PARTICIPANTS HANDBOOK

PARTICIPANTS HANDBOOK Index SECTION - 01 - INTRODUCTION TO FINANCIAL MANAGEMENT SECTION - 02 COST PRINCIPLES SECTION 03 BUDETING AND PLANNING OPERATIONS SECTION - 04 BOOK KEEPING FOR FOCUSED NGOS TRAINING SECTION - 05 CASH MANAGEMENT SECTION - 06 PAYROLL MANAGEMENT SECTION - 07 PROJECT FINANCIAL REPORTING FINANCIAL SECTION - 08 FINANCIAL MANAGEMENT AUDITS SECTION - 09 AWARD CLOSE-OUTS SECTION - 10 TAXATION AND FINANCIAL SUSTAINABILITY April 2014

Disclaimer This handbook was made possible with support from the American people through the U.S. Agency for International Development (USAID). The contents are the sole responsibility of Trust for Democratic Education and Accountability and do not necessarily reflect the opinion of USAID or the U.S. Government.

Table of Contents Session # Session title Page no 1 Introduction to Financial Management ------------------------------------- 1 2 Cost principles ---------------------------------------------------------------------- 23 3 Budgeting and Planning ---------------------------------------------------------- 68 4 Accounting & Reporting system ---------------------------------------------- 74 5 Cash management system ------------------------------------------------------ 95 6 Payroll management -------------------------------------------------------------- 110 7 Financial Audits --------------------------------------------------------------------- 138 8 Project Closeouts------------------------------------------------------------------- 180 9 Financial Sustainability of CSOs------------------------------------------------ 192 10 Internal Controls and Taxation ------------------------------------------------ 195

OFT MANUAL: FM Introduction to Financial Management SECTION 1 1.1 WHAT IS FINANCIAL MANAGEMENT? "Financial management is the area of business management, devoted to a judicious use of capital and a careful selection of sources of capital, in order to enable a spending unit to move in the direction of reaching its goals." Financial management is that function in an organization that is concerned with the raising and allocation of resources within that organization in order to attain its goals. In financial management, not only must resources be acquired and allocated within the organization for the day-to-day use, they must also be efficiently and prudently used. The organization must not only ensure that this happens, but it should endeavor to prove that it happens. Financial Management brings together Planning, Budgeting, Accounting, Financial reporting, Internal control including internal audit, External audit, Procurement, Disbursement of funds And the physical performance of the program, with the main aim of managing resources efficiently and achieving pre-determined objectives. Sound financial management is, therefore, a critical input for decision-making and program success. Good financial management can only be achieved if each one of these activities is operating well and is fully understood by the management committee, especially the Top Tier Management. Accurate and timely financial information provides a basis for better decisions about physical progress of the program, availability of funds, reducing delays and bottlenecks if noticed. The financial management system should produce timely, relevant and reliable financial information that would allow program managers and State/Central governments to plan and implement the USAID program, monitor compliance with agreed procedures and appraise progress towards its objectives. Relationship between proper financial management and the general goals of organization: Finances enable an organization to continue existing. Finances facilitate the organization acquire assets to use in its goals/objectives. Financial reward is one of the motivating factors to employees. Finances help the organization to meet the needs of its clients. Finances help organization to gain the confidence of others. Finances help organizations to deliver to society and on government requirements. 1

OFT MANUAL: FM Introduction to Financial Management SECTION 1 Financial management serves organizational goals in the following ways: Obtain funding for programs. Have contented employees. This depends on the wage/salary level and other benefits provided by the organization to its employees. Satisfy clients by the quality of service rendered to them. Fairly deal with suppliers e.g. creditors and financial institutions by paying the amounts due to them as soon as they are due. Improve social welfare. All the resources of the organization must be optimally allocated such that they will lead to the best possible social impact. Act according to the law and government requirements. It is a duty of an organization to follow all labor laws and financial management regulations in order to achieve economic stability and civil order. The goals of financial management can conflict with organizational goals when: Heading for a stronger assets position may mean reducing employee welfare or delivering less service to clients. Satisfying clients may require more expenditure, leaving less money available for improving the asset position and employee welfare. Quick payments to suppliers sometimes may lead to liquidity problems, which affect employees and may lead to failure in satisfying clients. Obeying all the laws, especially tax laws, may oppress employees. 1.2 OVER VIEW OF FINANCIAL MANAGEMENT SYSTEM: Financial management is more than just keeping accurate accounting records. It also involves planning, controlling and monitoring financial resources to achieve organizational objectives. At a minimum, a financial management system should ensure that costs are properly categorized, tracked and charged to the appropriate accounts, and that managers are able to report financial information accurately to the Board and to donors. A good financial management system makes it easier to be accountable to donors and project beneficiaries, thereby enhancing their respect and confidence in the organization. This, in turn, helps an NGO be more competitive and can increase its chances of maintaining long-term financial health. This section introduces the key elements of a comprehensive financial management system and ways in which an NGO can strengthen its capacity in this critical area. WHAT DOES GOOD FINANCIAL MANAGEMENT INVOLVE? Good financial management involves planning, organizing, controlling and monitoring resources so that your organization can achieve its objectives and fulfill its commitments to beneficiaries, donors and other stakeholders. 2

OFT MANUAL: FM Introduction to Financial Management SECTION 1 Four Key Pillars of Financial Management Although no one model of financial management fits every organization, the following components are essential to good financial management: Planning looks ahead to prepare for the future, such as developing budgets to cover activities of a program or the entire organization for a year or a longer period. Organizing clarifies who does what, why, when and how. Controlling establishes systems and procedures, checks and balances, to make sure that the financial resources of the organization are properly handled and that risks are managed. Monitoring compares plans with actual performance to identify strengths and weaknesses in planning and implementation and adjust as necessary. 1.3 COMPONENTS OF A GOOD FINANCIAL MANAGEMENT SYSTEM: Good financial management requires more than simply keeping accurate accounting records. Many NGOs may have only an accounting or bookkeeping system rather than a financial management system. Accounting is a subset of financial management. A financial management system encompasses both accounting systems and administrative systems. 1) Accounting systems encompass the methods, procedures and controls established to gather, record, classify, analyze, summarize, interpret and present accurate and timely financial data. 2) Administrative systems provide the framework for handling procurement, travel, inventory, facilities and personnel matters such as payroll and benefits. ACCOUNTING SYSTEM: How accounting can help organizations achieve their goals: It provides figures for planning compromise positions. It facilitates control. It provides information on the financial standing. It provides information on the funding trends. It provides information on expenditure trends. A practical accounting system for an organization typically consists of the following: i. The Funding Agreement The funding agreement between the donor and the organization outlines all aspects regarding the project and should include the following: activities to achieve the deliverables funding of the project 3

OFT MANUAL: FM Introduction to Financial Management SECTION 1 reporting on activities - narrative report - financial report - periods of reporting management of funding and procurement of goods Stipulations in the budget regarding how the funding is to be applied. ii. The Budget The budget includes all planned activities listed by type of activity. It is a financial framework listing all activities and deliverables as stipulated in the agreement. Each line item in the budget indicates the costs which may be incurred for the specific activity (for example, the number of workshops to be presented, the number of persons to attend, the venue rental costs, the presenter costs). Travelling costs and per diems are either provided for in a separate line item or aligned with specific activities. Fees per kilometer and per diems applicable are listed. Provision for administrative costs may include: bookkeeping fees audit fees telephone costs rental stationery other office costs - Office costs may be subdivided into specific costs or may be provided for as a lump-sum for overhead costs for the total project. - If divided into specific costs, actual costs are claimed per month as they occur - according to specification. - If specified as a lump sum, the total overhead provision may be transferred to -a dedicated account from which running costs are paid monthly in total. The organization can transfer the overhead funds to a dedicated account named, for example, own funds, pooling overhead funds from different projects. When transferring the overhead costs to an own funds account, that sum is entered as an expense in the records of the project in the month of transfer in one sum. The organization s running costs which are not project-specific may be paid from the own funds account. Funds remaining in this account may also be used to bridge periods when projects have been completed and new projects have not yet commenced, but running costs like rent, telephone and insurance still have to be paid by the organization. If, during the implementation of the agreement, it is found that certain reasonable costs could exceed the relevant budget line, an agreement has to be reached with the donor to re-adjust the costs accordingly and to rebalance the budget by reducing other line items. This should be done before overspending on a line item actually occurs. Salaries and fees are generally not adjustable during the course of an agreement. For the duration of the project a summary of expenses is drawn up and is updated monthly, indicating monthly 4

OFT MANUAL: FM Introduction to Financial Management SECTION 1 expenses, total expenditure to date and the remainder of funds per line item. This serves as a control instrument for both the manager of the organization and the project program managers. The following expenses are usually not allowed by donors: lobbying includes direct legislative lobbying and grassroots lobbying; fund-raising includes costs of organized fund-raising, endowment drives, solicitation of gifts and bequests and similar expenses incurred solely to raise capital or obtain contributions; bad debts any losses arising from uncollected accounts and other claims and related costs; contingencies contributions to a contingency reserve or any similar provision for unforeseen events; fines and penalties resulting from violations of, or failure to comply with state and local laws and regulations; losses on other awards any excess of costs over the grant budget is not allowable; unnecessary travel costs for example, when travelling by air, only economy class is allowable; contributions and donations by the organization to others; certain depreciation or use allowances on buildings and equipment purchased with the donor s funding; entertainment costs for amusement, social activities, ceremonials, hospitality and activities relating thereto, such as meals, lodging, rentals, alcoholic drinks, transportation and gratuities are unallowable; Interest costs incurred for interest on borrowed capital are unallowable. In addition, an NGO will generally have to submit a reconciliation of funds received to its donors at pre-arranged time intervals so that control can be kept of how much of a grant advance has been used, whether the NGO would need a subsequent advance and how much interest (which often has to be returned to the donor) any advanced funds have accumulated. Although the requirements of various donors and the forms to be used in this regard may differ. iii. Bank Accounts The choice of a bank will depend on the facilities available at the grantee s location. The decision should also be based on the willingness of the bank to pay interest on a current account. If the agreement stipulates that interest earned on the funds of the project is refundable to the donor, a dedicated bank account must be opened to accommodate that agreement. Management decides who is responsible for the approval of payments, the signing of cheques, electronic transfers, and the handling of petty cash: Cheques: A single signatory signs or two signatories co-sign cheques according to a resolution of the Board of Directors of the organization. The cheque plus a cheque requisition form is completed by the bookkeeper and presented to the signatory/ies, together with the approved invoice for payment. Electronic transfers: The same guidelines as for cheques apply. The transfer request is signed by one or two signatories, as has been determined. A designated person does the actual electronic 5

OFT MANUAL: FM Introduction to Financial Management SECTION 1 transfers. The transfer documentation is signed by the signatories who approved the transaction, or by other designated persons. Organizations must provide safeguards for all grant property, whether cash or other assets, and assure that it is used solely for authorized purposes. Control will be enhanced if the duties of the members of the organization are divided so that no one person handles all aspects of a transaction from beginning to end. Although a complete separation of functions may not be feasible for a small organization, some measure of effective control may be obtained by planning the assignment of duties carefully. Many of the most effective techniques for providing internal control are very simple. Within an organization, the same person should therefore not be performing the following duties: preparation of bank reconciliations and approval thereof; preparation of requisitions and approval of expenses; Accounting entries and approval of expense reports. Where required by a donor agency, a separate bank account should be opened for the specific use of the donor s approved budget and activities. Transfers between donor bank accounts are NEVER allowed. However, if necessary, funds may be transferred from the general account to a donor account when funds run low or funds are not transferred in time. Bank reconciliations should be conducted on a monthly basis by the financial officer and approved by the Executive Director. iv. Petty Cash Depending on the type of activities, cash payments sometimes cannot be avoided. In this case a petty cash structure must be put in place. One person only (supervised by, for example, the financial controller) should have control over cash funds, have sole access to the cash, and assume responsibility for the reconciliation of the petty cash vouchers and the remaining cash funds. If the financial controller is in charge of petty cash, another person is designated to supervise the petty cash operation at intervals. The handler of petty cash is responsible for the reconciliation of the petty cash funds and is liable for any shortages of cash. The key of the cash box remains with the person handling petty cash at all times. Cash is kept in a cash box in a secure, lockable cupboard or a safe. For payouts from petty cash, a petty cash request form must be completed. The recipient of the cash signs the petty cash request form when receiving the cash. The transaction is finalized when proof of purchase (invoice or till slip) is handed to the keeper of the petty cash and any surplus cash has been returned. The final amount paid, and the funds returned to petty cash, are noted on the petty cash request form. v. Procurement An organization s procurement policy should be based on the principle of assuring the most cost efficient and rational use of resources for goods or services that will best serve the organization both at the 6

OFT MANUAL: FM Introduction to Financial Management SECTION 1 present and in the long term. Organizations should follow a multi-quote system procurement policy for the supply of both products and services. This system of procurement should not preclude exercising good judgment in assessing the merits of the quotations received. This system of procurement should not result in a lowering of minimum standards or norms as required by the specific purchase in assessing the quotations received. In instances where long-term business relations have developed with suppliers to the extent of sole-sourcing, the relationship will be subject to market-related standards and competitive review. In instances where procurement occurs within monopolistic industries, such procurement will be exercised with good judgment. This does not preclude procurement of services beyond country borders if necessary and to the benefit of the organization. All assets are to be reflected on the organization s fixed asset register. Asset disposal shall occur in consultation with the relevant donor. Different approaches should apply to the purchase of non-expendable items, or fixed assets (such as computers, cars, printers and copying machines), on the one hand, and general purchases (such as office stationery) on the other. Non-expendable items are those with a useful life span of more than one year; they are permanent in nature and include (but are not limited to) office furniture, computer equipment, photocopiers and electronic equipment. In the case of non-expendable items, or fixed assets, such as computers, printers and photocopying machines: the purchase must be provided for by the agreement and approved by the Executive Director three quotations must be obtained if the purchase value of a single item exceeds N$1 000, or as specified by the agreement the Executive Director must confirm the choice (made from the quotations) of item to be purchased by signing the quotation before the item is actually ordered. A fixed asset register, listing the following details relating to non-expendable equipment, must be maintained: type of equipment serial number date purchased cost of purchase current cost (depreciated value) Location (office assigned to). All items removed from the asset register should be accounted for by the Executive Director. The asset register should be updated as soon as new items are purchased or acquired, but at least once a year. In the case of general purchases (fuel, stationery, refreshments, cleaning material): a purchase order is completed before the item is purchased; the delivery note, confirming receipt of goods, is signed by the person of the organization receiving the goods; 7

OFT MANUAL: FM Introduction to Financial Management SECTION 1 the invoice is approved by the Executive Director for payment and signed, along with the payment request form and he or she indicates the relevant budget line item; the payment is made by cheque or electronic transfer; low cost items such as refreshments and cleaning materials are mainly purchased via petty cash. Non-expendable items should not be removed from the office building unless for purposes relating to a program. In such a case, prior authorization must be given by the Executive Director. A prescribed consent form must be completed prior to the removal of the item from the office building. If a staff member removes a non-expendable item from the office without prior consent and it is damaged or stolen, the staff member will take responsibility for the damage or loss of property. A policy does not normally allow for the lending out any non-expendable items to a person or organization. However, the Executive Director may use his or her discretion if the need arises for lending out specific items. In such cases, the lender will take full responsibility for damages to or theft of the property. vi. Recording Of Project Activities Activities should be executed as agreed upon in the agreement with the donor. Records and proof per activity must be kept. Reporting is usually done as follows: Narrative reporting on activities The program manager summarizes the activity, supported by the following documentation, also reporting on outcomes, challenges incurred and results achieved, if measurable: an attendance register, signed by all participants of workshops, conferences and seminars; the date, place, venue and subject of the seminar or workshop and group addressed (recorded on the attendance register); evaluation forms, completed at the closure of the event by the participants; Questions regarding the presentation and the content of the workshop, completed anonymously by the participants of the workshop (listed on the evaluation document). Financial reporting on activities All costs incurred for the presentation of an activity are summarized in a financial report: venue costs rental of hall presenter fee external consultant travelling expenses per kilometer fees for presenter or participants from remote locations presentation materials and stationery used during the workshop refreshments consumed during the workshop daily allowances (per diems) only applicable for overnight absence from home. When planning an activity, expenses must be aligned with the budget. vii. Payments 8

OFT MANUAL: FM Introduction to Financial Management SECTION 1 Payments are usually made electronically by internet banking, by cheque or in cash. The procedures for paying electronically by internet banking or by cheque are as follows: payment of an invoice is authorized by the manager s signature and an indication of the budget line item on the invoice the bookkeeper completes the cheque requisition form, writes out the cheque and attaches the cheque and the invoice to the requisition form each cheque should be secured with the words Not negotiable, written out or stamped on the top part of the cheque the signatories sign the cheque as well as the cheque requisition form the cheque number, the date of the cheque and the project which funds the payment are clearly written on the invoice in order to prevent double payment of invoices Cash cheques are issued only to replenish petty cash and may not be secured with the Not negotiable note (a cheque which is marked Not negotiable has to be paid into a bank account). The procedure for payment in cash is as follows: each payment from petty cash is recorded on a cash requisition form the person in charge of the petty cash completes a cash requisition, noting the amount advanced the recipient of the cash signs in acknowledgement of receipt of the cash advance after the purchase has been made, the proof of payment (invoice or till slip) and the remaining cash funds are returned to the petty cash holder the actual costs, as well as the funds returned are recorded, and the requisition form is signed by the petty cash holder and the purchaser to indicate agreement regarding the conclusion of the transaction The proof of payment is attached to the petty cash requisition form. viii. Bank Transactions Cash Book Bank transactions may consist of cheques issued, electronic banking transactions, debit orders, interest received and bank charges. Banks issue bank statements on a monthly basis or as agreed upon with the bank. All transactions are recorded on a schedule indicating: opening balance at the beginning of the month all cheques issued during the month, listed in numerical order all e-banking transactions, listed in chronological order debit orders paid by the bank bank charges Balance at the end of the month. The balance reflected in the cash book is reconciled monthly with the balance showing in the bank statement. Differences between the two balances are reconciled by listing the outstanding items between the two balances. In the cash book, all payments are subdivided (if applicable) to the line item columns of the projects 9

OFT MANUAL: FM Introduction to Financial Management SECTION 1 budget line items, and then summarized on the cash book schedule, adding up to total expenses of the month paid from the bank account. On the cash book schedule, petty cash expenses are also listed and added to the columns for line items. These show movement in funds available in both the bank account and the petty cash. The cash book summarizes movement in funds payable and receivable, and income received from donors. ix. Cash Transactions Petty Cash All transactions are recorded on a schedule indicating: opening balance at beginning of the month cash received Payments made from petty cash. No petty cash transaction should be left incomplete at the end of each month. The closing balance at the end of the month must be reconciled with the cash available. Any shortfall is refunded to the petty cash by the handler of the petty cash from his or her own pocket. x. Monthly Summaries Of Expenses On this schedule all expenses are recorded for each budget line item, per month. In one column the budget according to the agreement is listed. In another column the differences between actual costs to date and the budget are indicated, appearing as under budget or over budget. This schedule is an important instrument to keep track of the progress of spending on a funding agreement. xi. Trial Balance The trial balance lists all general ledger accounts. The totals of the debit and the credit balances should be equal, proving that debit and credit entries were posted equally and are balancing. This does not prove that costs have been allocated correctly. xii. Balance Sheet And Income Statement The balance sheet and income and expenditure statement are extracted from the trial balance. The income and expenditure statement includes all monies the organization has earned or received and balances this against how much has been spent. Essentially, the statement presents total income received and the nature thereof, as well as the costs and expenses charged against this income. For an NGO this statement typically reflects funding sources compared against program expenses, administrative costs, and other operating commitments. Revenues and expenses are further categorized in the income statement by the donor restrictions on the funds received and expended. Whereas the income statement depicts the overall status of the organization s surplus or deficits by looking at income and expenses over a period of time, the balance sheet depicts the overall status of the organization s finances at a fixed point in time usually at the end of its financial year. All assets are added and all liabilities subtracted to compute the organization s overall net worth. 10

