level of administrative budget heads as well as high expenditure arrears (cf.

44 ADB’s Loan Disbursement Handbook describes which supporting documents should be submitted to ADB and which

should be retained by the government for liquidation and replenishment of an advance fund account. The bank charges incurred in operating the advance fund account can be financed from the loan proceeds. (http://www.adb.org/sites/default/files/institutional–document/33606/adb–loan–disbursement–handbook.pdf)

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Chapter 3), which indicates a risk that the MOI may not, from the GOC, receive sufficient resources for project implementation. In order to ensure that adequate resources are available for MOI to implement the project as planned in terms of timing and activities, it is therefore advisable to provide the Training Department/DLF with an advance account and the ability to use the SOE procedure, as and when required. Given the identified FM weaknesses, however, a ceiling in the equivalent of maximum $100,000 per individual payment is recommended for reimbursement of eligible expenses and liquidation of advances.45 Also, the PMU of NASLA will be supported by two consultants who, together with the PMU staff, will receive training on ADB FM procedures and requirements, and there will thus be adequate capacity for the use of advance account and SOE procedures. Supporting documents and records for expenditures claimed under the SOE procedure must, in accordance with ADB’s Loan Disbursement Handbook, be maintained by the Training Department/DLF and made readily available for review by ADB's disbursement and review missions, upon ADB's request for submission of supporting documents on a sampling basis, and for independent audit. 72. For the SOE procedure, which will be used for reimbursement of eligible expenses and liquidation of advances to the advance account, it is therefore proposed that a ceiling in the equivalent of maximum $100,000 per individual payment be applied. Supporting documents and records for expenditures claimed under the SOE procedure must be maintained by the Training Department/DLF and made readily available for review by ADB's disbursement and review missions, upon ADB's request for submission of supporting documents on a sampling basis, and for independent audit. 73. For efficiency reasons, the minimum value per WA is $100,000 equivalent, unless otherwise approved by ADB. ADB reserves the right not to accept WAs below the minimum amount. 74. Counterpart support will be in the form of land, office space, staff salaries, costs for guest lecturers, office accommodation and other in-kind contributions (i.e. funds will not be directly provided). 75. The disbursement procedures as well as related accounting and auditing arrangements are detailed in Chapter V of the Project Administration Manual (PAM). E. FINANCIAL MANAGEMENT RISK DESCRIPTION AND RATING 76. There are some weaknesses and shortcomings in the GOC’s FM system and as applied by the MOI. The resulting fiduciary risks are summarized below.46

45 This is in line with ADB’s Loan Disbursement Handbook, Section 7.19, according to which a ceiling may be

established if and when there is uncertainty about the FM capacity of an IA. 46 ADB does not apply a definition for fiduciary risk. The assessment is intended to determine the degree to which the

system will be able to manage fiduciary risks related to financial management and procurement so as provide reasonable assurance that program funds will be used for the intended purposes. This is one of three aspects applied by some donors as the definition of fiduciary risk. The two other aspects usually applied are whether funds are properly accounted for and the achievement of value–for–money (i.e. efficiency and effectiveness of operations).

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Table 2: Financial Management Risks

Risk Type Risk Description Risk Assessment

(without mitigation)a

Management Plan / Mitigation Measures

Inherent Risk b

Country-level risks

The country level PFM system weaknesses include low budget credibility, limited information provided in budget documentation, inadequate public access to fiscal information and limited compliance with internal control rules. In addition, inherent risk related to the country’s inconsistent application of the financial reporting standards used to prepare project financial statements are insufficient and need to be addressed at the country level.

Substantial ADB long term engagement with GOC on strengthening the overall national level PFM system will continue to strengthen systems through policy dialogue and TA resources to support the GOC in the implementation of the PFMRP. This includes strengthening the policy and regulatory framework for expenditure and revenue management and enhancing budgeting and expenditure management in selected line ministries, ADB is supporting the government to update its national financial reporting standards to fully align with the International Public Sector Accounting Standards (IPSAS). ADB will continue to resolve this issue through implementation of the time-bound roadmap.