OFT MANUAL: FM Introduction to Financial Management SECTION 1 xiii. Audited Annual Financial Statements Grantees are expected to maintain a state of audit readiness. This means that financial and program related records relating to their grants must be readily accessible for audit. Failure to provide the auditor with reliable documentation could lead to questioned costs and possibly result in cost disallowances. After the end of each financial year an annual audit must be performed by accredited auditors. Each donor is supplied with a copy of the audited financial statements. Donors often expect audited financial reports on their specific funding. This has to be agreed upon with the auditors at the start of the audit. The total period of the agreement with the donor has to be covered by audited financial statements. This specific reporting to a donor could span the audit reports of several financial years of the organization, depending on the total period covered by the agreement. An external audit is an independent report that covers: how much money the organization has received and spent in the financial year, and what the money was used for; whether the money has been spent in accordance with the constitution of the organization, board decisions and donor requirements; whether the accounts (the bookkeeping system) have been properly and honestly kept; the value of the organization s assets; How the financial record-keeping system could be improved. It is also possible to perform an internal audit for your own purposes. This can be done by someone inside the organization. The person who performs the external audit (the auditor) must not be actively involved in the organization, and should not be a relative or close associate of anyone actively involved in it. In some organizations, it is a government or donor requirement that the auditor be formally qualified and registered. In others, it is sufficient if the audit is performed by someone who is competent and not directly involved with the organization. The auditor is usually formally appointed at the organization s annual general meeting. The auditor can only be changed by a formal resolution at an official board meeting. Donors usually want to know why you are changing your auditor. In many countries there are strict legal guidelines stating who can act as an auditor, often linked to the size of the organization. As well as auditing the annual accounts, the auditor is usually available during the year to provide support and advice. The audit is usually done as soon as possible after the close of the organization s financial year. preparation of the audit the following documents should be ready: In a copy of the organization s constitution copies of contracts, agreements, or letters setting out the conditions of grants, donations or other income received for specific purposes copies of budgets for ongoing work or special projects copies of grant application forms copies of the minutes of board meetings 11

OFT MANUAL: FM Introduction to Financial Management SECTION 1 income and expenditure analysis records supporting documentation for income receipt books if receipts for money received are issued petty cash analysis records supporting documentation for petty cash records bank statements for the year bank reconciliations for the year cheque stubs (counterfoils) for all cheque books used during the year, and the one currently in use if it was used for the year under audit cheques returned to the organization by the bank once they have been cleared all deposit book records a list of creditors (everyone to whom the organization owed money) at the end of the financial year a list of debtors (everyone by whom the organization was owed money) at the end of the financial year a list of creditors and debtors from the end of the previous financial year records of statutory payments made, particularly on staff salaries Details of all assets. The auditor may also ask to see: a list of accruals income the organization has received for goods or services it has not yet provided; a list of pre-payments expenditure the organization has made for goods or services it has not yet received; List of accruals and pre-payments from the end of the previous financial year. Other documents the auditor may need or that will help the auditor include: - vehicle log books - value added tax (VAT) records - tax records When the audit is almost complete, the auditor will list issues that have not been fully resolved during the audit. The auditor will ask management to clarify these issues; if unresolved issues cannot be clarified, the auditor will mention them in the audit report. Such a circumstance, should it arise, is a very serious matter. At the end of the audit, the auditor usually draws up a set of draft annual accounts based on the information reviewed. He or she will include a record of income and expenditure actually received and spent, possibly with adjustments for creditors, debtors, accruals, pre-payments and depreciation of equipment or vehicles. There may also be a draft balance sheet showing the financial position of the organization on the last day of the financial year. The auditor will include a statement saying that the accounts have been drawn up in accordance with certain standards, based on information provided by the organization. The statement usually says that, in the auditor s opinion, the accounts are an accurate and honest statement of the organization s financial dealings and situation for the financial year in question. A good auditor will recommend ways to improve the organization s financial systems and procedures. The auditor s advice should always be taken 12

OFT MANUAL: FM Introduction to Financial Management SECTION 1 seriously. Such advice is usually given in a management letter. This is a very useful document that should be reviewed, along with the accounts, by the board. It may even be shared with donors. The idea is to improve the financial control and accountability practices of your organization. The Executive Director should report regularly to the board on how the recommendations of the auditor are being followed up. The draft audited statements should be checked by the Executive Director and then submitted to the board for approval and signing. When the accounts have been signed by board representatives, they are no longer draft accounts, and become final accounts. The accounts should not be signed by any person who does not understand them. If anything is unclear, the auditor may be asked for clarifications; alternatively, he or she may be requested to attend the meeting at which the board discusses the accounts. An NGO s Executive Director, who has the final responsibility and is accountable for all funding, needs to ensure that, when going over the audited statements, he or she is able to answer the following questions: How do the figures for income and expenditure compare with the actual expenditure for the previous year (which will be shown)? How do they compare with the budget for the year? Why have there been substantial increases and/or decreases on certain items? Have all items of expenditure been included? Are they all justified? Has the audit fee been included? How does this balance sheet compare with the previous one? Is the organization in a better or worse position financially than it was last year? How do the total current assets compare with the total current liabilities? Is any deficit in the year being audited covered by a surplus from previous years? Even though previous years surpluses are part of the accumulated fund or equivalent item, if there is a deficit, how will a similar situation be avoided in this year? Are there any large sums of money owing to the organization? If so, what steps could be taken to retrieve the outstanding payments? Where are the financial reserves of the organization invested, and are they earning a reasonable income? Is the investment in line with the policies of the organization and are donors happy with the investment policy? Does the audit expose any irregularities or problems? Do we need to change our financial record-keeping system in any way, and if so, how? What does the audit tell us about our financial strategy of last year? ADMINISTRATIVE AND INTERNAL CONTROL MECHANISM OMB 122 defines Internal Control as: Internal control means a process, affected by an entity's management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: (1) Effectiveness and efficiency of operations; 13

OFT MANUAL: FM Introduction to Financial Management SECTION 1 (2) Reliability of financial reporting; and (3) Compliance with applicable laws and regulations. All staff members, program beneficiaries, volunteers and board members generally have a responsibility to prevent financial mismanagement. It is therefore imperative to have internal financial control mechanisms and policies in place. Internal accounting control comprises a series of procedures designed to promote and protect sound management practices, both general and financial. By following internal accounting control procedures, an organization will significantly increase the likelihood that: financial information is reliable, so that managers and the Board can depend on accurate information to make decisions, assets and records of the organization are not stolen, misused or accidentally destroyed, the organization s policies are followed, Government regulations are complied with. The first step in developing an effective internal accounting control system is to identify those areas where abuses or errors are likely to occur. The following areas and objectives, which will be discussed in more detail in the following section of this session, need to be addressed through an effective internal accounting control system: cash receipts to ensure that all cash intended for the organization is received, promptly deposited, properly recorded, reconciled and kept under adequate security, cash disbursements to ensure that cash is disbursed only upon proper authorization of management, for valid business purposes and that all disbursements are properly recorded, petty cash to ensure that petty cash and other working funds are disbursed only for proper purposes, are adequately safeguarded and properly recorded, payroll to ensure that payroll disbursements are made only upon proper authorization to bona fide employees, that payroll disbursements are properly recorded, and that the organization is compliant with related legal requirements (such as payroll tax deposits), grants, gifts, and bequests to ensure that all grants, gifts, and bequests are received and properly recorded and that compliance with the terms of any related restriction is adequately monitored, fixed assets to ensure that fixed assets are acquired and disposed of only upon proper authorization, are adequately safeguarded and are properly recorded. Additional internal controls are also required to ensure proper recording of donated materials, pledges and other revenues, accurate, timely financial reports and information returns and compliance with other government regulations. Achieving these objectives requires that your organization clearly states procedures for handling each area, including a system of checks and balances in which no financial transaction is handled by only one person from beginning to end. This principle, called segregation of duties, is central to an effective internal controls system. Even in a small organization, duties may be divided up between paid staff and 14

OFT MANUAL: FM Introduction to Financial Management SECTION 1 volunteers to reduce the opportunity for error and wrongdoing. For example, in a small organization, the Executive Director might approve payments and sign checks prepared by the bookkeeper or office manager. The board treasurer might then review disbursements with accompanying documentation each month, prepare the bank reconciliation, and review cancelled cheques. The board and the Executive Director share the responsibility for setting the tone and standard of accountability and conscientiousness regarding the organization s assets and responsibilities. The board, usually through the work of the finance committee, fulfills that responsibility in part by approving many aspects of the internal control accounting system. The policies and procedures for handling financial transactions are best recorded in an accounting procedures manual describing the administrative tasks and identifying the person responsible for each task. The manual does not have to be a formal document; it can be a simple description of how functions such as paying bills, depositing cash and transferring money between funds are handled. As you start to document these procedures, even in simple memo form, the memos themselves can be kept together to form a very basic accounting procedures manual. Writing or revising an accounting procedures manual provides a good opportunity to ensure that adequate controls are in place; additionally, such a manual helps to facilitate a smooth turnover in financial staff. The Executive Director is commonly responsible for overseeing the day-to-day implementation of these policies and procedures. Due to the number of detailed requirements involved when an organization receives funding from a given donor, there should be one person in the organization (possibly the grant administrator) with the responsibility of understanding and monitoring the specific regulations, requirements and compliance factors specific to that donor. As an organization changes and matures and funding and programs change, you will periodically need to review the internal accounting control system which was established and to modify it to make allowance for new circumstances (bigger staff, more restricted funding) and regulations (such as receiving bigger grant awards with increased compliance demands). i. Accounting Policy And Procedure Manual One of the initial steps of a non-profit organization (NPOs) should be to establish an accounting policy and procedure manual. An accounting policy and procedure manual documents the policies and procedures an organization should use to record and monitor financial transactions. Documentation of accounting policies and procedures is important because it provides clarity regarding internal processes. In addition, it can be helpful to newcomers of a NPO while improving their financial management skills. Its purpose is to help NPOs: Record all financial transactions Monitor and control expenditures Satisfy statutory reporting requirements Ensure timely and accurate financial and management reporting to donors and grant-makers 15

OFT MANUAL: FM Introduction to Financial Management SECTION 1 In general, this manual should outline the areas covered in the section below. An effort has been made to simplify these procedures to make it easier for you to develop your own accounting policies and procedures manual. As your organization grows in terms of level of activity and number of donors, it will be necessary to update your procedure manual accordingly. ii. Ngo Financial Management Manual Sample Table of Contents Financial accounting routines The Chart of Accounts and cost center codes Delegated authority rules (that is, who can do what) The budget planning and management process Ordering and purchasing procedures Bank and cash handling procedures Management accounting routines and deadlines Management and control of fixed assets Staff benefits and allowances Annual audit arrangements How to deal with fraud and other irregularities Code of Conduct for staff and Board members The manual may also include reference materials such as: organization chart, job descriptions, standard forms, and Glossary and/or list of acronyms and abbreviations. 1.4 KEY RESPONSIBILITIES FOR FINANCIAL MANAGEMENT? Staff members at every level have a role to play in helping manage risks, answer to donors and beneficiaries and deliver results for the organization. The Board is responsible for the financial oversight of your organization and is ultimately accountable by law. However, the Board typically delegates the day-to-day responsibilities to the executive director or top management who delegate some functions to senior managers. The senior managers, in turn, delegate some functions downward, and so on, as illustrated in the table below. Players in Financial Management Board of Directors (Trustees) Sample Responsibilities Oversee financial controls and ensure accountability Review and approve annual budget Approve financial policies, including delegating authority Review and approve financial reports and audited financial statements Monitor and support resource mobilization Assess financial risks facing the NGO 16

OFT MANUAL: FM Introduction to Financial Management SECTION 1 Chief Executive Officer CEO (Executive Director) Senior Managers Program Staff Finance Staff Report to the Board and manage budgeting process Appoint/hire financial staff and delegate tasks Review donor and other agreements/contracts Ensure financial records are accurate and up to date Ensure correct, timely preparation and submission of financial reports Ensure that program activities are in line with budget and deliverables Monitor resource use and manage income generation Monitor financial needs of the organization and business planning Manage and monitor the budgets for their departments or projects Review organization financial reports and give input to CEO Further delegate some financial responsibilities to their team Project future financial needs Set project budgets to ensure that all costs are included (such as deliverables, M&E implementation) Control budgets to ensure money is spent as agreed and work with finance staff to ensure policies and procedures are followed, expenditures are coded and reported accurately Work with appropriate staff to ensure that procurements are best value for money Handle the NGO s cash, including banking and issuing receipts Administer the payment process to ensure bills are paid on time Complete the books of accounts and reconcile them every month Prepare internal and external financial report. 1.5 IMPORTANCE OF FINANCIAL MANAGEMENT: USAID recognizes that the financial management of program assumes critical importance. The financial management of the program deals with the following: Practices and arrangements for review and approval of annual work plans (AWPs) and budgets; based on costing guidelines and approved activities Funds flow mechanisms; Financial powers and delegation; Financial accounting system; Internal controls to ensure funds are effectively used for program objectives, Financial reporting which includes management reporting and external reporting; and Audit and accountability at Centre and State. During the implementation of USAID Program, implementing agencies do experience a number of financial management system delays and some constraints. These include Procedural delays in releasing of funds, Lack of uniformity in reporting the utilization of funds, 17

OFT MANUAL: FM Introduction to Financial Management SECTION 1 Inadequacy of reporting of performance based on resource concept in the absence of pooling of resources, Issues related to financial delegation and powers, And management of funds at NGO level, lack of personnel with adequate skill sets to manage the financial systems. It is important that the program focuses on further strengthening/improving the existing financial management arrangements and practices. As discussed above, the financial management aspects such as funds flow are critical. Timely availability of funds is important and critical from program implementation point of view. It is important that the process of preparing budget and developing annual plans must get completed on time. Financial reporting system should facilitate the monitoring of programs effectively. 1.6 CORNERSTONES OF GOOD FINANCIAL MANAGEMENT Discipline and Consistency lay the foundation for a good financial management structure to be built upon. There are six cornerstones that shape the financial management structure: Purchasing When you make a purchase you make-a commitment to spend the donor's money on goods or services. Get this right by asking yourself these questions and only proceeding when the answers to all of them are YES: Is the thing I want to spend money on included in the budget? Is the cost the same or less than in the budget? Is there enough unspent money in the budget line? Do I have all the competitive quotes needed? Is the supplier the best in terms of price and quality? Do I have a written explanation for why I did not choose any lower bids? Am I sure that the supplier is not in any way related to me or any of my colleagues? Does the purchase comply with any award specific restrictions on procurement "processes?' or Do I have a waiver for this specific transaction if needed? Do I have a complete document trail for each stage in the purchase to date? Payments Payment is the latter stage of the purchasing process carried out by finance staff; however, the agreement about when and how to pay is often part of the negotiations for the purchase which is often carried out by non-finance staff, Suppliers and consultants typically want payment as quickly as possible(often in advance)and, in many countries, in, cash. It can be very tempting for the person negotiating the purchase (e.g. the price of a workshop with a local hotel or a consultancy contract) to use advance payments and payments in cash as bargaining tools. However most suppliers work with a range of clients and are used to dealing with different payment regimes (The UN for example never pays in cash). Cash payments are a particular problem as they involve extra work and do not leave ah external trail of evidence(unlike payments by checks or bank transfer).for cash flow reasons, it s usually better to pay after purchase delivery or at least to limit any advance payment to a percentage of the total cost. The organizational finance manual should stipulate the percentage that may be paid in advance and the procedure for doing so. 18

OFT MANUAL: FM Introduction to Financial Management SECTION 1 Cost Allocation Each cost must be allocated to a particular cost center code (see glossary for description). A Cost center can be allocation, project, or a budget line within a project. The cost center or cost centers that the purchase is allocated to should be agreed on as soon as possible. It will often be obvious but sometimes a particular purchase may have to be split across different centers and this may involve some negotiation with other colleagues who may have to give their approval. These codes enable finance staff to record essential details of the transaction. Changing cost allocations at a later stage means increasing the chance of an error and almost assuring that the supporting documentation does not agree with the final recorded detail in the accounting system. This will present problems during the audit stage. The transaction may simply be disallowed or the auditor may take it as evidence that procedures are lax. Internal Controls Reporting Internal controls are organizational processes and measures such as the procedure manual, internal audit, cash management, authority levels,-division of duties and compliance with relevant laws. These are fundamental to good financial management and all donors insist that a range of internal controls are in place before signing awards. They are designed to ensure that assets are well looked after, fraud and mistakes are difficult, accounts are accurate, laws and regulations are not broken, and staff are protected. Internal controls are critical to ensuring projects are compliantly implemented: They exist to protect you from making a mistake, and The donor relies on their existence and your ability to follow them Funders rely on reports to know and understand what you have been doing with the funds they have awarded. Reports are usually written weeks or even months after the events occurred and it can be difficult to convey the full picture of an event or the circumstances surrounding a particular decision in the formats provided. On the other hand narrative and financial reports are the main means that your organization has to explain how brilliant you are and how, despite the inevitable obstacles and difficulties, you have managed to achieve the successes you have. It can be tempting to focus only on the successes, ignoring the things that didn't go well or things that did not happen at all. The problem with that approach is that nothing can be truly hidden. The finance report shows clearly what has been attempted, completed and not done at all. Both reports must tell the same story. Narrative Report "A narrative representation of the income and expenditures compared to budgets and plans for a defined period." A financial report is "A financial representation of activities, deeds and inactions compared to plans and expectations for a defined period. Documentation Trust is a wonderful thing. It works best when there are two people who know each other quite well and the issue at stake is personal to one or both of them. With donor funds, there are always more than two people involved and only two of them have a personal stake in either the investment or the outcome. You are neither of those people. Both the parties to an award contract are acting as agents for others. The donor is 19

OFT MANUAL: FM Introduction to Financial Management SECTION 1 acting on behalf of all the people who paid money through taxation or donations and the implementer is acting on behalf of the beneficiaries who will benefit from the work you are doing. Neither the beneficiaries nor the individual donors can be present during the implementation to see things for themselves. However, both want to know that the funds have been used responsibly. Therefore, we have to keep documentary evidence of every financial transaction as proof that the purchases actually happened and the goods or services paid for were actually received. 1.7ATTRIBUTES OF GOOD FINANCIAL MANAGEMENT Good Financial Management is the responsibility of all staff. There are clearly areas that are more relevant to finance staff, and other areas that are under the control of non-finance staff like you. This course will uncover and explore financial management principles and tools you can use to optimize compliance with USAID financial rules and regulations as you implement projects. In its widest sense, financial management is about making sure that funds are used properly. Funds are used properly when the right amount is spent on the right product at the right time with the right evidence to prove it. Financial Management is not only about accounting -it also includes budgeting, controlling, reporting and a critical element is how you- as program and operational staff- oversee and manage the process by which the funds are allocated, used,and reported to the financial staff. This is not an accounting course. You are not here to learn about accounting aspects of project management. Your organization has a number of well-qualified and skilled accounting staff to deal with all of that for you. During this course technical accounting terms will be used minimally- but it is inevitable that with so many important documents to consider accounting related words or phrases will be used that have a specific and not always obvious meaning. The glossary in this manual is a good place to check your understanding of terms as well as your accounting colleagues. The foundations of good financial management- Discipline and Consistency- are an important place to begin building a solid appreciation of the attributes that form good financial management. In fact, the foundations described on the following pages are necessary for good management, whether it be financial, human resource or program. Discipline Always do the right thing It is usually one of the least convenient options to take, it will usually take time, and it will usually make you appear to have less authority than you might want others to believe you have. Doing the right thing is the mark of the true professional Never guess, always check Consistency Coding This is how your finance colleagues make sense of everything that goes on. The person making the spending commitment (not the payment) is responsible for assigning the correct budget and analysis codes to the transaction. If this is done inconsistently, reports become meaningless and financial management is impossible. Review 20

OFT MANUAL: FM Introduction to Financial Management SECTION 1 Rules, regulations and procedures have been carefully written to meet compliance requirements of the donor. Because each donor is different and individual awards from the same donor can have project specific rules, guessing is dangerous. No short-cuts Cutting corners with procedures might seem like a good idea at the time, and of course, the paperwork can always be put in order later on. In almost every case however, the paperwork is not put in place and the transaction or decision is selected for closer review by the auditor. The few minutes, hours, or days saved at the time is never worth the worry of having your decision-making questioned by the donor. Follow procedure Always have a procedure manual handy. If none exists, lobby your colleagues to have one prepared that covers all aspects of financial decision making. Ask if unsure You often only get one chance to make a commitment decision and you often cannot take it back later if you have made a mistake without incurring a financial or other cost. Unbudgeted expenditure such as cancellation fee for a hotel workshop booking is usually disallowable. Peer review It is good practice to ask a colleague to review financial decisions either at the time or soon after make sure proper procedure has been followed and correct documentation received. Do not make promises you cannot keep When talking to partners, suppliers and consultants is very careful not to commit your project or organization financially or otherwise until you are absolutely certain that a) You have the authority, b) The necessary resources are available, and c) The proper procedure has been followed. All transactions should be reviewed. This provides an opportunity to correct errors and to amend coding decisions. This should be done early to ensure financial reports are accurate. Decision making Decision-making should be based on the budget agreed in the award and your organization's analysis coding requirements. Authority Authority levels should be clearly defined and maintained over different periods and different projects. Reporting Without a consistent approach to financial management decisions, reports become almost meaningless and will almost certainly lead to incorrect and potentially disallowable expenditure Project by project All projects should follow the same procedures. To put it another way, ensure that your organization's internal procedures meet the requirements of all of your donors. Mistakes happen too easily when officers have to use different procedures for different projects. Period by period Procedures and rules need to be applied consistently across time periods. If last year's evaluation workshop was charged out equally to all projects, do not charge this year's to central overheads. 21

OFT MANUAL: FM Introduction to Financial Management SECTION 1 Respect authority levels Remember, any agreements you make that exceed your formal authority level are not legally enforceable and you may be asked to personally fund any losses suffered because of it. Accepting a particular level of authority means that you are personally responsible for decisions made, if you chose to delegate that authority either officially or unofficially to another person, you are still responsible for the actions and decisions made by that person. Read the contract The particular contract and other identified documents contain all you need to know. Know where to find a copy of any document you might need and refer to them before making commitments or spending decisions if you are at all unsure. Partner by partner Treat each partner in exactly the same way. The rules must be applied impartially. Officer by officer Ensure that all officers with budgetary responsibility are fully aware of their responsibilities and have been trained in all relevant procedures. 22

OFT MANUAL: FM Cost Principles SECTION 2 Cost Principles for Non-Profit Organizations 1. Purpose. This Circular establishes principles for determining costs of grants, contracts and other agreements with non-profit organizations. It does not apply to colleges and universities which are covered by Office of Management and Budget (OMB) Circular A-21, "Cost Principles for Educational Institutions"; State, local, and federally recognized Indian tribal governments which are covered by OMB Circular A-87, "Cost Principles for State, Local, and Indian Tribal Governments"; or hospitals. The principles are designed to provide that the Federal Government bear its fair share of costs except where restricted or prohibited by law. The principles do not attempt to prescribe the extent of cost sharing or matching on grants, contracts, or other agreements. However, such cost sharing or matching shall not be accomplished through arbitrary limitations on individual cost elements by Federal agencies. Provision for profit or other increment above cost is outside the scope of this Circular. 2. Supersession. This Circular supersedes cost principles issued by individual agencies for non-profit organizations. 3. Applicability. These principles shall be used by all Federal agencies in determining the costs of work performed by non-profit organizations under grants, cooperative agreements, cost reimbursement contracts, and other contracts in which costs are used in pricing, administration, or settlement. All of these instruments are hereafter referred to as awards. The principles do not apply to awards under which an organization is not required to account to the Federal Government for actual costs incurred. All cost reimbursement sub awards (sub grants, subcontracts, etc.) are subject to those Federal cost principles applicable to the particular organization concerned. Thus, if a sub award is to a non-profit organization, this Circular shall apply; if a sub award is to a commercial organization, the cost principles applicable to commercial concerns shall apply; if a sub award is to a college or university, Circular A-21 shall apply; if a sub award is to a State, local, or federally recognized Indian tribal government, Circular A-87 shall apply. 4. Definitions. a. Non-profit organization means any corporation, trust, association, cooperative, or other organization which: is operated primarily for scientific, educational, service, charitable, or similar purposes in the public interest; is not organized primarily for profit; and uses its net proceeds to maintain, improve, and/or expand its operations. For this purpose, the term "non-profit organization" excludes (i) colleges and universities; (ii) hospitals; (iii) State, local, and federally recognized Indian tribal governments; and (iv) those non-profit organizations which are excluded from coverage of this Circular in accordance with paragraph 5. b. Prior approval means securing the awarding agency's permission in advance to incur cost for those items that are designated as requiring prior approval by the Circular. Generally this permission will be in writing. Where an item of cost requiring prior approval is specified in the budget of an award, approval of the budget constitutes approval of that cost. 23

OFT MANUAL: FM Cost Principles SECTION 2 5. Exclusion of some non-profit organizations Some non-profit organizations, because of their size and nature of operations, can be considered to be similar to commercial concerns for purpose of applicability of cost principles. Such non-profit organizations shall operate under Federal cost principles applicable to commercial concerns. A listing of these organizations is contained in Attachment C. Other organizations may be added from time to time. 6. Responsibilities. Agencies responsible for administering programs that involve awards to non-profit organizations shall implement the provisions of this Circular. Upon request, implementing instruction shall be furnished to OMB. Agencies shall designate a liaison official to serve as the agency representative on matters relating to the implementation of this Circular. The name and title of such representative shall be furnished to OMB within 30 days of the date of this Circular. 7. Attachments. The principles and related policy guides are set forth in the following Attachments: Attachment A - General Principles Attachment B - Selected Items of Cost Attachment C - Non-Profit Organizations Not Subject To This Circular 8. Requests for exceptions. OMB may grant exceptions to the requirements of this Circular when permissible under existing law. However, in the interest of achieving maximum uniformity, exceptions will be permitted only in highly unusual circumstances. 9. Effective Date. The provisions of this Circular are effective immediately. Implementation shall be phased in by incorporating the provisions into new awards made after the start of the organization's next fiscal year. For existing awards, the new principles may be applied if an organization and the cognizant Federal agency agree. Earlier implementation, or a delay in implementation of individual provisions, is also permitted by mutual agreement between an organization and the cognizant Federal agency. 10. Inquiries. Further information concerning this Circular may be obtained by contacting the Office of Federal Financial Management, OMB, Washington, DC 20503, telephone (202) 395-3993 Attachments 24

OFT MANUAL: FM Cost Principles SECTION 2 Table of Contents for this course A. Basic Considerations 1. Composition of total costs 2. Factors affecting allowability of costs 3. Reasonable costs 4. Allocable costs 5. Applicable credits 6. Advance understandings 7. Conditional exemptions B. Direct Costs C. Indirect Costs D. Allocation of Indirect Costs and Determination of Indirect Cost Rates 1. General 2. Simplified allocation method 3. Multiple allocation base method 4. Direct allocation method 5. Special indirect cost rates E. Negotiation and Approval of Indirect Cost Rates 1. Definitions 2. Negotiation and approval of rates 25

OFT MANUAL: FM Cost Principles SECTION 2 GENERAL PRINCIPLES Basic Considerations 1. Composition of total costs. The total cost of an award is the sum of the allowable direct and allocable indirect costs less any applicable credits. 2. Factors affecting allowability of costs. To be allowable under an award, costs must meet the following general criteria: a. Be reasonable for the performance of the award and be allocable thereto under these principles. b. Conform to any limitations or exclusions set forth in these principles or in the award as to types or amount of cost items. c. Be consistent with policies and procedures that apply uniformly to both federally financed and other activities of the organization. d. Be accorded consistent treatment. e. Be determined in accordance with generally accepted accounting principles (GAAP). f. Not be included as a cost or used to meet cost sharing or matching requirements of any other federally financed program in either the current or a prior period. g. Be adequately documented. 3. Reasonable costs. A cost is reasonable if, in its nature or amount, it does not exceed that which would be incurred by a prudent person under the circumstances prevailing at the time the decision was made to incur the costs. The question of the reasonableness of specific costs must be scrutinized with particular care in connection with organizations or separate divisions thereof which receive the preponderance of their support from awards made by Federal agencies. In determining the reasonableness of a given cost, consideration shall be given to: a. Whether the cost is of a type generally recognized as ordinary and necessary for the operation of the organization or the performance of the award. b. The restraints or requirements imposed by such factors as generally accepted sound business practices, arm s length bargaining, Federal and State laws and regulations, and terms and conditions of the award. c. Whether the individuals concerned acted with prudence in the circumstances, considering their responsibilities to the organization, its members, employees, and clients, the public at large, and the Federal Government. d. Significant deviations from the established practices of the organization which may unjustifiably increase the award costs. 4. Allocable costs. a. A cost is allocable to a particular cost objective, such as a grant, contract, project, service, or other activity, in accordance with the relative benefits received. A cost is allocable to a Federal award if it is 26

OFT MANUAL: FM Cost Principles SECTION 2 treated consistently with other costs incurred for the same purpose in like circumstances and if it: (1) Is incurred specifically for the award. (2) Benefits both the award and other work and can be distributed in reasonable proportion to the benefits received, or (3) Is necessary to the overall operation of the organization, although a direct relationship to any particular cost objective cannot be shown. b. Any cost allocable to a particular award or other cost objective under these principles may not be shifted to other Federal awards to overcome funding deficiencies, or to avoid restrictions imposed by law or by the terms of the award. 5. Applicable credits. a. The term applicable credits refers to those receipts, or reduction of expenditures which operate to offset or reduce expense items that are allocable to awards as direct or indirect costs. Typical examples of such transactions are: purchase discounts, rebates or allowances, recoveries or indemnities on losses, insurance refunds, and adjustments of overpayments or erroneous charges. To the extent that such credits accruing or received by the organization relate to allowable cost, they shall be credited to the Federal Government either as a cost reduction or cash refund, as appropriate. b. In some instances, the amounts received from the Federal Government to finance organizational activities or service operations should be treated as applicable credits. Specifically, the concept of netting such credit items against related expenditures should be applied by the organization in determining the rates or amounts to be charged to Federal awards for services rendered whenever the facilities or other resources used in providing such services have been financed directly, in whole or in part, by Federal funds. c. For rules covering program income (i.e., gross income earned from federally supported activities) see Sec..24 of Office of Management and Budget (OMB) Circular A-110, "Uniform Administrative Requirements for Grants and Agreements with Institutions of Higher Education, Hospitals, and Other Non-Profit Organizations." 6. Advance understandings. Under any given award, the reasonableness and allocability of certain items of costs may be difficult to determine. This is particularly true in connection with organizations that receive a preponderance of their support from Federal agencies. In order to avoid subsequent disallowance or dispute based on unreasonableness or nonallocability, it is often desirable to seek a written agreement with the cognizant or awarding agency in advance of the incurrence of special or unusual costs. The absence of an advance agreement on any element of cost will not, in itself, affect the reasonableness or allocability of that element. 6. Conditional exemptions. a. OMB authorizes conditional exemption from OMB administrative requirements and cost principles circulars for certain Federal programs with statutorily-authorized consolidated planning and consolidated administrative funding that are identified by a Federal agency and approved by the head of the Executive department or establishment. A Federal agency shall consult with OMB during its consideration of whether to grant such an exemption. 27

OFT MANUAL: FM Cost Principles SECTION 2 b. To promote efficiency in State and local program administration, when Federal non-entitlement programs with common purposes have specific statutorily-authorized consolidated planning and consolidated administrative funding and where most of the State agency's resources come from non-federal sources, Federal agencies may exempt these covered State-administered, non-entitlement grant programs from certain OMB grants management requirements. The exemptions would be from all but the allocability of costs provisions of OMB Circulars A-87 (Attachment A, subsection C.3), "Cost Principles for State, Local, and Indian Tribal Governments," A-21 (Section C, subpart 4), "Cost Principles for Educational Institutions," and A-122 (Attachment A, subsection A.4), "Cost Principles for Non-Profit Organizations," and from all of the administrative requirements provisions of OMB Circular A-110, "Uniform Administrative Requirements for Grants and Agreements with Institutions of Higher Education, Hospitals, and Other Non-Profit Organizations," and the agencies' grants management common rule. c. When a Federal agency provides this flexibility, as a prerequisite to a State's exercising this option, a State must adopt its own written fiscal and administrative requirements for expending and accounting for all funds, which are consistent with the provisions of OMB Circular A-87, and extend such policies to all sub recipients. These fiscal and administrative requirements must be sufficiently specific to ensure that: funds are used in compliance with all applicable Federal statutory and regulatory provisions, costs are reasonable and necessary for operating these programs, and funds are not be used for general expenses required to carry out other responsibilities of a State or its sub recipients. B. Direct Costs 1. Direct costs are those that can be identified specifically with a particular final cost objective, i.e., a particular award, project, service, or other direct activity of an organization. However, a cost may not be assigned to an award as a direct cost if any other cost incurred for the same purpose, in like circumstance, has been allocated to an award as an indirect cost. Costs identified specifically with awards are direct costs of the awards and are to be assigned directly thereto. Costs identified specifically with other final cost objectives of the organization are direct costs of those cost objectives and are not to be assigned to other awards directly or indirectly. 2. Any direct cost of a minor amount may be treated as an indirect cost for reasons of practicality where the accounting treatment for such cost is consistently applied to all final cost objectives. 3. The cost of certain activities are not allowable as charges to Federal awards (see, for example, fundraising costs in paragraph 17 of Attachment B). However, even though these costs are unallowable for purposes of computing charges to Federal awards, they nonetheless must be treated as direct costs for purposes of determining indirect cost rates and be allocated their share of the organization's indirect costs if they represent activities which (1) include the salaries of personnel, (2) occupy space, and (3) benefit from the organization's indirect costs. 4. The costs of activities performed primarily as a service to members, clients, or the general public when significant and necessary to the organization's mission must be treated as direct costs whether or not allowable and be allocated an equitable share of indirect costs. Some examples of these types of activities include: a. Maintenance of membership rolls, subscriptions, publications, and related functions. b. Providing services and information to members, legislative or administrative bodies, or the public. 28

OFT MANUAL: FM Cost Principles SECTION 2 c. Promotion, lobbying, and other forms of public relations. d. Meetings and conferences except those held to conduct the general administration of the organization. e. Maintenance, protection, and investment of special funds not used in operation of the organization. f. Administration of group benefits on behalf of members or clients, including life and hospital insurance, annuity or retirement plans, financial aid, etc. C. Indirect Costs 1. Indirect costs are those that have been incurred for common or joint objectives and cannot be readily identified with a particular final cost objective. Direct cost of minor amounts may be treated as indirect costs under the conditions described in subparagraph B.2. After direct costs have been determined and assigned directly to awards or other work as appropriate, indirect costs are those remaining to be allocated to benefiting cost objectives. A cost may not be allocated to an award as an indirect cost if any other cost incurred for the same purpose, in like circumstances, has been assigned to an award as a direct cost. 2. Because of the diverse characteristics and accounting practices of non-profit organizations, it is not possible to specify the types of cost which may be classified as indirect cost in all situations. However, typical examples of indirect cost for many non-profit organizations may include depreciation or use allowances on buildings and equipment, the costs of operating and maintaining facilities, and general administration and general expenses, such as the salaries and expenses of executive officers, personnel administration, and accounting. 3. Indirect costs shall be classified within two broad categories: "Facilities" and "Administration." "Facilities" is defined as depreciation and use allowances on buildings, equipment and capital improvement, interest on debt associated with certain buildings, equipment and capital improvements, and operations and maintenance expenses. "Administration" is defined as general administration and general expenses such as the director's office, accounting, personnel, library expenses and all other types of expenditures not listed specifically under one of the subcategories of "Facilities" (including cross allocations from other pools, where applicable). See indirect cost rate reporting requirements in subparagraphs D.2.e and D.3.g. D. Allocation of Indirect Costs and Determination of Indirect Cost Rates 1. General. a. Where a non-profit organization has only one major function, or where all its major functions benefit from its indirect costs to approximately the same degree, the allocation of indirect costs and the computation of an indirect cost rate may be accomplished through simplified allocation procedures, as described in subparagraph 2. b. Where an organization has several major functions which benefit from its indirect costs in varying degrees, allocation of indirect costs may require the accumulation of such costs into separate cost groupings which then are allocated individually to benefiting functions by means of a base which best measures the relative degree of benefit. The indirect costs allocated to each function are then distributed to individual awards and other activities included in that function by means of an indirect cost rate(s). c. The determination of what constitutes an organization's major functions will depend on its purpose in being; the types of services it renders to the public, its clients, and its members; and the amount of effort 29

OFT MANUAL: FM Cost Principles SECTION 2 it devotes to such activities as fundraising, public information and membership activities. d. Specific methods for allocating indirect costs and computing indirect cost rates along with the conditions under which each method should be used are described in subparagraphs 2 through 5. e. The base period for the allocation of indirect costs is the period in which such costs are incurred and accumulated for allocation to work performed in that period. The base period normally should coincide with the organization's fiscal year but, in any event, shall be so selected as to avoid inequities in the allocation of the costs. 2. Simplified allocation method. a. Where an organization's major functions benefit from its indirect costs to approximately the same degree, the allocation of indirect costs may be accomplished by (i) separating the organization's total costs for the base period as either direct or indirect, and (ii) dividing the total allowable indirect costs (net of applicable credits) by an equitable distribution base. The result of this process is an indirect cost rate which is used to distribute indirect costs to individual awards. The rate should be expressed as the percentage which the total amount of allowable indirect costs bears to the base selected. This method should also be used where an organization has only one major function encompassing a number of individual projects or activities, and may be used where the level of Federal awards to an organization is relatively small. b. Both the direct costs and the indirect costs shall exclude capital expenditures and unallowable costs. However, unallowable costs which represent activities must be included in the direct costs under the conditions described in subparagraph B.3. c. The distribution base may be total direct costs (excluding capital expenditures and other distorting items, such as major subcontracts or sub grants), direct salaries and wages, or other base which results in an equitable distribution. The distribution base shall generally exclude participant support costs as defined in paragraph 32 of Attachment B. d. Except where a special rate(s) is required in accordance with subparagraph 5, the indirect cost rate developed under the above principles is applicable to all awards at the organization. If a special rate(s) is required, appropriate modifications shall be made in order to develop the special rate(s). e. For an organization that receives more than $10 million in Federal funding of direct costs in a fiscal year, a breakout of the indirect cost component into two broad categories, Facilities and Administration as defined in subparagraph C.3, is required. The rate in each case shall be stated as the percentage which the amount of the particular indirect cost category (i.e., Facilities or Administration) is of the distribution base identified with that category. 3. Multiple allocation base method a. General. Where an organization's indirect costs benefit its major functions in varying degrees, indirect costs shall be accumulated into separate cost groupings, as described in subparagraph b. Each grouping shall then be allocated individually to benefitting functions by means of a base which best measures the relative benefits. The default allocation bases by cost pool are described in subparagraph c. b. Identification of indirect costs. Cost groupings shall be established so as to permit the allocation of each grouping on the basis of benefits provided to the major functions. Each grouping shall constitute a pool of expenses that are of like character in terms of functions they benefit and in terms of the allocation 30