Entity-specific risks

The NASLA does not have experience with the FM procedures and requirements of externally-financed programs/projects, including the management of disbursements, and is not familiar with the GOC’s SOP or FMM. Availability of qualified FM staff in market

High A PMU will be established within and overseen by the NASLA and training will be provided on the SOP and FMM as well as ADB FM procedures and requirements. Consultants will undertake capacity development of NASLA

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Risk Type Risk Description Risk Assessment

(without mitigation)a

Management Plan / Mitigation Measures

may impact overall implementation.

PMU and staff. Procedural support will also be provided by NCDDS and MOI entities on an ad hoc basis.

Overall Inherent Risk Substantial-High

Control Risk c

Planning and budgeting

Program budgeting has been only recently implemented, and related procedures thus remain to be fully developed and institutionalized.

Moderate The MOI will request that MEF provide for additional support to further develop and strengthen program budgeting procedures.

Funds flow The funds flow arrangements for ADB’s loan are clear, and the government counterpart funding covers limited and clearly identified areas.

- -

Staffing Capacity in some entities is limited in terms of skills and staff numbers. NASLA does not have a project management or FM function. Availability of qualified FM staff in the market and understaffing may impact overall implementation.

Substantial

NASLA will establish a team to manage project implementation, including designating a staff member with relevant educational qualifications and professional experience as Finance Officer taking into consideration the availability of FM capacity on the market and the duration of the recruitment process.

Accounting and internal control

The accounting system is manual, which increases the risk of errors. Some entities do not adhere to the eligibility requirements for payment requests. The process of liquidating advances is in some cases protracted.

Substantial NASLA PMU will maintain separate project accounts, and will carry out the project-related FM in accordance with the FMM and SOP as well as ADB procedures and requirements.

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Risk Type Risk Description Risk Assessment

(without mitigation)a

Management Plan / Mitigation Measures

Internal audit Not all staff of the Internal Audit Department (IAD) have received training on internal audit policies, standards and procedures.

Moderate The MOI will request that the MEF’s GDIA provide training to all its internal auditors. MOI will commit to include the project into the annual audit program and assign trained IAD staff to it

Financial reporting

Financial reports are produced manually and are occasionally delayed, which limits the possibilities for undertaking proactive budget management.

Substantial NASLA PMU will apply the financial reporting formats provided in the FMM and as required by ADB.

Information systems

The MOI does not have a computerized FM system, which increases the risk of manual errors as well as processing time.

Substantial The MOI will continue preparations for implementing the GOC’s FMIS, including ensuring that training will be provided to all identified users.

External Audit

The audit of the project financial statements by a private firm contracted by MEF does not include an opinion on the ‘true and fair’ presentation of the financial position.

Low ADB and MEF will define and agree on aligned accounting standards, which will be incorporated into a new Standard ToR

Overall Control Risk Substantial

Overall Risk Substantial ADB = Asian Development Bank, FM = financial management, FMIS = financial management information system, FMM = Financial Management Manual, GDIA = General Department of Internal Audit, IAD = Internal Audit Department, MEF = Ministry of Economy and Finance, MOI = Ministry of Interior, NASLA = National School for Local Administration, NCDDS = National Committee for Sub-National Democratic Development Secretariat, PFM = public financial management, PFMRP = Public Financial Management Reform Program, PMO = Project Management Office, GOC = Government of Cambodia, SOP = Standard Operating Procedures, TA = technical assistance, TOR = Terms of Reference. a Low, moderate, substantial, high. b Inherent risk is the susceptibility of the program financial management system to factors present in its operating

environment, such as country- or sector-level rules and regulations, and the agency’s working environment (assuming absence of any checks or internal controls).

c Control risk is the risk that the program’s accounting and internal control framework are inadequate to ensure program funds are used economically and efficiently and for the purpose intended, and that the use of funds is properly reported.

Source: Asian Development Bank (ADB).

77. The overall fiduciary risk for the project pre-mitigation is considered to be substantial. This is a result of a substantial risk rating for the country system, high risk rating for the IA, and combined substantial control risk rating for the project FM elements. When proposed mitigation

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measures are taken into account, the overall fiduciary risk is considered moderate. F. PROPOSED TIME-BOUND FINANCIAL MANAGEMENT ACTION PLAN 78. The following time-bound financial management action plan is proposed.

Table 3:Financial Management Action Plan

Risk Description Rating Action Item Period Responsibility

1 Country-level risks: The overall PFM system in Cambodia includes weaknesses such as low budget credibility, inadequate public access to fiscal information, frequent non-compliance with internal control rules and ineffective internal audit all present at country level. In addition, inherent risk related to the country’s inconsistent application of the financial reporting standards used to prepare project financial statements are insufficient and need to be addressed

Substantial ADB will continue to provide TA to support the GOC in the implementation of the PFMRP for overall improvements to the PFM framework. ADB will support the government to update its national financial reporting standards to fully align with the International Public Sector Accounting Standards

2020 MEF ADB

2 Entity-specific risks: The TD does not have experience with the FM procedures and requirements of externally-financed programs/projects, including the management of disbursements, and is not familiar with the GOC’s SOP or FMM.

High Establish the NASLA PMU staff and hire consultants.

2019/2020 NASLA

Provide training on the SOP and FMM as well as ADB FM procedures and requirements.

2019–2020 NASLA ADB

Undertake capacity development of NASLA PMU.

2020–2026 NASLA

Provide procedural support on an ad hoc basis.

2020–2022 NCDDS DLF

3 Planning and budgeting: Program budgeting has been only recently implemented, and related procedures thus remain to be fully developed and institutionalized.

Moderate Request MEF to provide additional support to further develop and strengthen program budgeting procedures.

2020 MOI MEF

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Risk Description Rating Action Item Period Responsibility

4 Staffing: Capacity in some entities is limited in terms of skills and staff numbers. The TD does not have a project management or FM function.

Substantial Establish a PMU, including designating a NASLA staff member with relevant educational qualifications and professional experience as Finance Officer.

2019 NASLA

5 Accounting and internal control: The accounting system is manual, which increases the risk of errors. Some entities do not adhere to the eligibility requirements for payment requests. The process of liquidating advances is in some cases protracted.

Substantial Maintain separate project accounts and carry out the project-related FM in accordance with the FMM and SOP as well as ADB procedures and requirements.

2020–2026 NASLA

6 Internal audit: Not all staff of the Internal Audit Department (IAD) have received training on internal audit policies, standards and procedures.

Moderate Request the MEF’s GDIA to provide training to all its internal auditors.

2020 IAD MEF

7 Financial reporting: Financial reports are produced manually and are occasionally delayed, which limits the possibilities for undertaking proactive budget management.

Substantial Apply the financial reporting formats provided in the FMM and as required by ADB.

2020–2026 DLF

8 Information systems: The MOI does not have a computerized FM system, which increases the risk of manual errors as well as processing time.

Substantial Implement the FMIS and provide training to all identified users.

2020–2021 MEF MOI

ADB = Asian Development Bank, Department of Logistics and Finance, FM = financial management, FMIS = financial management information system, FMM = Financial Management Manual, GDIA = General Department of Internal Audit, IAD = Internal Audit Department, MEF = Ministry of Economy and Finance, MOI = Ministry of Interior, NASLA = National School for Local Administration, NCDDS = National Committee for Sub-National Democratic Development Secretariat, Program, PMU = Project Management Unit, GOC = Government of Cambodia, SOP = Standard Operating Procedures, TOR = Terms of Reference. Source: Asian Development Bank (ADB).

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79. The FM action plan should be discussed and agreed between ADB and NASLA prior to loan negotiations. The Action Plan should thereafter be considered a rolling plan so that it will be regularly reviewed for progress and updated as and when required, including if new FM issues are identified that require improvement. 80. Based on the FMA, technical and managerial support should be provided for capacity building to familiarize the NASLA PMU with the GOC’s FMM and SOP as well as ADB’s FM procedures and reporting requirements, and also to support the Training Department’s project management functions. G. SUGGESTED FINANCIAL MANAGEMENT COVENANTS 81. The following is proposed as FM covenants for the project:

• The Borrower shall make available, or cause to be made available, promptly as needed the funds, facilities, services and other resources required, in addition to the proceeds of the loan, for the carrying out of the Project, and for the operation and maintenance of Project facilities;

• The Borrower shall cause the EA to: - (i) maintain separate accounts and records for the Project; - (ii) prepare annual financial statements for the Project and the Loan in

accordance with accounting principles and financial reporting standards acceptable to ADB for each fiscal year until the Loan Closing Date;