OFT MANUAL: FM Cost Principles SECTION 2 base which best measures the relative benefits provided to each function. The groupings are classified within the two broad categories: "Facilities" and "Administration," as described in subparagraph C.3. The indirect cost pools are defined as follows: (1) Depreciation and use allowances. The expenses under this heading are the portion of the costs of the organization's buildings, capital improvements to land and buildings, and equipment which are computed in accordance with paragraph 11 of Attachment B ("Depreciation and use allowances"). (2) Interest. Interest on debt associated with certain buildings, equipment and capital improvements are computed in accordance with paragraph 23 of Attachment B ("Interest"). (3) Operation and maintenance expenses. The expenses under this heading are those that have been incurred for the administration, operation, maintenance, preservation, and protection of the organization's physical plant. They include expenses normally incurred for such items as: janitorial and utility services; repairs and ordinary or normal alterations of buildings, furniture and equipment; care of grounds; maintenance and operation of buildings and other plant facilities; security; earthquake and disaster preparedness; environmental safety; hazardous waste disposal; property, liability and other insurance relating to property; space and capital leasing; facility planning and management; and, central receiving. The operation and maintenance expenses category shall also include its allocable share of fringe benefit costs, depreciation and use allowances, and interest costs. (4) General administration and general expenses. The expenses under this heading are those that have been incurred for the overall general executive and administrative offices of the organization and other expenses of a general nature which do not relate solely to any major function of the organization. This category shall also include its allocable share of fringe benefit costs, operation and maintenance expense, depreciation and use allowances, and interest costs. Examples of this category include central offices, such as the director's office, the office of finance, business services, budget and planning, personnel, safety and risk management, general counsel, management information systems, and library costs. In developing this cost pool, special care should be exercised to ensure that costs incurred for the same purpose in like circumstances are treated consistently as either direct or indirect costs. For example, salaries of technical staff, project supplies, project publication, telephone toll charges, computer costs, travel costs, and specialized services costs shall be treated as direct costs wherever identifiable to a particular program. The salaries and wages of administrative and pooled clerical staff should normally be treated as indirect costs. Direct charging of these costs may be appropriate where a major project or activity explicitly requires and budgets for administrative or clerical services and other individuals involved can be identified with the program or activity. Items such as office supplies, postage, local telephone costs, periodicals and memberships should normally be treated as indirect costs. c. Allocation bases. Actual conditions shall be taken into account in selecting the base to be used in allocating the expenses in each grouping to benefitting functions. The essential consideration in selecting a method or a base is that it is the one best suited for assigning the pool of costs to cost objectives in accordance with benefits derived; a traceable cause and effect relationship; or logic and reason, where neither the cause nor the effect of the relationship is determinable. When an allocation can be made by assignment of a cost grouping directly to the function benefited, the allocation shall be made in that manner. When the expenses in a cost grouping are more general in nature, the allocation shall be made through the use of a selected base which produces results that are equitable to both the Federal Government and the organization. The distribution shall be made in accordance with the bases described herein unless it can be demonstrated that the use of a different base would result in a more equitable allocation of the costs, or that a more readily available base would not increase the costs charged to sponsored awards. The results of special cost studies (such as an engineering utility study) shall not be 31

OFT MANUAL: FM Cost Principles SECTION 2 used to determine and allocate the indirect costs to sponsored awards. (1) Depreciation and use allowances. Depreciation and use allowances expenses shall be allocated in the following manner: (a) Depreciation or use allowances on buildings used exclusively in the conduct of a single function, and on capital improvements and equipment used in such buildings, shall be assigned to that function. (b) Depreciation or use allowances on buildings used for more than one function, and on capital improvements and equipment used in such buildings, shall be allocated to the individual functions performed in each building on the basis of usable square feet of space, excluding common areas, such as hallways, stairwells, and restrooms. (c) Depreciation or use allowances on buildings, capital improvements and equipment related space (e.g., individual rooms, and laboratories) used jointly by more than one function (as determined by the users of the space) shall be treated as follows. The cost of each jointly used unit of space shall be allocated to the benefitting functions on the basis of: (i) the employees and other users on a full-time equivalent (FTE) basis or salaries and wages of those individual functions benefitting from the use of that space; or (ii) organization-wide employee FTEs or salaries and wages applicable to the benefitting functions of the organization. (d) Depreciation or use allowances on certain capital improvements to land, such as paved parking areas, fences, sidewalks, and the like, not included in the cost of buildings, shall be allocated to user categories on a FTE basis and distributed to major functions in proportion to the salaries and wages of all employees applicable to the functions. (2) Interest. Interest costs shall be allocated in the same manner as the depreciation or use allowances on the buildings, equipment and capital equipments to which the interest relates. (3) Operation and maintenance expenses. Operation and maintenance expenses shall be allocated in the same manner as the depreciation and use allowances. (4) General administration and general expenses. General administration and general expenses shall be allocated to benefitting functions based on modified total direct costs (MTDC), as described in subparagraph D.3.f. The expenses included in this category could be grouped first according to major functions of the organization to which they render services or provide benefits. The aggregate expenses of each group shall then be allocated to benefitting functions based on MTDC. d. Order of distribution. (1) Indirect cost categories consisting of depreciation and use allowances, interest, operation and maintenance, and general administration and general expenses shall be allocated in that order to the remaining indirect cost categories as well as to the major functions of the organization. Other cost categories could be allocated in the order determined to be most appropriate by the organization. When cross allocation of costs is made as provided in subparagraph (2), this order of allocation does not apply. (2) Normally, an indirect cost category will be considered closed once it has been allocated to other cost 32

OFT MANUAL: FM Cost Principles SECTION 2 objectives, and costs shall not be subsequently allocated to it. However, a cross allocation of costs between two or more indirect costs categories could be used if such allocation will result in a more equitable allocation of costs. If a cross allocation is used, an appropriate modification to the composition of the indirect cost categories is required. e. Application of indirect cost rate or rates. Except where a special indirect cost rate(s) is required in accordance with subparagraph D.5, the separate groupings of indirect costs allocated to each major function shall be aggregated and treated as a common pool for that function. The costs in the common pool shall then be distributed to individual awards included in that function by use of a single indirect cost rate. f. Distribution basis. Indirect costs shall be distributed to applicable sponsored awards and other benefitting activities within each major function on the basis of MTDC. MTDC consists of all salaries and wages, fringe benefits, materials and supplies, services, travel, and sub grants and subcontracts up to the first $25,000 of each sub grant or subcontract (regardless of the period covered by the sub grant or subcontract). Equipment, capital expenditures, charges for patient care, rental costs and the portion in excess of $25,000 shall be excluded from MTDC. Participant support costs shall generally be excluded from MTDC. Other items may only be excluded when the Federal cost cognizant agency determines that exclusion is necessary to avoid a serious inequity in the distribution of indirect costs. g. Individual Rate Components. An indirect cost rate shall be determined for each separate indirect cost pool developed. The rate in each case shall be stated as the percentage which the amount of the particular indirect cost pool is of the distribution base identified with that pool. Each indirect cost rate negotiation or determination agreement shall include development of the rate for each indirect cost pool as well as the overall indirect cost rate. The indirect cost pools shall be classified within two broad categories: "Facilities" and "Administration," as described in subparagraph C.3. 4. Direct allocation method. a. Some non-profit organizations treat all costs as direct costs except general administration and general expenses. These organizations generally separate their costs into three basic categories: (i) General administration and general expenses, (ii) fundraising, and (iii) other direct functions (including projects performed under Federal awards). Joint costs, such as depreciation, rental costs, operation and maintenance of facilities, telephone expenses, and the like are prorated individually as direct costs to each category and to each award or other activity using a base most appropriate to the particular cost being prorated. b. This method is acceptable, provided each joint cost is prorated using a base which accurately measures the benefits provided to each award or other activity. The bases must be established in accordance with reasonable criteria, and be supported by current data. This method is compatible with the Standards of Accounting and Financial Reporting for Voluntary Health and Welfare Organizations issued jointly by the National Health Council, Inc., the National Assembly of Voluntary Health and Social Welfare Organizations, and the United Way of America. c. Under this method, indirect costs consist exclusively of general administration and general expenses. In all other respects, the organization's indirect cost rates shall be computed in the same manner as that described in subparagraph 2. 5. Special indirect cost rates. In some instances, a single indirect cost rate for all activities of an organization or for each major function of the organization may not be appropriate, since it would not take into account those different factors which may substantially affect the indirect costs applicable to a particular segment of work. For this purpose, a particular segment of work may be that performed under a single 33

OFT MANUAL: FM Cost Principles SECTION 2 award or it may consist of work under a group of awards performed in a common environment. These factors may include the physical location of the work, the level of administrative support required, the nature of the facilities or other resources employed, the scientific disciplines or technical skills involved, the organizational arrangements used, or any combination thereof. When a particular segment of work is performed in an environment which appears to generate a significantly different level of indirect costs, provisions should be made for a separate indirect cost pool applicable to such work. The separate indirect cost pool should be developed during the course of the regular allocation process, and the separate indirect cost rate resulting therefrom should be used, provided it is determined that (i) the rate differs significantly from that which would have been obtained under subparagraphs 2, 3, and 4, and (ii) the volume of work to which the rate would apply is material. E. Negotiation and Approval of Indirect Cost Rates 1. Definitions. As used in this section, the following terms have the meanings set forth below: a. Cognizant agency means the Federal agency responsible for negotiating and approving indirect cost rates for a non-profit organization on behalf of all Federal agencies. b. Predetermined rate means an indirect cost rate, applicable to a specified current or future period, usually the organization's fiscal year. The rate is based on an estimate of the costs to be incurred during the period. A predetermined rate is not subject to adjustment. c. Fixed rate means an indirect cost rate which has the same characteristics as a predetermined rate, except that the difference between the estimated costs and the actual costs of the period covered by the rate is carried forward as an adjustment to the rate computation of a subsequent period. d. Final rate means an indirect cost rate applicable to a specified past period which is based on the actual costs of the period. A final rate is not subject to adjustment. e. Provisional rate or billing rate means a temporary indirect cost rate applicable to a specified period which is used for funding, interim reimbursement, and reporting indirect costs on awards pending the establishment of a final rate for the period. f. Indirect cost proposal means the documentation prepared by an organization to substantiate its claim for the reimbursement of indirect costs. This proposal provides the basis for the review and negotiation leading to the establishment of an organization's indirect cost rate. g. Cost objective means a function, organizational subdivision, contract, grant, or other work unit for which cost data are desired and for which provision is made to accumulate and measure the cost of processes, projects, jobs and capitalized projects. 2. Negotiation and approval of rates. a. Unless different arrangements are agreed to by the agencies concerned, the Federal agency with the largest dollar value of awards with an organization will be designated as the cognizant agency for the negotiation and approval of the indirect cost rates and, where necessary, other rates such as fringe benefit and computer charge-out rates. Once an agency is assigned cognizance for a particular non-profit organization, the assignment will not be changed unless there is a major long-term shift in the dollar volume of the Federal awards to the organization. All concerned Federal agencies shall be given the opportunity to participate in the negotiation process but, after a rate has been agreed upon, it will be accepted by all Federal agencies. When a Federal agency has reason to believe that special operating 34

OFT MANUAL: FM Cost Principles SECTION 2 factors affecting its awards necessitate special indirect cost rates in accordance with subparagraph D.5, it will, prior to the time the rates are negotiated, notify the cognizant agency. b. A non-profit organization which has not previously established an indirect cost rate with a Federal agency shall submit its initial indirect cost proposal immediately after the organization is advised that an award will be made and, in no event, later than three months after the effective date of the award. c. Organizations that have previously established indirect cost rates must submit a new indirect cost proposal to the cognizant agency within six months after the close of each fiscal year. d. A predetermined rate may be negotiated for use on awards where there is reasonable assurance, based on past experience and reliable projection of the organization's costs, that the rate is not likely to exceed a rate based on the organization's actual costs. e. Fixed rates may be negotiated where predetermined rates are not considered appropriate. A fixed rate, however, shall not be negotiated if (i) all or a substantial portion of the organization's awards are expected to expire before the carry-forward adjustment can be made; (ii) the mix of Federal and non-federal work at the organization is too erratic to permit an equitable carry-forward adjustment; or (iii) the organization's operations fluctuate significantly from year to year. f. Provisional and final rates shall be negotiated where neither predetermined nor fixed rates are appropriate. g. The results of each negotiation shall be formalized in a written agreement between the cognizant agency and the non-profit organization. The cognizant agency shall distribute copies of the agreement to all concerned Federal agencies. h. If a dispute arises in a negotiation of an indirect cost rate between the cognizant agency and the non-profit organization, the dispute shall be resolved in accordance with the appeals procedures of the cognizant agency. i. To the extent that problems are encountered among the Federal agencies in connection with the negotiation and approval process, OMB will lend assistance as required to resolve such problems in a timely manner. 35

OFT MANUAL: FM Cost Principles SECTION 2 SELECTED ITEMS OF COST Table of Contents 1. Advertising and public relations costs 2. Advisory councils 3. Alcoholic beverages 4. Audit costs and related services 5. Bad debts 6. Bonding costs 7. Communication costs 8. Compensation for personal services 9. Contingency provisions 10. Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringement 11. Depreciation and use allowances 12. Donations and contributions 13. Employee morale, health, and welfare costs 14. Entertainment costs 15. Equipment and other capital expenditures 16. Fines and penalties 17. Fund raising and investment management costs 18. Gains and losses on depreciable assets 19. Goods or services for personal use 20. Housing and personal living expenses 21. Idle facilities and idle capacity 22. Insurance and indemnification 23. Interest 24. Labor relations costs 25. Lobbying 26. Losses on other sponsored agreements or contracts 27. Maintenance and repair costs 28. Materials and supplies costs 29. Meetings and conferences 30. Memberships, subscriptions, and professional activity costs 31. Organization costs 32. Page charges in professional journals 33. Participant support costs 34. Patent costs 35. Plant and homeland security costs 36. Pre-agreement costs 37. Professional services costs 38. Publication and printing costs 39. Rearrangement and alteration costs 40. Reconversion costs 41. Recruiting costs 42. Relocation costs 43. Rental costs of buildings and equipment 44. Royalties and other costs for use of patents and copyrights 45. Selling and marketing 46. Specialized service facilities 36

OFT MANUAL: FM Cost Principles SECTION 2 47. Taxes 48. Termination costs applicable to sponsored agreements 49. Training costs 50. Transportation costs 51. Travel costs 52. Trustees 37

OFT MANUAL: FM Cost Principles SECTION 2 Paragraphs 1 through 53 provide principles to be applied in establishing the allowability of certain items of cost. These principles apply whether a cost is treated as direct or indirect. Failure to mention a particular item of cost is not intended to imply that it is unallowable; rather, determination as to allowability in each case should be based on the treatment or principles provided for similar or related items of cost. 1. Advertising and public relations costs. a. The term advertising costs means the costs of advertising media and corollary administrative costs. Advertising media include magazines, newspapers, radio and television, direct mail, exhibits, electronic or computer transmittals, and the like. b. The term public relations includes community relations and means those activities dedicated to maintaining the image of the non-profit organization or maintaining or promoting understanding and favorable relations with the community or public at large or any segment of the public. c. The only allowable advertising costs are those which are solely for: (1) The recruitment of personnel required for the performance by the non-profit organization of obligations arising under a Federal award (See also Attachment B, paragraph 41, Recruiting costs, and paragraph 42, Relocation costs); (2) The procurement of goods and services for the performance of a Federal award; (3) The disposal of scrap or surplus materials acquired in the performance of a Federal award except when non-profit organizations are reimbursed for disposal costs at a predetermined amount; or (4) Other specific purposes necessary to meet the requirements of the Federal award. d. The only allowable public relations costs are: (1) Costs specifically required by the Federal award; (2) Costs of communicating with the public and press pertaining to specific activities or accomplishments which result from performance of Federal awards (these costs are considered necessary as part of the outreach effort for the Federal award); or (3) Costs of conducting general liaison with news media and government public relations officers, to the extent that such activities are limited to communication and liaison necessary keep the public informed on matters of public concern, such as notices of Federal contract/grant awards, financial matters, etc. e. Costs identified in subparagraphs c and d if incurred for more than one Federal award or for both sponsored work and other work of the non-profit organization, are allowable to the extent that the principles in Attachment A, paragraphs B. ("Direct Costs") and C. ("Indirect Costs") are observed. f. Unallowable advertising and public relations costs include the following: (1) All advertising and public relations costs other than as specified in subparagraphs c, d, and e; 38

OFT MANUAL: FM Cost Principles SECTION 2 (2) Costs of meetings, conventions, convocations, or other events related to other activities of the non-profit organization, including: (a) Costs of displays, demonstrations, and exhibits; (b) Costs of meeting rooms, hospitality suites, and other special facilities used in conjunction with shows and other special events; and (c) Salaries and wages of employees engaged in setting up and displaying exhibits, making demonstrations, and providing briefings; (3) Costs of promotional items and memorabilia, including models, gifts, and souvenirs; (4) Costs of advertising and public relations designed solely to promote the non-profit organization. 2. Advisory Councils Costs incurred by advisory councils or committees are allowable as a direct cost where authorized by the Federal awarding agency or as an indirect cost where allocable to Federal awards. 3. Alcoholic beverages. Costs of alcoholic beverages are unallowable. 4. Audit costs and related services a. The costs of audits required by, and performed in accordance with, the Single Audit Act, as implemented by Circular A-133, "Audits of States, Local Governments, and Non-Profit Organizations" are allowable. Also see 31 USC 7505(b) and section 230 ("Audit Costs") of Circular A-133. b. Other audit costs are allowable if included in an indirect cost rate proposal, or if specifically approved by the awarding agency as a direct cost to an award. c. The cost of agreed-upon procedures engagements to monitor sub recipients who are exempted from A-133 under section 200(d) are allowable, subject to the conditions listed in A-133, section 230 (b)(2). 5. Bad debts. Bad debts, including losses (whether actual or estimated) arising from uncollectable accounts and other claims, related collection costs, and related legal costs, are unallowable. 6. Bonding costs. a. Bonding costs arise when the Federal Government requires assurance against financial loss to itself or others by reason of the act or default of the non-profit organization. They arise also in instances where the non-profit organization requires similar assurance. Included are such bonds as bid, performance, payment, advance payment, infringement, and fidelity bonds. b. Costs of bonding required pursuant to the terms of the award are allowable. c. Costs of bonding required by the non-profit organization in the general conduct of its operations are allowable to the extent that such bonding is in accordance with sound business practice and the rates and premiums are reasonable under the circumstances. 7. Communication costs. Costs incurred for telephone services, local and long distance telephone calls, telegrams, postage, messenger, electronic or computer transmittal services and the like are allowable. 39

OFT MANUAL: FM Cost Principles SECTION 2 8. Compensation for personal services. a. Definition. Compensation for personal services includes all compensation paid currently or accrued by the organization for services of employees rendered during the period of the award (except as otherwise provided in subparagraph h). It includes, but is not limited to, salaries, wages, director's and executive committee member's fees, incentive awards, fringe benefits, pension plan costs, and allowances for off-site pay, incentive pay, location allowances, hardship pay, and cost of living differentials. b. Allowability. Except as otherwise specifically provided in this paragraph, the costs of such compensation are allowable to the extent that: (1) Total compensation to individual employees is reasonable for the services rendered and conforms to the established policy of the organization consistently applied to both Federal and non-federal activities; and (2) Charges to awards whether treated as direct or indirect costs are determined and supported as required in this paragraph. c. Reasonableness. (1) When the organization is predominantly engaged in activities other than those sponsored by the Federal Government, compensation for employees on federally sponsored work will be considered reasonable to the extent that it is consistent with that paid for similar work in the organization's other activities. (2) When the organization is predominantly engaged in federally sponsored activities and in cases where the kind of employees required for the Federal activities are not found in the organization's other activities, compensation for employees on federally sponsored work will be considered reasonable to the extent that it is comparable to that paid for similar work in the labor markets in which the organization competes for the kind of employees involved. d. Special considerations in determining allowability. Certain conditions require special consideration and possible limitations in determining costs under Federal awards where amounts or types of compensation appear unreasonable. Among such conditions are the following: (1) Compensation to members of non-profit organizations, trustees, directors, associates, officers, or the immediate families thereof. Determination should be made that such compensation is reasonable for the actual personal services rendered rather than a distribution of earnings in excess of costs. (2) Any change in an organization's compensation policy resulting in a substantial increase in the organization's level of compensation, particularly when it was concurrent with an increase in the ratio of Federal awards to other activities of the organization or any change in the treatment of allowability of specific types of compensation due to changes in Federal policy. e. Unallowable costs. Costs which are unallowable under other paragraphs of this Attachment shall not be allowable under this paragraph solely on the basis that they constitute personal compensation. 40