- (iii) have such financial statements 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;

- (iv) as part of each such audit, have the auditors prepare a report, which includes the auditors’ opinions on the financial statements, use of the Loan proceeds and compliance with the financial covenants of the Loan Agreement; and a Management Letter, which sets out the deficiencies in the internal control of the Project that were identified in the course of the audit, if any; and

- (v) furnish to ADB, no later than six months after the end of each related fiscal year, copies of such audited financial statements, Audit Report and Management Letter, all in the English language, and such other information concerning these documents and the audit thereof as ADB shall from time to time reasonably request;

• ADB shall disclose the annual audited financial statements for the Project and the opinion of the auditors on the financial statements within 14 days of the date of ADB’s confirmation of their acceptability by posting them on ADB’s website;

• The Borrower shall enable ADB, upon ADB’s request, to discuss the financial reports for the Project, the financial statements for the Project, and the Borrower’s financial affairs where they relate to the Project with the auditors appointed, and shall authorize and require any representative of such auditors to participate in any such discussions requested by ADB. This is provided that such discussions shall be conducted only in the presence of authorized officer of the Borrower, unless the Borrower shall otherwise agree; and

• The Borrower shall enable ADB’s representatives to inspect the Project and any relevant records and documents.

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82. The detailed financial reporting and external audit arrangements will be set out in the Project Administration Manual (PAM). 83. Governance and Anticorruption: The GOC should ensure that: (i) the p roject is carried out in compliance with all applicable national anticorruption regulations, and ADB’s Anticorruption Policy (1998, as amended); (ii) all involved MOI staff actively participate in training on GOC’s anticorruption regulations and ADB’s Anticorruption Policy; and (iii) a website is maintained to disclose the audited annual project financial statements, project progress reports, and procurement activities. H. CONCLUSION 84. The GOC’s PFM system has undergone some important developments in the past few years. However, there continues to be a number of weaknesses, including with regard to specific PFM elements and procedures. This in particular relates to control in budget execution as well as accounting and recording. It is clear though that the GOC, through the MEF and with the PFMRP, is showing commitment to reform and improve the PFM system. 85. The MOI’s FM procedures and practices are affected by the systemic issues of the GOC and hence exhibit many of the deficiencies and limitations of the overall PFM system. However, some strengths in MOI’s FM arrangements have also been identified, for example that the IAD provides on-the-job training to new staff. 86. The establishment by MOI’s NASLA of a PMU to manage project implementation will provide some safeguards against fiduciary risks. However, it will be important that the MOI ensures that the PMU, especially in the initial phase, receives adequate technical and managerial support as well as guidance from other MOI entities and NCDDS. Also, the proper application of the GOC’s SOP and FMM is important, which should be provided for through training. Similarly, training will be required in order to familiarize the NASLA PMU with ADB’s requirements and procedures as regards FM. Specific mitigation measures are outlined in the FM Action Plan. 87. On this basis, the planned project FM arrangements are considered satisfactory.

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Ministry of Interior Minister Cabinet

General Secretariat GD of Internal Audit

Abbreviations: CS = commune/Sangkat D. = Department DM = District/Municipality GC = General Commission GD = General Department

Remarks: - Sub-decree # 109/19.8.15 on the establishment and functioning of Ministry of Interior - Sub-decree # 239/28.11.16 on the revision of article 9, 10, 42 and 45 of sub-decree #109 - Sub-decree # 240/28.11.19 on the establishment of private security management department and Anti-Commercial Game Crime Department

APPENDIX A – ORGANIZATIONAL CHARTS

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MOI’s Training Department

MOI’s Department of Logistics and Finance

Deputy Directors(9)

Administrative Office (10)

Planning and Curriculum Office

(12)

Human Resource Development

Office (12)

Research and Governance Development

Office (11)

Information and Dissemination

Office (12)

Director

Senior Management (7)

Financial Planning Office

(12)

Accounting Office (21)

SNA Budget Office (5)

State Property Management

Office (10)

External Aid Management

Office (5)

Administration Office (5)

Deputy Director General

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APPENDIX B: FUNDS FLOW DIAGRAM

SOE = statement of expenditures, WA = withdrawal application. Source: Asian Development Bank.