OFT MANUAL: FM Cost Principles SECTION 2 f. Overtime, extra-pay shift, and multi-shift premiums. Premiums for overtime, extra-pay shifts, and multi-shift work are allowable only with the prior approval of the awarding agency except: (1) When necessary to cope with emergencies, such as those resulting from accidents, natural disasters, breakdowns of equipment, or occasional operational bottlenecks of a sporadic nature. (2) When employees are performing indirect functions, such as administration, maintenance, or accounting. (3) In the performance of tests, laboratory procedures, or other similar operations which are continuous in nature and cannot reasonably be interrupted or otherwise completed. (4) When lower overall cost to the Federal Government will result. g. Fringe benefits. (1) Fringe benefits in the form of regular compensation paid to employees during periods of authorized absences from the job, such as vacation leave, sick leave, military leave, and the like, are allowable, provided such costs are absorbed by all organization activities in proportion to the relative amount of time or effort actually devoted to each. (2) Fringe benefits in the form of employer contributions or expenses for social security, employee insurance, workmen's compensation insurance, pension plan costs (see subparagraph h), and the like, are allowable, provided such benefits are granted in accordance with established written organization policies. Such benefits whether treated as indirect costs or as direct costs, shall be distributed to particular awards and other activities in a manner consistent with the pattern of benefits accruing to the individuals or group of employees whose salaries and wages are chargeable to such awards and other activities. (3) (a) Provisions for a reserve under a self-insurance program for unemployment compensation or workers' compensation are allowable to the extent that the provisions represent reasonable estimates of the liabilities for such compensation, and the types of coverage, extent of coverage, and rates and premiums would have been allowable had insurance been purchased to cover the risks. However, provisions for self-insured liabilities which do not become payable for more than one year after the provision is made shall not exceed the present value of the liability. (b) Where an organization follows a consistent policy of expensing actual payments to, or on behalf of, employees or former employees for unemployment compensation or workers' compensation, such payments are allowable in the year of payment with the prior approval of the awarding agency, provided they are allocated to all activities of the organization. (4) Costs of insurance on the lives of trustees, officers, or other employees holding positions of similar responsibility are allowable only to the extent that the insurance represents additional compensation. The costs of such insurance when the organization is named as beneficiary are unallowable. h. Organization-furnished automobiles. That portion of the cost of organization-furnished automobiles that relates to personal use by employees (including transportation to and from work) is unallowable as fringe benefit or indirect costs regardless of whether the cost is reported as taxable income to the employees. These costs are allowable as direct costs to sponsored award when necessary for the performance of the sponsored award and approved by awarding agencies. 41

OFT MANUAL: FM Cost Principles SECTION 2 i. Pension plan costs. (1) Costs of the organization's pension plan which are incurred in accordance with the established policies of the organization are allowable, provided: (a) Such policies meet the test of reasonableness; (b) The methods of cost allocation are not discriminatory; (c) The cost assigned to each fiscal year is determined in accordance with generally accepted accounting principles (GAAP), as prescribed in Accounting Principles Board Opinion No. 8 issued by the American Institute of Certified Public Accountants; and (d) The costs assigned to a given fiscal year are funded for all plan participants within six months after the end of that year. However, increases to normal and past service pension costs caused by a delay in funding the actuarial liability beyond 30 days after each quarter of the year to which such costs are assignable are unallowable. (2) Pension plan termination insurance premiums paid pursuant to the Employee Retirement Income Security Act (ERISA) of 1974 (Pub. L. 93-406) are allowable. Late payment charges on such premiums are unallowable. (3) Excise taxes on accumulated funding deficiencies and other penalties imposed under ERISA are unallowable. j. Incentive compensation. Incentive compensation to employees based on cost reduction, or efficient performance, suggestion awards, safety awards, etc., are allowable to the extent that the overall compensation is determined to be reasonable and such costs are paid or accrued pursuant to an agreement entered into in good faith between the organization and the employees before the services were rendered, or pursuant to an established plan followed by the organization so consistently as to imply, in effect, an agreement to make such payment. k. Severance pay. (1) Severance pay, also commonly referred to as dismissal wages, is a payment in addition to regular salaries and wages, by organizations to workers whose employment is being terminated. Costs of severance pay are allowable only to the extent that in each case, it is required by (a) law, (b) employer-employee agreement, (c) established policy that constitutes, in effect, an implied agreement on the organization's part, or (d) circumstances of the particular employment. (2) Costs of severance payments are divided into two categories as follows: (a) Actual normal turnover severance payments shall be allocated to all activities; or, where the organization provides for a reserve for normal severances, such method will be acceptable if the charge to current operations is reasonable in light of payments actually made for normal severances over a 42

OFT MANUAL: FM Cost Principles SECTION 2 representative past period, and if amounts charged are allocated to all activities of the organization. (b) Abnormal or mass severance pay is of such a conjectural nature that measurement of costs by means of an accrual will not achieve equity to both parties. Thus, accruals for this purpose are not allowable. However, the Federal Government recognizes its obligation to participate, to the extent of its fair share, in any specific payment. Thus, allowability will be considered on a case-by-case basis in the event or occurrence. (c) Costs incurred in certain severance pay packages (commonly known as "a golden parachute" payment) which are in an amount in excess of the normal severance pay paid by the organization to an employee upon termination of employment and are paid to the employee contingent upon a change in management control over, or ownership of, the organization's assets are unallowable. (d) Severance payments to foreign nationals employed by the organization outside the United States, to the extent that the amount exceeds the customary or prevailing practices for the organization in the United States are unallowable, unless they are necessary for the performance of Federal programs and approved by awarding agencies. (e) Severance payments to foreign nationals employed by the organization outside the United States due to the termination of the foreign national as a result of the closing of, or curtailment of activities by, the organization in that country, are unallowable, unless they are necessary for the performance of Federal programs and approved by awarding agencies. l. Training costs. See paragraph 49. m. Support of salaries and wages. (1) Charges to awards for salaries and wages, whether treated as direct costs or indirect costs, will be based on documented payrolls approved by a responsible official(s) of the organization. The distribution of salaries and wages to awards must be supported by personnel activity reports, as prescribed in subparagraph (2), except when a substitute system has been approved in writing by the cognizant agency. (See subparagraph E.2 of Attachment A.) (2) Reports reflecting the distribution of activity of each employee must be maintained for all staff members (professionals and nonprofessionals) whose compensation is charged, in whole or in part, directly to awards. In addition, in order to support the allocation of indirect costs, such reports must also be maintained for other employees whose work involves two or more functions or activities if a distribution of their compensation between such functions or activities is needed in the determination of the organization's indirect cost rate(s) (e.g., an employee engaged part-time in indirect cost activities and part-time in a direct function). Reports maintained by non-profit organizations to satisfy these requirements must meet the following standards: (a) The reports must reflect an after-the-fact determination of the actual activity of each employee. Budget estimates (i.e., estimates determined before the services are performed) do not qualify as support for charges to awards. (b) Each report must account for the total activity for which employees are compensated and which is required in fulfillment of their obligations to the organization. (c) The reports must be signed by the individual employee, or by a responsible supervisory official having firsthand knowledge of the activities performed by the employee, that the distribution of activity 43

OFT MANUAL: FM Cost Principles SECTION 2 represents a reasonable estimate of the actual work performed by the employee during the periods covered by the reports. (d) The reports must be prepared at least monthly and must coincide with one or more pay periods. (3) Charges for the salaries and wages of nonprofessional employees, in addition to the supporting documentation described in subparagraphs (1) and (2), must also be supported by records indicating the total number of hours worked each day maintained in conformance with Department of Labor regulations implementing the Fair Labor Standards Act (FLSA) (29 CFR Part 516). For this purpose, the term "nonprofessional employee" shall have the same meaning as "nonexempt employee," under FLSA. (4) Salaries and wages of employees used in meeting cost sharing or matching requirements on awards must be supported in the same manner as salaries and wages claimed for reimbursement from awarding agencies. 9. Contingency provisions. Contributions to a contingency reserve or any similar provision made for events the occurrence of which cannot be foretold with certainty as to time, intensity, or with an assurance of their happening, are unallowable. The term "contingency reserve" excludes self-insurance reserves (see Attachment B, paragraphs 8.g. (3) and 22.a(2)(d)); pension funds (see paragraph 8.i): and reserves for normal severance pay (see paragraph 8.k.) 10. Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringement. a. Definitions. (1) Conviction, as used herein, means a judgment or a conviction of a criminal offense by any court of competent jurisdiction, whether entered upon as a verdict or a plea, including a conviction due to a plea of nolo contendere. (2) Costs include, but are not limited to, administrative and clerical expenses; the cost of legal services, whether performed by in-house or private counsel; and the costs of the services of accountants, consultants, or others retained by the organization to assist it; costs of employees, officers and trustees, and any similar costs incurred before, during, and after commencement of a judicial or administrative proceeding that bears a direct relationship to the proceedings. (3) Fraud, as used herein, means (i) acts of fraud corruption or attempts to defraud the Federal Government or to corrupt its agents, (ii) acts that constitute a cause for debarment or suspension (as specified in agency regulations), and (iii) acts which violate the False Claims Act, 31 U.S.C., sections 3729-3731, or the Anti-Kickback Act, 41 U.S.C., sections 51 and 54. (4) Penalty does not include restitution, reimbursement, or compensatory damages. (5) Proceeding includes an investigation. b. (1) Except as otherwise described herein, costs incurred in connection with any criminal, civil or administrative proceeding (including filing of a false certification) commenced by the Federal Government, or a State, local or foreign government, are not allowable if the proceeding: (1) relates to a violation of, or failure to comply with, a Federal, State, local or foreign statute or regulation by the organization (including its agents and employees), and (2) results in any of the following dispositions: 44

OFT MANUAL: FM Cost Principles SECTION 2 (a) In a criminal proceeding, a conviction. (b) In a civil or administrative proceeding involving an allegation of fraud or similar misconduct, a determination of organizational liability. (c) In the case of any civil or administrative proceeding, the imposition of a monetary penalty. (d) A final decision by an appropriate Federal official to debar or suspend the organization, to rescind or void an award, or to terminate an award for default by reason of a violation or failure to comply with a law or regulation. (e) A disposition by consent or compromise, if the action could have resulted in any of the dispositions described in (a), (b), (c) or (d). (2) If more than one proceeding involves the same alleged misconduct, the costs of all such proceedings shall be unallowable if any one of them results in one of the dispositions shown in subparagraph b.(1). c. If a proceeding referred to in subparagraph b is commenced by the Federal Government and is resolved by consent or compromise pursuant to an agreement entered into by the organization and the Federal Government, then the costs incurred by the organization in connection with such proceedings that are otherwise not allowable under subparagraph b may be allowed to the extent specifically provided in such agreement. d. If a proceeding referred to in subparagraph b is commenced by a State, local or foreign government, the authorized Federal official may allow the costs incurred by the organization for such proceedings, if such authorized official determines that the costs were incurred as a result of (1) a specific term or condition of a federally sponsored award, or (2) specific written direction of an authorized official of the sponsoring agency. e. Costs incurred in connection with proceedings described in subparagraph b, but which are not made unallowable by that subparagraph, may be allowed by the Federal Government, but only to the extent that: (1) The costs are reasonable in relation to the activities required to deal with the proceeding and the underlying cause of action; (2) Payment of the costs incurred, as allowable and allocable costs, is not prohibited by any other provision(s) of the sponsored award; (3) The costs are not otherwise recovered from the Federal Government or a third party, either directly as a result of the proceeding or otherwise; and, (4) The percentage of costs allowed does not exceed the percentage determined by an authorized Federal official to be appropriate, considering the complexity of the litigation, generally accepted principles governing the award of legal fees in civil actions involving the United States as a party, and such other factors as may be appropriate. Such percentage shall not exceed 80 percent. However, if an agreement reached under subparagraph c has explicitly considered this 80 percent limitation and permitted a higher percentage, then the full amount of costs resulting from that agreement shall be allowable. 45

OFT MANUAL: FM Cost Principles SECTION 2 f. Costs incurred by the organization in connection with the defense of suits brought by its employees or ex-employees under section 2 of the Major Fraud Act of 1988 (Pub. L. 100-700), including the cost of all relief necessary to make such employee whole, where the organization was found liable or settled, are unallowable. g. Costs of legal, accounting, and consultant services, and related costs, incurred in connection with defense against Federal Government claims or appeals, antitrust suits, or the prosecution of claims or appeals against the Federal Government, are unallowable. h. Costs of legal, accounting, and consultant services, and related costs, incurred in connection with patent infringement litigation, are unallowable unless otherwise provided for in the sponsored awards. i. Costs which may be unallowable under this paragraph, including directly associated costs, shall be segregated and accounted for by the organization separately. During the pendency of any proceeding covered by subparagraphs b and f, the Federal Government shall generally withhold payment of such costs. However, if in the best interests of the Federal Government, the Federal Government may provide for conditional payment upon provision of adequate security, or other adequate assurance, and agreements by the organization to repay all unallowable costs, plus interest, if the costs are subsequently determined to be unallowable. 11. Depreciation and use allowances. a. Compensation for the use of buildings, other capital improvements, and equipment on hand may be made through use allowance or depreciation. However, except as provided in Attachment B, paragraph f, a combination of the two methods may not be used in connection with a single class of fixed assets (e.g., buildings, office equipment, computer equipment, etc.). b. The computation of use allowances or depreciation shall be based on the acquisition cost of the assets involved. The acquisition cost of an asset donated to the non-profit organization by a third party shall be its fair market value at the time of the donation. c. The computation of use allowances or depreciation will exclude: (1) The cost of land; (2) Any portion of the cost of buildings and equipment borne by or donated by the Federal Government irrespective of where title was originally vested or where it presently resides; and (3) Any portion of the cost of buildings and equipment contributed by or for the non-profit organization in satisfaction of a statutory matching requirement. d. Where depreciation method is followed, the period of useful service (useful life) established in each case for usable capital assets must take into consideration such factors as type of construction, nature of the equipment used, technological developments in the particular program area, and the renewal and replacement policies followed for the individual items or classes of assets involved. The method of depreciation used to assign the cost of an asset (or group of assets) to accounting periods shall reflect the pattern of consumption of the asset during its useful life. In the absence of clear evidence indicating that the expected consumption of the asset will be significantly greater or lesser in the early portions of its useful life than in the later portions, the straightline method shall be presumed to be the appropriate method. 46

OFT MANUAL: FM Cost Principles SECTION 2 Depreciation methods once used shall not be changed unless approved in advance by the cognizant Federal agency. When the depreciation method is introduced for application to assets previously subject to a use allowance, the combination of use allowances and depreciation applicable to such assets must not exceed the total acquisition cost of the assets. e. When the depreciation method is used for buildings, a building's shell may be segregated from each building component (e.g., plumbing system, heating, and air conditioning system, etc.) and each item depreciated over its estimated useful life; or the entire building (i.e., the shell and all components) may be treated as a single asset and depreciated over a single useful life. f. When the depreciation method is used for a particular class of assets, no depreciation may be allowed on any such assets that, under subparagraph d, would be viewed as fully depreciated. However, a reasonable use allowance may be negotiated for such assets if warranted after taking into consideration the amount of depreciation previously charged to the Federal Government, the estimated useful life remaining at time of negotiation, the effect of any increased maintenance charges or decreased efficiency due to age, and any other factors pertinent to the utilization of the asset for the purpose contemplated. g. Where the use allowance method is followed, the use allowance for buildings and improvement (including land improvements, such as paved parking areas, fences, and sidewalks) will be computed at an annual rate not exceeding two percent of acquisition cost. The use allowance for equipment will be computed at an annual rate not exceeding six and two-thirds percent of acquisition cost. When the use allowance method is used for buildings, the entire building must be treated as a single asset; the building's components (e.g., plumbing system, heating and air conditioning, etc.) cannot be segregated from the building's shell. The two percent limitation, however, need not be applied to equipment which is merely attached or fastened to the building but not permanently fixed to it and which is used as furnishings or decorations or for specialized purposes (e.g., dentist chairs and dental treatment units, counters, laboratory benches bolted to the floor, dishwashers, modular furniture, carpeting, etc.). Such equipment will be considered as not being permanently fixed to the building if it can be removed without the need for costly or extensive alterations or repairs to the building or the equipment. Equipment that meets these criteria will be subject to the 6 2/3 percent equipment use allowance limitation. h. Charges for use allowances or depreciation must be supported by adequate property records and physical inventories must be taken at least once every two years (a statistical sampling basis is acceptable) to ensure that assets exist and are usable and needed. When the depreciation method is followed, adequate depreciation records indicating the amount of depreciation taken each period must also be maintained. 12. Donations and contributions. a. Contributions or donations rendered. Contributions or donations, including cash, property, and services, made by the organization, regardless of the recipient, are unallowable. b. Donated services received: (1) Donated or volunteer services may be furnished to an organization by professional and technical personnel, consultants, and other skilled and unskilled labor. The value of these services is not reimbursable either as a direct or indirect cost. However, the value of donated services may be used to meet cost sharing or matching requirements in accordance with the Common Rule. 47

OFT MANUAL: FM Cost Principles SECTION 2 (2)The value of donated services utilized in the performance of a direct cost activity shall, when material in amount, be considered in the determination of the non-profit organization's indirect costs or rate(s) and, accordingly, shall be allocated a proportionate share of applicable indirect costs when the following exist: (a) The aggregate value of the services is material; (b) The services are supported by a significant amount of the indirect costs incurred by the non-profit organization; and (c) The direct cost activity is not pursued primarily for the benefit of the Federal Government. (3) In those instances where there is no basis for determining the fair market value of the services rendered, the recipient and the cognizant agency shall negotiate an appropriate allocation of indirect cost to the services. (4) Where donated services directly benefit a project supported by an award, the indirect costs allocated to the services will be considered as a part of the total costs of the project. Such indirect costs may be reimbursed under the award or used to meet cost sharing or matching requirements. (5) The value of the donated services may be used to meet cost sharing or matching requirements under conditions described in Sec..23 of Circular A-110. Where donated services are treated as indirect costs, indirect cost rates will separate the value of the donations so that reimbursement will not be made. c. Donated goods or space. (1) Donated goods; i.e., expendable personal property/supplies, and donated use of space may be furnished to a non-profit organization. The value of the goods and space is not reimbursable either as a direct or indirect cost. (2) The value of the donations may be used to meet cost sharing or matching share requirements under the conditions described in Circular A-110. Where donations are treated as indirect costs, indirect cost rates will separate the value of the donations so that reimbursement will not be made. 13. Employee morale, health, and welfare costs. a. The costs of employee information publications, health or first-aid clinics and/or infirmaries, recreational activities, employee counseling services, and any other expenses incurred in accordance with the nonprofit organization's established practice or custom for the improvement of working conditions, employer-employee relations, employee morale, and employee performance are allowable. b. Such costs will be equitably apportioned to all activities of the non-profit organization. Income generated from any of these activities will be credited to the cost thereof unless such income has been irrevocably set over to employee welfare organizations. 14. Entertainment costs. Costs of entertainment, including amusement, diversion, and social activities and any costs directly associated with such costs (such as tickets to shows or sports events, meals, lodging, rentals, transportation, and gratuities) are unallowable. 15. Equipment and other capital expenditures. 48

OFT MANUAL: FM Cost Principles SECTION 2 a. For purposes of this subparagraph, the following definitions apply: (1) "Capital Expenditures" means expenditures for the acquisition cost of capital assets (equipment, buildings, land), or expenditures to make improvements to capital assets that materially increase their value or useful life. Acquisition cost means the cost of the asset including the cost to put it in place. Acquisition cost for equipment, for example, means the net invoice price of the equipment, including the cost of any modifications, attachments, accessories, or auxiliary apparatus necessary to make it usable for the purpose for which it is acquired. Ancillary charges, such as taxes, duty, and protective in transit insurance, freight, and installation may be included in, or excluded from the acquisition cost in accordance with the non-profit organization's regular accounting practices. (2) "Equipment" means an article of nonexpendable, tangible personal property having a useful life of more than one year and an acquisition cost which equals or exceeds the lesser of the capitalization level established by the non-profit organization for financial statement purposes, or $5000. (3) "Special purpose equipment" means equipment which is used only for research, medical, scientific, or other technical activities. Examples of special purpose equipment include microscopes, x-ray machines, surgical instruments, and spectrometers. (4) "General purpose equipment" means equipment, which is not limited to research, medical, scientific or other technical activities. Examples include office equipment and furnishings, modular offices, telephone networks, information technology equipment and systems, air conditioning equipment, reproduction and printing equipment, and motor vehicles. b. The following rules of allowability shall apply to equipment and other capital expenditures: (1) Capital expenditures for general purpose equipment, buildings, and land are unallowable as direct charges, except where approved in advance by the awarding agency. (2) Capital expenditures for special purpose equipment are allowable as direct costs, provided that items with a unit cost of $5000 or more have the prior approval of the awarding agency. (3) Capital expenditures for improvements to land, buildings, or equipment which materially increase their value or useful life are unallowable as a direct cost except with the prior approval of the awarding agency. (4) When approved as a direct charge pursuant to paragraph 15.b.(1), (2), and (3) above, capital expenditures will be charged in the period in which the expenditure is incurred, or as otherwise determined appropriate by and negotiated with the awarding agency. (5) Equipment and other capital expenditures are unallowable as indirect costs. However, see Attachment B, paragraph 11., Depreciation and use allowance, for rules on the allowability of use allowances or depreciation on buildings, capital improvements, and equipment. Also, see Attachment B, paragraph 43., Rental costs of buildings and equipment, for rules on the allowability of rental costs for land, buildings, and equipment. (6) The unamortized portion of any equipment written off as a result of a change in capitalization levels may be recovered by continuing to claim the otherwise allowable use allowances or depreciation on the equipment, or by amortizing the amount to be written off over a period of years negotiated with the cognizant agency. 49

OFT MANUAL: FM Cost Principles SECTION 2 16. Fines and penalties. Costs of fines and penalties resulting from violations of, or failure of the organization to comply with Federal, State, and local laws and regulations are unallowable except when incurred as a result of compliance with specific provisions of an award or instructions in writing from the awarding agency. 17. Fund raising and investment management costs. a. Costs of organized fund raising, including financial campaigns, endowment drives, solicitation of gifts and bequests, and similar expenses incurred solely to raise capital or obtain contributions are unallowable. b. Costs of investment counsel and staff and similar expenses incurred solely to enhance income from investments are unallowable. c. Fund raising and investment activities shall be allocated an appropriate share of indirect costs under the conditions described in subparagraph B.3 of Attachment A. 18. Gains and losses on depreciable assets. a. (1) Gains and losses on sale, retirement, or other disposition of depreciable property shall be included in the year in which they occur as credits or charges to cost grouping(s) in which the depreciation applicable to such property was included. The amount of the gain or loss to be included as a credit or charge to the appropriate cost grouping(s) shall be the difference between the amount realized on the property and the depreciated basis of the property. (2) Gains and losses on the disposition of depreciable property shall not be recognized as a separate credit or charge under the following conditions: (a) The gain or loss is processed through a depreciation account and is reflected in the depreciation allowable under paragraph 11. (b) The property is given in exchange as part of the purchase price of a similar item and the gain or loss is taken into account in determining the depreciation cost basis of the new item. (c) A loss results from the failure to maintain permissible insurance, except as otherwise provided in Attachment B, paragraph 22. (d) Compensation for the use of the property was provided through use allowances in lieu of depreciation in accordance with paragraph 9. (e) Gains and losses arising from mass or extraordinary sales, retirements, or other dispositions shall be considered on a case-by-case basis. b. Gains or losses of any nature arising from the sale or exchange of property other than the property covered in subparagraph a shall be excluded in computing award costs. 19. Goods or services for personal use. Costs of goods or services for personal use of the organization's employees are unallowable regardless of whether the cost is reported as taxable income to the employees. 20. Housing and personal living expenses. 50

OFT MANUAL: FM Cost Principles SECTION 2 a. Costs of housing (e.g., depreciation, maintenance, utilities, furnishings, rent, etc.), housing allowances and personal living expenses for/of the organization's officers are unallowable as fringe benefit or indirect costs regardless of whether the cost is reported as taxable income to the employees. These costs are allowable as direct costs to sponsored award when necessary for the performance of the sponsored award and approved by awarding agencies. b. The term "officers" includes current and past officers and employees. 21. Idle facilities and idle capacity. a. As used in this section the following terms have the meanings set forth below: (1) "Facilities" means land and buildings or any portion thereof, equipment individually or collectively, or any other tangible capital asset, wherever located, and whether owned or leased by the non-profit organization. (2) "Idle facilities" means completely unused facilities that are excess to the non-profit organization's current needs. (3) "Idle capacity" means the unused capacity of partially used facilities. It is the difference between: (a) that which a facility could achieve under 100 percent operating time on a one-shift basis less operating interruptions resulting from time lost for repairs, setups, unsatisfactory materials, and other normal delays; and (b) the extent to which the facility was actually used to meet demands during the accounting period. A multi-shift basis should be used if it can be shown that this amount of usage would normally be expected for the type of facility involved. (4) "Cost of idle facilities or idle capacity" means costs such as maintenance, repair, housing, rent, and other related costs, e.g., insurance, interest, property taxes and depreciation or use allowances. b. The costs of idle facilities are unallowable except to the extent that: (1) They are necessary to meet fluctuations in workload; or (2) Although not necessary to meet fluctuations in workload, they were necessary when acquired and are now idle because of changes in program requirements, efforts to achieve more economical operations, reorganization, termination, or other causes which could not have been reasonably foreseen. Under the exception stated in this subparagraph, costs of idle facilities are allowable for a reasonable period of time, ordinarily not to exceed one year, depending on the initiative taken to use, lease, or dispose of such facilities. c. The costs of idle capacity are normal costs of doing business and are a factor in the normal fluctuations of usage or indirect cost rates from period to period. Such costs are allowable, provided that the capacity is reasonably anticipated to be necessary or was originally reasonable and is not subject to reduction or elimination by use on other Federal awards, subletting, renting, or sale, in accordance with sound business, economic, or security practices. Widespread idle capacity throughout an entire facility or among a group of assets having substantially the same function may be considered idle facilities. 22. Insurance and indemnification. a. Insurance includes insurance which the organization is required to carry, or which is approved, under the terms of the award and any other insurance which the organization maintains in connection with the 51

OFT MANUAL: FM Cost Principles SECTION 2 general conduct of its operations. This paragraph does not apply to insurance which represents fringe benefits for employees (see subparagraphs 8.g and 8.i(2)). (1) Costs of insurance required or approved, and maintained, pursuant to the award are allowable. (2) Costs of other insurance maintained by the organization in connection with the general conduct of its operations are allowable subject to the following limitations: (a) Types and extent of coverage shall be in accordance with sound business practice and the rates and premiums shall be reasonable under the circumstances. (b) Costs allowed for business interruption or other similar insurance shall be limited to exclude coverage of management fees. (c) Costs of insurance or of any provisions for a reserve covering the risk of loss or damage to Federal property are allowable only to the extent that the organization is liable for such loss or damage. (d) Provisions for a reserve under a self-insurance program are allowable to the extent that types of coverage, extent of coverage, rates, and premiums would have been allowed had insurance been purchased to cover the risks. However, provision for known or reasonably estimated self-insured liabilities, which do not become payable for more than one year after the provision is made, shall not exceed the present value of the liability. (e) Costs of insurance on the lives of trustees, officers, or other employees holding positions of similar responsibilities are allowable only to the extent that the insurance represents additional compensation (see subparagraph 8.g(4)). The cost of such insurance when the organization is identified as the beneficiary is unallowable. (f) Insurance against defects. Costs of insurance with respect to any costs incurred to correct defects in the organization's materials or workmanship are unallowable. (g) Medical liability (malpractice) insurance. Medical liability insurance is an allowable cost of Federal research programs only to the extent that the Federal research programs involve human subjects or training of participants in research techniques. Medical liability insurance costs shall be treated as a direct cost and shall be assigned to individual projects based on the manner in which the insurer allocates the risk to the population covered by the insurance. (3) Actual losses which could have been covered by permissible insurance (through the purchase of insurance or a self-insurance program) are unallowable unless expressly provided for in the award, except: (a) Costs incurred because of losses not covered under nominal deductible insurance coverage provided in keeping with sound business practice are allowable. (b) Minor losses not covered by insurance, such as spoilage, breakage, and disappearance of supplies, which occur in the ordinary course of operations, are allowable. b. Indemnification includes securing the organization against liabilities to third persons and any other loss or damage, not compensated by insurance or otherwise. The Federal Government is obligated to indemnify the organization only to the extent expressly provided in the award. 52

OFT MANUAL: FM Cost Principles SECTION 2 23. Interest. a. Costs incurred for interest on borrowed capital, temporary use of endowment funds, or the use of the non-profit organization s own funds, however represented, are unallowable. However, interest on debt incurred after September 29, 1995 to acquire or replace capital assets (including renovations, alterations, equipment, land, and capital assets acquired through capital leases), acquired after September 29, 1995 and used in support of Federal awards is allowable, provided that: (1) For facilities acquisitions (excluding renovations and alterations) costing over $10 million where the Federal Government's reimbursement is expected to equal or exceed 40 percent of an asset's cost, the non-profit organization prepares, prior to the acquisition or replacement of the capital asset(s), a justification that demonstrates the need for the facility in the conduct of federally sponsored activities. Upon request, the needs justification must be provided to the Federal agency with cost cognizance authority as a prerequisite to the continued allowability of interest on debt and depreciation related to the facility. The needs justification for the acquisition of a facility should include, at a minimum, the following: (a) A statement of purpose and justification for facility acquisition or replacement (b) A statement as to why current facilities are not adequate (c) A statement of planned future use of the facility (d) A description of the financing agreement to be arranged for the facility (e) A summary of the building contract with estimated cost information and statement of source and use of funds (f) A schedule of planned occupancy dates (2) For facilities costing over $500,000, the non-profit organization prepares, prior to the acquisition or replacement of the facility, a lease/purchase analysis in accordance with the provisions of Sec..30 through.37 of Circular A-110, which shows that a financed purchase or capital lease is less costly to the organization than other leasing alternatives, on a net present value basis. Discount rates used should be equal to the non-profit organization's anticipated interest rates and should be no higher than the fair market rate available to the non-profit organization from an unrelated ("arm's length") third-party. The lease/purchase analysis shall include a comparison of the net present value of the projected total cost comparisons of both alternatives over the period the asset is expected to be used by the non-profit organization. The cost comparisons associated with purchasing the facility shall include the estimated purchase price, anticipated operating and maintenance costs (including property taxes, if applicable) not included in the debt financing, less any estimated asset salvage value at the end of the period defined above. The cost comparison for a capital lease shall include the estimated total lease payments, any estimated bargain purchase option, operating and maintenance costs, and taxes not included in the capital leasing arrangement, less any estimated credits due under the lease at the end of the period defined above. Projected operating lease costs shall be based on the anticipated cost of leasing comparable facilities at fair market rates under rental agreements that would be renewed or reestablished over the period defined above, and any expected maintenance costs and allowable property taxes to be borne by the non-profit organization directly or as part of the lease arrangement. (3) The actual interest cost claimed is predicated upon interest rates that are no higher than the fair market rate available to the non-profit organization from an unrelated ("arm's length") third party. 53

OFT MANUAL: FM Cost Principles SECTION 2 (4) Investment earnings, including interest income, on bond or loan principal, pending payment of the construction or acquisition costs, are used to offset allowable interest cost. Arbitrage earnings reportable to the Internal Revenue Service are not required to be offset against allowable interest costs. (5) Reimbursements are limited to the least costly alternative based on the total cost analysis required under subparagraph (b). For example, if an operating lease is determined to be less costly than purchasing through debt financing, then reimbursement is limited to the amount determined if leasing had been used. In all cases where a lease/purchase analysis is performed, Federal reimbursement shall be based upon the least expensive alternative. (6) Non-profit organizations are also subject to the following conditions: (a) Interest on debt incurred to finance or refinance assets acquired before or reacquired after September 29, 1995, is not allowable. (b) Interest attributable to fully depreciated assets is unallowable. (c) For debt arrangements over $1 million, unless the non-profit organization makes an initial equity contribution to the asset purchase of 25 percent or more, non-profit organizations shall reduce claims for interest expense by an amount equal to imputed interest earnings on excess cash flow, which is to be calculated as follows. Annually, non-profit organizations shall prepare a cumulative (from the inception of the project) report of monthly cash flows that includes inflows and outflows, regardless of the funding source. Inflows consist of depreciation expense, amortization of capitalized construction interest, and annual interest expense. For cash flow calculations, the annual inflow figures shall be divided by the number of months in the year (usually 12) that the building is in service for monthly amounts. Outflows consist of initial equity contributions, debt principal payments (less the pro rata share attributable to the unallowable costs of land) and interest payments. Where cumulative inflows exceed cumulative outflows, interest shall be calculated on the excess inflows for that period and be treated as a reduction to allowable interest expense. The rate of interest to be used to compute earnings on excess cash flows shall be the three month Treasury Bill closing rate as of the last business day of that month. (d) Substantial relocation of federally sponsored activities from a facility financed by indebtedness, the cost of which was funded in whole or part through Federal reimbursements, to another facility prior to the expiration of a period of 20 years requires notice to the Federal cognizant agency. The extent of the relocation, the amount of the Federal participation in the financing, and the depreciation and interest charged to date may require negotiation and/or downward adjustments of replacement space charged to Federal programs in the future. (e) The allowable costs to acquire facilities and equipment are limited to a fair market value available to the non-profit organization from an unrelated ("arm's length") third party. b. For non-profit organizations subject to "full coverage"' under the Cost Accounting Standards (CAS) as defined at 48 CFR 9903.201, the interest allowability provisions of subparagraph a do not apply. Instead, these organizations' sponsored agreements are subject to CAS 414 (48 CFR 9903.414), cost of money as an element of the cost of facilities capital, and CAS 417 (48 CFR 9903.417), cost of money as an element of the cost of capital assets under construction. c. The following definitions are to be used for purposes of this paragraph: 54

OFT MANUAL: FM Cost Principles SECTION 2 (1) Re-acquired assets means assets held by the non-profit organization prior to September 29, 1995 that have again come to be held by the organization, whether through repurchase or refinancing. It does not include assets acquired to replace older assets. (2) Initial equity contribution means the amount or value of contributions made by non-profit organizations for the acquisition of the asset or prior to occupancy of facilities. (3) Asset costs means the capitalizable costs of an asset, including construction costs, acquisition costs, and other such costs capitalized in accordance with GAAP. 24. Labor relations costs. Costs incurred in maintaining satisfactory relations between the organization and its employees, including costs of labor management committees, employee publications, and other related activities are allowable. 25. Lobbying. a. Notwithstanding other provisions of this Circular, costs associated with the following activities are unallowable: (1) Attempts to influence the outcomes of any Federal, State, or local election, referendum, initiative, or similar procedure, through in kind or cash contributions, endorsements, publicity, or similar activity; (2) Establishing, administering, contributing to, or paying the expenses of a political party, campaign, political action committee, or other organization established for the purpose of influencing the outcomes of elections; (3) Any attempt to influence: (i) The introduction of Federal or State legislation; or (ii) the enactment or modification of any pending Federal or State legislation through communication with any member or employee of the Congress or State legislature (including efforts to influence State or local officials to engage in similar lobbying activity), or with any Government official or employee in connection with a decision to sign or veto enrolled legislation; (4) Any attempt to influence: (i) The introduction of Federal or State legislation; or (ii) the enactment or modification of any pending Federal or State legislation by preparing, distributing or using publicity or propaganda, or by urging members of the general public or any segment thereof to contribute to or participate in any mass demonstration, march, rally, fundraising drive, lobbying campaign or letter writing or telephone campaign; or (5) Legislative liaison activities, including attendance at legislative sessions or committee hearings, gathering information regarding legislation, and analyzing the effect of legislation, when such activities are carried on in support of or in knowing preparation for an effort to engage in unallowable lobbying. b. The following activities are excepted from the coverage of subparagraph a: (1) Providing a technical and factual presentation of information on a topic directly related to the performance of a grant, contract or other agreement through hearing testimony, statements or letters to the Congress or a State legislature, or subdivision, member, or cognizant staff member thereof, in response to a documented request (including a Congressional Record notice requesting testimony or statements for the record at a regularly scheduled hearing) made by the recipient member, legislative body or subdivision, or a cognizant staff member thereof; provided such information is readily obtainable and can be readily put in deliverable form; and further provided that costs under this section for travel, lodging or meals are unallowable unless incurred to offer testimony at a regularly scheduled 55

OFT MANUAL: FM Cost Principles SECTION 2 Congressional hearing pursuant to a written request for such presentation made by the Chairman or Ranking Minority Member of the Committee or Subcommittee conducting such hearing. (2) Any lobbying made unallowable by subparagraph a(3) to influence State legislation in order to directly reduce the cost, or to avoid material impairment of the organization's authority to perform the grant, contract, or other agreement. (3) Any activity specifically authorized by statute to be undertaken with funds from the grant, contract, or other agreement. c. (1) When an organization seeks reimbursement for indirect costs, total lobbying costs shall be separately identified in the indirect cost rate proposal, and thereafter treated as other unallowable activity costs in accordance with the procedures of subparagraph B.3 of Attachment A. (2) Organizations shall submit, as part of the annual indirect cost rate proposal, a certification that the requirements and standards of this paragraph have been complied with. (3) Organizations shall maintain adequate records to demonstrate that the determination of costs as being allowable or unallowable pursuant to paragraph 25 complies with the requirements of this Circular. (4) Time logs, calendars, or similar records shall not be required to be created for purposes of complying with this paragraph during any particular calendar month when: (1) the employee engages in lobbying (as defined in subparagraphs (a) and (b)) 25 percent or less of the employee's compensated hours of employment during that calendar month, and (2) within the preceding five-year period, the organization has not materially misstated allowable or unallowable costs of any nature, including legislative lobbying costs. When conditions (1) and (2) are met, organizations are not required to establish records to support the allowabliliy of claimed costs in addition to records already required or maintained. Also, when conditions (1) and (2) are met, the absence of time logs, calendars, or similar records will not serve as a basis for disallowing costs by contesting estimates of lobbying time spent by employees during a calendar month. (5) Agencies shall establish procedures for resolving in advance, in consultation with OMB, any significant questions or disagreements concerning the interpretation or application of paragraph 25. Any such advance resolution shall be binding in any subsequent settlements, audits or investigations with respect to that grant or contract for purposes of interpretation of this Circular; provided, however, that this shall not be construed to prevent a contractor or grantee from contesting the lawfulness of such a determination. d. Executive lobbying costs. Costs incurred in attempting to improperly influence either directly or indirectly, an employee or officer of the Executive Branch of the Federal Government to give consideration or to act regarding a sponsored agreement or a regulatory matter are unallowable. Improper influence means any influence that induces or tends to induce a Federal employee or officer to give consideration or to act regarding a federally sponsored agreement or regulatory matter on any basis other than the merits of the matter. 26. Losses on other sponsored agreements or contracts. Any excess of costs over income on any award is unallowable as a cost of any other award. This includes, but is not limited to, the organization's contributed portion by reason of cost sharing agreements or any under-recoveries through negotiation of lump sums for, or ceilings on, indirect costs. 56

OFT MANUAL: FM Cost Principles SECTION 2 27. Maintenance and repair costs. Costs incurred for necessary maintenance, repair, or upkeep of buildings and equipment (including Federal property unless otherwise provided for) which neither add to the permanent value of the property nor appreciably prolong its intended life, but keep it in an efficient operating condition, are allowable. Costs incurred for improvements which add to the permanent value of the buildings and equipment or appreciably prolong their intended life shall be treated as capital expenditures (see paragraph 15). 28. Materials and supplies costs. a. Costs incurred for materials, supplies, and fabricated parts necessary to carry out a Federal award are allowable. b. Purchased materials and supplies shall be charged at their actual prices, net of applicable credits. Withdrawals from general stores or stockrooms should be charged at their actual net cost under any recognized method of pricing inventory withdrawals, consistently applied. Incoming transportation charges are a proper part of materials and supplies costs. c. Only materials and supplies actually used for the performance of a Federal award may be charged as direct costs. d. Where federally donated or furnished materials are used in performing the Federal award, such materials will be used without charge. 29. Meetings and conferences. Costs of meetings and conferences, the primary purpose of which is the dissemination of technical information, are allowable. This includes costs of meals, transportation, rental of facilities, speakers' fees, and other items incidental to such meetings or conferences. But see Attachment B, paragraphs 14., Entertainment costs, and 33., Participant support costs. 30. Memberships, subscriptions, and professional activity costs. a. Costs of the non-profit organization s membership in business, technical, and professional organizations are allowable. b. Costs of the non-profit organization s subscriptions to business, professional, and technical periodicals are allowable. c. Costs of membership in any civic or community organization are allowable with prior approval by Federal cognizant agency. d. Costs of membership in any country club or social or dining club or organization are unallowable. 31. Organization costs. Expenditures, such as incorporation fees, brokers' fees, fees to promoters, organizers or management consultants, attorneys, accountants, or investment counselors, whether or not employees of the organization, in connection with establishment or reorganization of an organization, are unallowable except with prior approval of the awarding agency. 32. Page charges in professional journals. Page charges for professional journal publications are allowable as a necessary part of research costs, where: a. The research papers report work supported by the Federal Government; and 57