Ministry of Economy and Finance

Pass-through Account for Loan

Asian Development Bank

National School for Local Administration

Executing Agency Advance Account for Loan

Consultants Contractors Suppliers

National School for Local Administration

Project Management Unit Implementing Agency

Direct Payments

Loan Proceeds

WAs, SOEs and Advance Liquidation

WAs, SOEs and

Advance Liquidation

Transfers

Invoices and Receipts

Payments

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APPENDIX C: DOCUMENTS REVIEWED

• ADB. 2018a. Report and Recommendation of the President to the Board of Directors: Kingdom of Cambodia: Climate-Friendly Agribusiness Value Chains Sector Project. Project Number: 48409-002. Manila.

• ADB 2018b. Fiscal Decentralization Reform in Cambodia – Progress over the Past Decade and Opportunities. Manila.

• ADB 2019. Kingdom of Cambodia: Sector Assessment and Roadmap (Public Sector Management). Manila.

• Finnish Consulting Group. 2018. National School for Local Administration (NASLA). Concept Paper. Final Report, June.

• IMF. 2018. Cambodia. 2018 Article IV Consultation – Press Release; Staff Report; Staff Statement; and Statement by the Executive Directors for Cambodia. Country Report No. 18/369, December.

• International Budget Partnership. 2018. Cambodia, Open Budget Survey 2017.

• GOC. 2012a. Financial Management Manual for All Externally Financed Projects/Programs in Cambodia. Updated Version, May.

• GOC. 2012b. Procurement Manual for All Externally Financed Projects/Programs in Cambodia. Volume I and II. Updated Version, May.

• GOC. 2012c. Standard Operating Procedures for All Externally Financed Projects/Programs in Cambodia. Volume I and II. Updated Version, May.

• GOC. 2015. Report of the Evaluation on the Public Financial Management System of Cambodia. 31 December.

• GOC. 2018. Budget System Reform Strategy (2018-2025) – “Effectiveness, Accountability and Transparency.” Adopted by the Council of Minister’s Plenary Session on 12 January 2018.

• GOC. 2019a. Final Draft of Progress Report of Public Financial Management Reform Program Implementation for 2018. Steering Committee of Public Financial Management Reform.

• GOC. 2019b. Consolidated Action Plan in Stage 3 (CAP3–2020). Steering Committee of Public Financial Management Reform.

• GOC. 2019c. 2016–2017 Joint Country Portfolio Performance Review (JCPPR) of Loans/Grants funded by the Asian Development Bank/World Bank and Japan International Cooperation Agency – Memorandum of Understanding. February.

Websites:

• https://www.adb.org/countries/cambodia/main.

• https://www.ifac.org/about-ifac/membership/country/cambodia.

• https://www.interior.gov.kh/#.

• http://gdia.mef.gov.kh/.

• https://www.kicpaa.org/.

• http://mef.gov.kh/.

• http://www.naccambodia.gov.kh/.

• http://www.pfm.gov.kh/index.php/en/.

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APPENDIX D: LIST OF PERSONS CONSULTED

ADB CARM

• Mr. Chamroen Ouch – Senior Programs Officer (Governance)

• Mr. Sophana San – Project Analyst

• Mr. Sokunthea Sok – Senior Procurement Officer

MOI’s Training Department

• Mr. Munyraksa So – Director

• Mr. Yasak Ly – Senior Monitoring and Evaluation Officer

• Ms. Sreyleak Sak – Deputy Chief, Information & Dissemination Office

• Mr. Youra Kou – Officer, Planning and Curriculum Office

• Mr. Romnea Uy – Officer, Human Resources Development Office

MOI’s General Department of Logistics and Finance

• Mr. Nguon Pov – Deputy General Director

• Mr. Sorm Sotha – Deputy Director, Department of Planning, Economy and Finance

• Ms. Duong Chorm Nimul – Deputy Chief, Planning, Economy and Finance Office

• Mr. Sam So Panharith – Chief, Sub-National Budget Office

MOI’s Internal Audit Department

• Mr. Hov Lenin – Deputy General Director

MEF • Mr. Sophorn Ouch – PFM Senior Specialist, General

Secretariat of PFM Reform Steering Committee