OFT MANUAL: FM Cost Principles SECTION 2 b. The charges are levied impartially on all research papers published by the journal, whether or not by federally sponsored authors. 33. Participant support costs. Participant support costs are direct costs for items such as stipends or subsistence allowances, travel allowances, and registration fees paid to or on behalf of participants or trainees (but not employees) in connection with meetings, conferences, symposia, or training projects. These costs are allowable with the prior approval of the awarding agency. 34. Patent costs. a. The following costs relating to patent and copyright matters are allowable: (i) cost of preparing disclosures, reports, and other documents required by the Federal award and of searching the art to the extent necessary to make such disclosures; (ii) cost of preparing documents and any other patent costs in connection with the filing and prosecution of a United States patent application where title or royaltyfree license is required by the Federal Government to be conveyed to the Federal Government; and (iii) general counseling services relating to patent and copyright matters, such as advice on patent and copyright laws, regulations, clauses, and employee agreements (but see paragraphs 37., Professional services costs, and 44., Royalties and other costs for use of patents and copyrights). b. The following costs related to patent and copyright matter are unallowable: (1) Cost of preparing disclosures, reports, and other documents and of searching the art to the extent necessary to make disclosures not required by the award (2) Costs in connection with filing and prosecuting any foreign patent application, or any United States patent application, where the Federal award does not require conveying title or a royalty-free license to the Federal Government (but see paragraph 45., Royalties and other costs for use of patents and copyrights). 35. Plant and homeland security costs. Necessary and reasonable expenses incurred for routine and homeland security to protect facilities, personnel, and work products are allowable. Such costs include, but are not limited to, wages and uniforms of personnel engaged in security activities; equipment; barriers; contractual security services; consultants; etc. Capital expenditures for homeland and plant security purposes are subject to paragraph 15., Equipment and other capital expenditures, of this Circular. 36. Pre-agreement costs. Pre-award costs are those incurred prior to the effective date of the award directly pursuant to the negotiation and in anticipation of the award where such costs are necessary to comply with the proposed delivery schedule or period of performance. Such costs are allowable only to the extent that they would have been allowable if incurred after the date of the award and only with the written approval of the awarding agency. 37. Professional services costs. a. Costs of professional and consultant services rendered by persons who are members of a particular profession or possess a special skill, and who are not officers or employees of the non-profit organization, are allowable, subject to subparagraphs b and c when reasonable in relation to the services rendered and when not contingent upon recovery of the costs from the Federal Government. In addition, legal and related services are limited under Attachment B, paragraph 10. b. In determining the allowability of costs in a particular case, no single factor or any special combination of factors is necessarily determinative. However, the following factors are relevant: 58

OFT MANUAL: FM Cost Principles SECTION 2 (1) The nature and scope of the service rendered in relation to the service required. (2) The necessity of contracting for the service, considering the non-profit organization's capability in the particular area. (3) The past pattern of such costs, particularly in the years prior to Federal awards. (4) The impact of Federal awards on the non-profit organization's business (i.e., what new problems have arisen). (5) Whether the proportion of Federal work to the non-profit organization's total business is such as to influence the non-profit organization in favor of incurring the cost, particularly where the services rendered are not of a continuing nature and have little relationship to work under Federal grants and contracts. (6) Whether the service can be performed more economically by direct employment rather than contracting. (7) The qualifications of the individual or concern rendering the service and the customary fees charged, especially on non-federal awards. (8) Adequacy of the contractual agreement for the service (e.g., description of the service, estimate of time required, rate of compensation, and termination provisions). c. In addition to the factors in subparagraph b, retainer fees to be allowable must be supported by evidence of bona fide services available or rendered 38. Publication and printing costs. a. Publication costs include the costs of printing (including the processes of composition, plate-making, press work, binding, and the end products produced by such processes), distribution, promotion, mailing, and general handling. Publication costs also include page charges in professional publications. b. If these costs are not identifiable with a particular cost objective, they should be allocated as indirect costs to all benefiting activities of the non-profit organization. c. Page charges for professional journal publications are allowable as a necessary part of research costs where: (1) The research papers report work supported by the Federal Government: and (2) The charges are levied impartially on all research papers published by the journal, whether or not by federally sponsored authors. 39. Rearrangement and alteration costs. Costs incurred for ordinary or normal rearrangement and alteration of facilities are allowable. Special arrangement and alteration costs incurred specifically for the project are allowable with the prior approval of the awarding agency. 40. Reconversion costs. Costs incurred in the restoration or rehabilitation of the non-profit organization's facilities to approximately the same condition existing immediately prior to commencement of Federal awards, less costs related to normal wear and tear, are allowable. 41. Recruiting costs. 59

OFT MANUAL: FM Cost Principles SECTION 2 a. Subject to subparagraphs b, c, and d, and provided that the size of the staff recruited and maintained is in keeping with workload requirements, costs of "help wanted" advertising, operating costs of an employment office necessary to secure and maintain an adequate staff, costs of operating an aptitude and educational testing program, travel costs of employees while engaged in recruiting personnel, travel costs of applicants for interviews for prospective employment, and relocation costs incurred incident to recruitment of new employees, are allowable to the extent that such costs are incurred pursuant to a well-managed recruitment program. Where the organization uses employment agencies, costs that are not in excess of standard commercial rates for such services are allowable. b. In publications, costs of help wanted advertising that includes color, includes advertising material for other than recruitment purposes, or is excessive in size (taking into consideration recruitment purposes for which intended and normal organizational practices in this respect), are unallowable. c. Costs of help wanted advertising, special emoluments, fringe benefits, and salary allowances incurred to attract professional personnel from other organizations that do not meet the test of reasonableness or do not conform with the established practices of the organization, are unallowable. d. Where relocation costs incurred incident to recruitment of a new employee have been allowed either as an allocable direct or indirect cost, and the newly hired employee resigns for reasons within his control within twelve months after being hired, the organization will be required to refund or credit such relocation costs to the Federal Government. 42. Relocation costs. a. Relocation costs are costs incident to the permanent change of duty assignment (for an indefinite period or for a stated period of not less than 12 months) of an existing employee or upon recruitment of a new employee. Relocation costs are allowable, subject to the limitation described in subparagraphs b, c, and d, provided that: (1) The move is for the benefit of the employer. (2) Reimbursement to the employee is in accordance with an established written policy consistently followed by the employer. (3) The reimbursement does not exceed the employee's actual (or reasonably estimated) expenses. b. Allowable relocation costs for current employees are limited to the following: (1) The costs of transportation of the employee, members of his immediate family and his household, and personal effects to the new location. (2) The costs of finding a new home, such as advance trips by employees and spouses to locate living quarters and temporary lodging during the transition period, up to maximum period of 30 days, including advance trip time. (3) Closing costs, such as brokerage, legal, and appraisal fees, incident to the disposition of the employee's former home. These costs, together with those described in (4), are limited to 8 percent of the sales price of the employee's former home. (4) The continuing costs of ownership of the vacant former home after the settlement or lease date of the employee's new permanent home, such as maintenance of buildings and grounds (exclusive of fixing up expenses), utilities, taxes, and property insurance. 60

OFT MANUAL: FM Cost Principles SECTION 2 (5) Other necessary and reasonable expenses normally incident to relocation, such as the costs of canceling an unexpired lease, disconnecting and reinstalling household appliances, and purchasing insurance against loss of or damages to personal property. The cost of canceling an unexpired lease is limited to three times the monthly rental. c. Allowable relocation costs for new employees are limited to those described in (1) and (2) of subparagraph b. When relocation costs incurred incident to the recruitment of new employees have been allowed either as a direct or indirect cost and the employee resigns for reasons within his control within 12 months after hire, the organization shall refund or credit the Federal Government for its share of the cost. However, the costs of travel to an overseas location shall be considered travel costs in accordance with paragraph 50 and not relocation costs for the purpose of this paragraph if dependents are not permitted at the location for any reason and the costs do not include costs of transporting household goods. d. The following costs related to relocation are unallowable: (1) Fees and other costs associated with acquiring a new home. (2) A loss on the sale of a former home. (3) Continuing mortgage principal and interest payments on a home being sold. (4) Income taxes paid by an employee related to reimbursed relocation costs. 43. Rental costs of buildings and equipment. a. Subject to the limitations described in subparagraphs b. through d. of this paragraph 43, rental costs are allowable to the extent that the rates are reasonable in light of such factors as: rental costs of comparable property, if any; market conditions in the area; alternatives available; and, the type, life expectancy, condition, and value of the property leased. Rental arrangements should be reviewed periodically to determine if circumstances have changed and other options are available. b. Rental costs under "sale and lease back" arrangements are allowable only up to the amount that would be allowed had the non-profit organization continued to own the property. This amount would include expenses such as depreciation or use allowance, maintenance, taxes, and insurance. c. Rental costs under "less-than-arms-length" leases are allowable only up to the amount (as explained in subparagraph b. of this paragraph 43.) that would be allowed had title to the property vested in the nonprofit organization. For this purpose, a less-than-arms-length lease is one under which one party to the lease agreement is able to control or substantially influence the actions of the other. Such leases include, but are not limited to those between (i) divisions of a non-profit organization; (ii) non-profit organizations under common control through common officers, directors, or members; and (iii) a nonprofit organization and a director, trustee, officer, or key employee of the non-profit organization or his immediate family, either directly or through corporations, trusts, or similar arrangements in which they hold a controlling interest. For example, a non-profit organization may establish a separate corporation for the sole purpose of owning property and leasing it back to the non-profit organization. d. Rental costs under leases which are required to be treated as capital leases under GAAP are allowable only up to the amount (as explained in subparagraph b) that would be allowed had the non-profit organization purchased the property on the date the lease agreement was executed. The provisions of Financial Accounting Standards Board Statement 13, Accounting for Leases, shall be used to determine 61

OFT MANUAL: FM Cost Principles SECTION 2 whether a lease is a capital lease. Interest costs related to capital leases are allowable to the extent they meet the criteria in subparagraph 23. Unallowable costs include amounts paid for profit, management fees, and taxes that would not have been incurred had the non-profit organization purchased the facility. 44. Royalties and other costs for use of patents and copyrights. a. Royalties on a patent or copyright or amortization of the cost of acquiring by purchase a copyright, patent, or rights thereto, necessary for the proper performance of the award are allowable unless: (1) The Federal Government has a license or the right to free use of the patent or copyright. (2) The patent or copyright has been adjudicated to be invalid, or has been administratively determined to be invalid. (3) The patent or copyright is considered to be unenforceable. (4) The patent or copyright is expired. b. Special care should be exercised in determining reasonableness where the royalties may have arrived at as a result of less-than-arm's-length bargaining, e.g.: (1) Royalties paid to persons, including corporations, affiliated with the non-profit organization. (2) Royalties paid to unaffiliated parties, including corporations, under an agreement entered into in contemplation that a Federal award would be made. (3) Royalties paid under an agreement entered into after an award is made to a non-profit organization. c. In any case involving a patent or copyright formerly owned by the non-profit organization, the amount of royalty allowed should not exceed the cost which would have been allowed had the non-profit organization retained title thereto. 45. Selling and marketing. Costs of selling and marketing any products or services of the non-profit organization are unallowable (unless allowed under Attachment B, paragraph 1. as allowable public relations cost. However, these costs are allowable as direct costs, with prior approval by awarding agencies, when they are necessary for the performance of Federal programs. 46. Specialized service facilities. a. The costs of services provided by highly complex or specialized facilities operated by the non-profit organization, such as computers, wind tunnels, and reactors are allowable, provided the charges for the services meet the conditions of either 46 b. or c. and, in addition, take into account any items of income or Federal financing that qualify as applicable credits under Attachment A, subparagraph A.5. of this Circular. b. The costs of such services, when material, must be charged directly to applicable awards based on actual usage of the services on the basis of a schedule of rates or established methodology that (i) does not discriminate against federally supported activities of the non-profit organization, including usage by the non-profit organization for internal purposes, and (ii) is designed to recover only the aggregate costs of the services. The costs of each service shall consist normally of both its direct costs and its allocable share of all indirect costs. Rates shall be adjusted at least biennially, and shall take into consideration 62

OFT MANUAL: FM Cost Principles SECTION 2 over/under applied costs of the previous period(s). c. Where the costs incurred for a service are not material, they may be allocated as indirect costs. d. Under some extraordinary circumstances, where it is in the best interest of the Federal Government and the institution to establish alternative costing arrangements, such arrangements may be worked out with the cognizant Federal agency. 47. Taxes. a. In general, taxes which the organization is required to pay and which are paid or accrued in accordance with GAAP, and payments made to local governments in lieu of taxes which are commensurate with the local government services received are allowable, except for (i) taxes from which exemptions are available to the organization directly or which are available to the organization based on an exemption afforded the Federal Government and in the latter case when the awarding agency makes available the necessary exemption certificates, (ii) special assessments on land which represent capital improvements, and (iii) Federal income taxes. b. Any refund of taxes, and any payment to the organization of interest thereon, which were allowed as award costs, will be credited either as a cost reduction or cash refund, as appropriate, to the Federal Government. 48. Termination costs applicable to sponsored agreements. Termination of awards generally gives rise to the incurrence of costs, or the need for special treatment of costs, which would not have arisen had the Federal award not been terminated. Cost principles covering these items are set forth below. They are to be used in conjunction with the other provisions of this Circular in termination situations. a. The cost of items reasonably usable on the non-profit organization's other work shall not be allowable unless the non-profit organization submits evidence that it would not retain such items at cost without sustaining a loss. In deciding whether such items are reasonably usable on other work of the non-profit organization, the awarding agency should consider the non-profit organization's plans and orders for current and scheduled activity. Contemporaneous purchases of common items by the non-profit organization shall be regarded as evidence that such items are reasonably usable on the non-profit organization's other work. Any acceptance of common items as allocable to the terminated portion of the Federal award shall be limited to the extent that the quantities of such items on hand, in transit, and on order are in excess of the reasonable quantitative requirements of other work. b. If in a particular case, despite all reasonable efforts by the non-profit organization, certain costs cannot be discontinued immediately after the effective date of termination, such costs are generally allowable within the limitations set forth in this Circular, except that any such costs continuing after termination due to the negligent or willful failure of the non-profit organization to discontinue such costs shall be unallowable. c. Loss of useful value of special tooling, machinery, and is generally allowable if: (1) Such special tooling, special machinery, or equipment is not reasonably capable of use in the other work of the non-profit organization, 63

OFT MANUAL: FM Cost Principles SECTION 2 (2) The interest of the Federal Government is protected by transfer of title or by other means deemed appropriate by the awarding agency, and (3) The loss of useful value for any one terminated Federal award is limited to that portion of the acquisition cost which bears the same ratio to the total acquisition cost as the terminated portion of the Federal award bears to the entire terminated Federal award and other Federal awards for which the special tooling, special machinery, or equipment was acquired. d. Rental costs under unexpired leases are generally allowable where clearly shown to have been reasonably necessary for the performance of the terminated Federal award less the residual value of such leases, if: (1) the amount of such rental claimed does not exceed the reasonable use value of the property leased for the period of the Federal award and such further period as may be reasonable, and (2) the non-profit organization makes all reasonable efforts to terminate, assign, settle, or otherwise reduce the cost of such lease. There also may be included the cost of alterations of such leased property, provided such alterations were necessary for the performance of the Federal award, and of reasonable restoration required by the provisions of the lease. e. Settlement expenses including the following are generally allowable: (1) Accounting, legal, clerical, and similar costs reasonably necessary for: (a) The preparation and presentation to the awarding agency of settlement claims and supporting data with respect to the terminated portion of the Federal award, unless the termination is for default (see Subpart.61 of Circular A-110); and (b) The termination and settlement of sub awards. (2) Reasonable costs for the storage, transportation, protection, and disposition of property provided by the Federal Government or acquired or produced for the Federal award, except when grantees or contractors are reimbursed for disposals at a predetermined amount in accordance with Subparts.32 through.37 of Circular A-110. (3) Indirect costs related to salaries and wages incurred as settlement expenses in subparagraphs (1) and (2). Normally, such indirect costs shall be limited to fringe benefits, occupancy cost, and immediate supervision. f. Claims under sub awards, including the allocable portion of claims which are common to the Federal award, and to other work of the non-profit organization are generally allowable. An appropriate share of the non-profit organization's indirect expense may be allocated to the amount of settlements with subcontractors and/or sub grantees, provided that the amount allocated is otherwise consistent with the basic guidelines contained in Attachment A. The indirect expense so allocated shall exclude the same and similar costs claimed directly or indirectly as settlement expenses. 49. Training costs. a. Costs of preparation and maintenance of a program of instruction including but not limited to on-thejob, classroom, and apprenticeship training, designed to increase the vocational effectiveness of employees, including training materials, textbooks, salaries or wages of trainees (excluding overtime compensation which might arise therefrom), and (i) salaries of the director of training and staff when the 64

OFT MANUAL: FM Cost Principles SECTION 2 training program is conducted by the organization; or (ii) tuition and fees when the training is in an institution not operated by the organization, are allowable. b. Costs of part-time education, at an undergraduate or post-graduate college level, including that provided at the organization's own facilities, are allowable only when the course or degree pursued is relative to the field in which the employee is now working or may reasonably be expected to work, and are limited to: (1) Training materials. (2) Textbooks. (3) Fees charges by the educational institution. (4) Tuition charged by the educational institution or, in lieu of tuition, instructors' salaries and the related share of indirect costs of the educational institution to the extent that the sum thereof is not in excess of the tuition which would have been paid to the participating educational institution. (5) Salaries and related costs of instructors who are employees of the organization. (6) Straight-time compensation of each employee for time spent attending classes during working hours not in excess of 156 hours per year and only to the extent that circumstances do not permit the operation of classes or attendance at classes after regular working hours; otherwise, such compensation is unallowable. c. Costs of tuition, fees, training materials, and textbooks (but not subsistence, salary, or any other emoluments) in connection with full-time education, including that provided at the organization's own facilities, at a post-graduate (but not undergraduate) college level, are allowable only when the course or degree pursued is related to the field in which the employee is now working or may reasonably be expected to work, and only where the costs receive the prior approval of the awarding agency. Such costs are limited to the costs attributable to a total period not to exceed one school year for each employee so trained. In unusual cases the period may be extended. d. Costs of attendance of up to 16 weeks per employee per year at specialized programs specifically designed to enhance the effectiveness of executives or managers or to prepare employees for such positions are allowable. Such costs include enrollment fees, training materials, textbooks and related charges, employees' salaries, subsistence, and travel. Costs allowable under this paragraph do not include those for courses that are part of a degree-oriented curriculum, which are allowable only to the extent set forth in subparagraphs b and c. e. Maintenance expense, and normal depreciation or fair rental, on facilities owned or leased by the organization for training purposes are allowable to the extent set forth in paragraphs 11, 27, and 50. f. Contributions or donations to educational or training institutions, including the donation of facilities or other properties, and scholarships or fellowships, are unallowable. g. Training and education costs in excess of those otherwise allowable under subparagraphs b and c may be allowed with prior approval of the awarding agency. To be considered for approval, the organization must demonstrate that such costs are consistently incurred pursuant to an established training and education program, and that the course or degree pursued is relative to the field in which the employee is now working or may reasonably be expected to work. 65

OFT MANUAL: FM Cost Principles SECTION 2 50. Transportation costs. Transportation costs include freight, express, cartage, and postage charges relating either to goods purchased, in process, or delivered. These costs are allowable. When such costs can readily be identified with the items involved, they may be directly charged as transportation costs or added to the cost of such items (see paragraph 28). Where identification with the materials received cannot readily be made, transportation costs may be charged to the appropriate indirect cost accounts if the organization follows a consistent, equitable procedure in this respect. 51. Travel costs. a. General. Travel costs are the expenses for transportation, lodging, subsistence, and related items incurred by employees who are in travel status on official business of the non-profit organization. Such costs may be charged on an actual cost basis, on a per diem or mileage basis in lieu of actual costs incurred, or on a combination of the two, provided the method used is applied to an entire trip and not to selected days of the trip, and results in charges consistent with those normally allowed in like circumstances in the non-profit organization s non-federally sponsored activities. b. Lodging and subsistence. Costs incurred by employees and officers for travel, including costs of lodging, other subsistence, and incidental expenses, shall be considered reasonable and allowable only to the extent such costs do not exceed charges normally allowed by the non-profit organization in its regular operations as the result of the non-profit organization s written travel policy. In the absence of an acceptable, written non-profit organization policy regarding travel costs, the rates and amounts established under subchapter I of Chapter 57, Title 5, United States Code ("Travel and Subsistence Expenses; Mileage Allowances"), or by the Administrator of General Services, or by the President (or his or her designee) pursuant to any provisions of such subchapter shall apply to travel under Federal awards (48 CFR 31.205-46(a)). c. Commercial air travel. (1) Airfare costs in excess of the customary standard commercial airfare (coach or equivalent), Federal Government contract airfare (where authorized and available), or the lowest commercial discount airfare are unallowable except when such accommodations would: (a) require circuitous routing; (b) require travel during unreasonable hours; (c) excessively prolong travel; (d) result in additional costs that would offset the transportation savings; or (e) offer accommodations not reasonably adequate for the traveler s medical needs. The non-profit organization must justify and document these conditions on a case-by-case basis in order for the use of first-class airfare to be allowable in such cases. (2) Unless a pattern of avoidance is detected, the Federal Government will generally not question a nonprofit organization's determinations that customary standard airfare or other discount airfare is unavailable for specific trips if the non-profit organization can demonstrate either of the following: (a) that such airfare was not available in the specific case; or (b) that it is the non-profit organization s overall practice to make routine use of such airfare. d. Air travel by other than commercial carrier. Costs of travel by non-profit organization-owned, -leased, or -chartered aircraft include the cost of lease, charter, operation (including personnel costs), maintenance, depreciation, insurance, and other related costs. The portion of such costs that exceeds the cost of allowable commercial air travel, as provided for in subparagraph] c., is unallowable. e. Foreign travel. Direct charges for foreign travel costs are allowable only when the travel has received prior approval of the awarding agency. Each separate foreign trip must receive such approval. For purposes of this provision, "foreign travel" includes any travel outside Canada, Mexico, the United 66

OFT MANUAL: FM Cost Principles SECTION 2 States, and any United States territories and possessions. However, the term "foreign travel" for a nonprofit organization located in a foreign country means travel outside that country. 52. Trustees. Travel and subsistence costs of trustees (or directors) are allowable. The costs are subject to restrictions regarding lodging, subsistence and air travel costs provided in paragraph 51. 67

OFT MANUAL: FM Budgeting and Planning SECTION 3 What is Budgeting? A budget is a financial document used to project future income and expenses. It is an itemized summary of estimated or intended expenditures for a given period along with proposals for financing them. A budget is a forecast of revenue, expenditure and profit. A budget shows you exactly where your money goes and provides a spending plan that lets you save for the things that are important to you Purpose of Budgeting: The budget is a tool providing targets and direction. Budgets provide control over the immediate environment, help to master the financial aspects of the job and department, and solve problems before they occur. Budgets focus on the importance of evaluating alternative actions before decisions are actually implemented. There are two (often overlapping) reasons for producing a budget. One is to persuade potential investors that your company is a good bet. The other one is to plan your business finances. Budgeting For NGO s: Budget is a term that NGOs often come across when they need to plan and implement a project activity. Besides, we also come across this term again and again when we are in the process of developing a proposal. Any donor funding for NGOs is limited and a proper and planned budget is required to convince the donor to access this funding. Donor agencies also have their limitations and they distribute their financial resources evenly amongst NGOs based not only on their project plans but also according to the budget they present. Budget, in simple terms, means a document where you specify how much money you are going to spend (in other words, expenditure), especially if your organization has received grants. In some cases, as in businesses, budgets can also include the money that the organization is going to generate or income. The latter is important for all NGOs now because managing any organization, including an NGO does not mean just spending we also need to look at how costs can be covered and money can be saved for other activities. Budget development and oversight is a fundamental part of management's responsibility to oversee and improve operations. Corporate and volunteer organizations alike utilize budget practices to manage financial resources on an annual, quarterly, and even project-by-project basis. Many NGOs tend to plan out a budget only when they need to develop a project proposal for a donor agency Planning for budgeting Planning is one of the most important project management and time management techniques. Planning is preparing a sequence of action steps to achieve some specific goal. If you do it e effectively, you can reduce much the necessary time and effort of achieving the goal. A plan is like a map. When following a plan, you can always see how much you have progressed towards your project goal and how far you are from your destination. Knowing where you are is essential for making good decisions on where to go or what to do next. Planning is beneficial because it allows the project team to: 68

OFT MANUAL: FM Budgeting and Planning SECTION 3 Take stock of the current position Identify precisely what is to be achieved Detail the who, what, when, where, why and how of achieving the target. Assess the impact of the plan on your organization and the people within it, and on the outside world. Evaluate whether the effort, costs and implications of achieving the plan are worth the achievement. Consider the control mechanisms (for example reporting, quality or cost control) that are needed to achieve your plan and keep it on course. Myths about Budgets clarified: Budgets cannot be changed Budgets can be modified to some extent. You can diversify your resources and cut your costs. Of course, take prior permission from your donor agency for this. Budgets can be developed overnight Often in our effort to meet proposal deadlines, we develop budgets overnight. This ends up in poor planning and even rejection of proposals. Always take time to build your budget your NGO should live with a budget always! Budgets do not have a basis Budgets should be developed on a certain base. They cannot be developed without any basis. In most cases, the basis should be the previous year s income and expenditure. If applying for a project, look out for the expenses of the project s previous year. Donor funding limitation to be also considered Budget can be developed by a single Budget work is a joint exercise. It is a team work. Involving the entire team is 69

OFT MANUAL: FM Budgeting and Planning SECTION 3 person important to produce an effective budget. Budgets have same formats All budgets do not have same formats. Different budgets are developed for different purposes. If you are writing a proposal, it is a different budget format and if you managing an organization, you will have a different budget format. Similarly, different donor agencies have different budget formats Purpose of budgeting and budgetary control procedures The purpose of budgeting and budgetary control procedures is to: Prepare annual and/or operational budgets To record daily expenditure by the grant recipient budget code To record cumulative expenditure to date by budget code To compare and monitor cumulative expenditure by budget code to the original (or revised) budget allocations from donors These procedures should satisfy the requirements of the donors funding the grant recipient. Information from the budget book can be used in the budget-monitoring sheet for reporting and also for assisting in controlling expenditure. Ideally, the budget book should be maintained on a computer spreadsheet. This makes it easy to update and amend. However, the budget book may be maintained and updated manually. Each budget line should be on a separate page. Procedure for withdrawing amount for budgeted program Check whether activity/expenditure is approved by the line manager Sufficient fund approvals exist The Finance Department need to check for the availability of budget in the respective budget heads for conducting the activity/expenditure Budget and expenditure procedures Principal activities that should be performed: Prepare annual work programme and budget. Prepare operational budgets. Record the original (or revised) budget for the financial year. Post daily expenditure to the budget book, record cumulative expenditure and monitor remaining budget. Obtain donor approval in advance for revisions of budgets 70

OFT MANUAL: FM Budgeting and Planning SECTION 3 Preparing the Budget When preparing an operating budget, nonprofits embark on a thorough and oftentimes painstaking development process. Although nonprofits are expected to create a financial plan that dually represents their service philosophy and the agency's commitment to fiscal accountability. As with most businesses, the mission statement drives operations; therefore, the final budget must fully support its mission and vision statements. Comprehensive budget projections include income, expense, and profit (or loss) estimations. Nonprofit organizations, as do profitable organizations, include an income section to represent any revenue projected for receipt in the upcoming fiscal year. However, amounts included here primarily include any approved grant dollars, community donations, or membership fees. Expenses, conversely, are amounts projected as an outflow of money paid to another person or entity for goods provided or services rendered. Therefore, a nonprofit organization sheltering abused domestic animals might develop a budget that includes revenue received from funders, membership donations as well as any anticipated operational expenses such as veterinarian fees, shelter supplies, and food. (An example of a budget template used by a non-profit can be accessed here). Frequently, a nonprofit organization offering several programs and services has indirect costs that apply to more than one program. These indirect or administrative costs may include professional services, rent, liability insurance, or staff time. Nonprofits often calculate these costs by calculating the percentage of the cost that applies to each program and then uniformly applying the amount based on grant stipulations. Steps in making a budget 1. Gathering financial data. This step involves the development of reasonable assumptions regarding the expected outflows and inflows in the years in question. This includes bank statements, investment accounts, recent utility bills and any information regarding a source of income or expense. The key for this process is to create a monthly average based on historical data or assumptions based on a reasonable source. 2. Recording of all sources of income per month and for the years. This step also required a lot of financial data analysis to back up figures given in the budget as they have to be realistic and prudent. 3. Create a list of monthly expenses. Write down a list of all the expected expenses incurring over the course of a month. This might include office rent, car payments, utilities, entertainment etc. 4. Break expenses into two categories: fixed and variable. Fixed expenses are those that stay relatively the same each month and are necessary for normal operation of business. They included expenses such as internet service, phone bills, trash pickup, credit card payments and so on. These expenses for the most part are essential yet not likely to change in the budget. Variable expenses are the type that will change from month to month and include items such as gasoline, entertainment etc. This category will be important when making adjustments. 5. Total your monthly income and monthly expenses. If the end result shows more income than expenses then it s a good start although it is normal for a business to face some losses in the start. If the expenses are higher than the income or funding available that means some changes will have to be made. 6. Make adjustments to expenses. If all the expenses are accurately identified and they still outnumber the inflows then readjustments will have to be made in order to justify the budget to the donors/ investors. 71

OFT MANUAL: FM Budgeting and Planning SECTION 3 7. Review the budget monthly. It is important to review the budget on a regular basis to make sure that all the activities preformed are within the approved budget. What does USAID say about Budget? Cost proposals must be submitted as a separate section, which is not subject to the page limitation of the program proposal. Cost proposals must be in USD only. USAID/OFDA will review the cost proposal in conjunction with the program proposal for purposes of cost realism. Cost realism is the relationship between the level of resources and their relative cost to the achievement of the performance targets. In addition to cost realism, USAID/OFDA will apply the following criteria to the cost proposal: Are costs allowable Are costs allocable Are costs reasonable and effective Levels of cost sharing or in-kind contributions Contributions of other donors Program income Sufficiency of justifications for any procurement of restricted goods For further information on costs considered allowable, allocable, and reasonable, please refer to 22 CFR 230, Cost Principles for Non-Profit Organizations, which was formerly OMB Circular A-122 http://www.whitehouse.gov/omb/circulars/index.html For further information on program income, refer to 22 CFR 22624, Administration of Assistance Awards to U.S. Non-governmental Organization http://www.access.gpo.gov/nara/cfr/waisidx_06/22cfr226_06.html Detailed/Itemized Budget The detailed and itemized budget should list and account for individual line items within each object class category for each sector objective. Object class categories are logical groupings of costs, such as staff salaries, fringe benefits, travel, capital equipment, supplies, and indirect costs. These sample budgets are strictly illustrative; applicants should use their own dollar figures, rates, and cost allocation methodologies. USAID/OFDA prefers budgets be provided in Excel. Shared costs, meaning costs that are not precisely allocable to a specific objective, may no longer be budgeted as a separate category, as this tends to result in under-reporting on sector-based objectives. Instead, such costs should be allocated to each objective based on estimated utilization. For example, rather than listing office rent as lump sum, applicants should estimate the use of office space toward implementation in each sector, and assign costs to each objective accordingly. Following the award, pursuant to 22 CFR 226.25 (c), U.S. NGOs may shift funds between objectives without approval, although notification of changes is mandatory. For non-u.s. NGOs, the standard provision entitled Revision of Award Budget requires the agreement officer s approval to shift funds between objectives. However, since August 2005, all new awards with non-u.s. NGOs permit shifting of funds between objectives without the agreement officer s approval, subject to concurrence of the OFDA/W Cognizant Technical Officer (CTO). For any recipient, USAID/OFDA has the discretion to impose a 10 percent limit on budget transfers between objectives; however, this restriction is rarely invoked. 72

OFT MANUAL: FM Budgeting and Planning SECTION 3 Budget Narrative The budget narrative justifies proposed expenses and explains how costs were estimated. Applicants should provide their rationale for cost development, such as the methodology and assumptions used to determine individual costs, i.e., engineering cost estimates, actual current costs incurred, costs obtained through tenders or bids, catalog prices, or published salary tables. A thorough budget narrative will expedite the cost proposal review and prevent NGO field staff from having to revisit the proposal and provide justifications following proposal submission. For ease of review, budget narratives should follow the order of line items in the detailed budget (top to bottom), rather than by objective (left to right). These narratives are strictly illustrative, and are based on the sample detailed budgets. Applicants should use their own rationale based on their proposed program design, associated inputs, and detailed budget. 73

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Why NGOs maintain accounting system? Credibility The robust accounting system has paramount significance in maintaining the fiduciary relationship among key stakeholders of NGO named as governing body, funding agencies, regulators and beneficiaries. Information Accounting system provides information; Stewardship of entrusted financial resources Spending rate / program / project implementation rates Financial position and health of NGO Legal Requirement Under applicable NGO registration statutes named as Societies Registration Act 1860, Trust Act 1882, Voluntary Social Welfare Agencies (Registration & Control) Ordinance 1961and Companies Ordinance 1984 require maintaining transparent accounting records. Planning and control The accounting information enables the decision makers to evaluate past results and assess spending trends during the previous planning periods. The historical accounting data helps the financial planners to drive reliable cost estimates for budgeting purposes. The updated and accurate accounting information also enables the governing body to exercise due control over the utilization of financial resources. 74

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Accounting System in the Context of NGO Sector NGO Funding from donor agencies and internal sources of funds Organizational, Program and Project activities Financial Transactions Accounting System Financial Accountability Statement Donor agencies Governing Body Regulators Beneficiaries 75

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Overview of Accounting System Definition of Accounting System Gather Recording Classification Summarization Analyzing Supporting documentation General Ledger / Nominal Ledger Trial balance Financial statements Cash vouchers Bank vouchers Journal vouchers Methods of Accounting Single Entry System Double Entry System Cash basis of Accounting Basis of accounting Accrual basis of Accounting 76

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Definition of accounting system It is the process to gather, record, classify, summarize and analyze the financial transactions and events 3.4.1 Qualities of accounting information Relevant: To fulfill the information needs of governing body, donor agencies, regulators, beneficiaries, general public and employees Reliable: Reliable financial information should be incorporated in the accounting system Complete: The complete records of program / project activities should be maintained for accountability and integrity purposes Accurate: Accurate and update data should be entered in the accounting system Objective: Accounting system procedures should prevent the element of management bias Comparable: Accounting system should enable the responsible manager to perform analytical procedures on the project implementation cost Cost effective: Accounting information system should meet the cost and benefit criteria User-friendly: Accounting system should be designed as per the knowledge and experience of finance and program team Timely: Accounting information system should fulfill the submission deadlines of donor agencies and regulators USG and Agency regulations such as 22 CFR 226.21 contains guidelines and instructions to maintain accurate, complete, updated accounting information for accountability purposes 77

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Supporting documentation Every NGO should keep files of the following original documents to support every transaction taking place: Voucher for money received Voucher for money paid out Invoices certified and stamped as paid Bank paying-in vouchers stamped and dated when money is deposited bank statements Journal vouchers for one-off adjustments and non-cash transactions. With these documents on file it will enable the accountants to record the financial transactions in appropriate manner. 3.6.1 Vouchers 78

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Types of vouchers Methods of Accounting Methods of Accounting Financial transactions are recorded in the petty cash and bank books Every transaction has a double or dual effect on the operations of NGO. The second effect is equal and opposite of the first Rule: Every debit has a matching credit such that they sum to zero The donor agencies encourage NGOs to adopt double entry accounting system for record organizational, program and project transactions 79

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Definitions of elements of accounting information Assets An asset is a resource controlled by the NGO as a result of past events and from which future economic benefits are expected to flow to the organization. Liabilities A liability is a present obligation of the NGO arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Accumulated Funds Accumulated Funds are the residual interest in the assets of the entity after deducting all its liabilities. Income Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in accumulated funds Expenses Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence s of liabilities that result in decreases in accumulated funds. Basis of Accounting There are two main bases for keeping accounts: Cash accounting Accruals accounting The two methods differ in a number of ways but the crucial difference is in how they deal with the timing of the two types of financial transaction: Cash transactions which have no time delay since the trading and exchange of monies takes place simultaneously. Credit transactions which involve a time lag between the contract and payment of money for the goods or services. Cash Accounting This is the simplest way to keep accounting records and does not require advanced Bookkeeping skills to maintain. The main features are: 80

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Payment transactions are recorded in a Bank (or Cash) Book as and when they are made and incoming transactions as and when received. The system takes no account of time lags and any bills which might be outstanding. The system does not automatically maintain a record of any money owed by (liabilities) or to (assets) the organization. The system cannot record non-cash transactions such as a donation in kind or depreciation. When summarized, the records produce a Receipts and Payments Account for a given period. This simply shows the movement of cash in and out of the organization and the cash balances at any given time. Accruals Accounting This involves double entry bookkeeping which refers to the dual aspects of recording financial transactions to recognize that there are always two parties involved: the giver and The receiver. The dual aspects are referred to as debits and credits. This system is more advanced and requires accountancy skills to maintain. Expenses are recorded in a General Ledger as they are incurred, rather than when The bill is actually paid; and when income is truly earned (i.e. we are 100% certain it will be paid) rather than when received. By recognizing financial obligations when they occur, not when they are paid or received, this overcomes the problem of time lags, giving a truer picture of the financial position. The system can deal with all types of transactions and adjustments. The system automatically builds in up-to-date information on assets and liabilities. These records provide an Income and Expenditure Account summarizing all income and expenditure committed during a given period; and a Balance Sheet which demonstrates, amongst other things, moneys owed to and by the organization on the last day of the period. Comparison of Cash Accounting and Accrual Accounting Cash Accounting Accrual Accounting Accounting system Single entry Double entry Transaction types Cash Cash and credit Terminology Receipts and Payments Income and Expenditure Main Book of Account Petty and cash book General Ledger Skill level Basic Advanced Non-cash transactions No Yes Assets and liabilities No Yes Reports Receipts and Payment Report Income and Expenditure Report 81

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 General Ledger This is a central record which pulls together basic bookkeeping information from the main working books of account (Bank Book, Petty Cash Book, Grant and Purchase Ledgers). It is like a series of pigeonholes used to sort basic financial information and is especially useful when an organization has several projects and different donors requiring different reports. The General (or Nominal) Ledger has one page for each category of income, expenditure, assets and liabilities and information is posted from the other accounting books into each pigeonhole. It plays a central role in the double-entry bookkeeping system and is the basis for the Trial Balance, the starting point for preparation of financial statements. Other Ledgers Other elements in a full-bookkeeping system include: Grants ledger and sales day book Purchase ledger and purchase day book Stock ledger Journal These, together with the Bank Book and Petty Cash Book are the day-to-day working accounts books. It is quite possible to set up a General Ledger without these additional ledgers; the choice will depend on the activities of your organization. The Journal is used to record unusual, one-off transactions which cannot be recorded easily in other books of accounts. These will include non-cash transactions (such as depreciation and donations-in-kind), adjustments and corrections. A journal entry follows the rules of double entry and will always include entries to at least two accounts. For example, a donation-in-kind in the form of rent-free office space would be recorded as income under Donations and expenditure under Office Rent. Example to under standard accounting system In December 2012, the ABC NGO succeeded to obtain funds from USAID under the terms and conditions of grant agreement and approved budget for one year. The ABC management has been prepared following chart of accounts as per the approved project budget lines Chart of Accounts Budget line Account title Account code Type of account Focus group discussions Focus group discussions 1001 Expense Seminars Seminars 1002 Expense Follow up workshops Follow up workshops 1003 Expense Salaries and fringe benefits Salaries and fringe benefits 1004 Expense Audit fee Audit fee 1005 Expense Consultancy fee Consultancy fee 1006 Expense Utilities Utilities 1007 Expense Office rent Office supplies 1008 Expense 82

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Car rentals Car rentals 1009 Expense Grant income 2000 Income Restricted funds 3000 Liability Payable to suppliers 3001 Liability Bank account 4001 Asset Cash in hand account 4002 Asset Prepayments 4003 Asset Accounting policies The ABC NGO management has been recognizing the financial transactions of project as per the generally accepted accounting principles-gaap Details of occurrence of financial transactions in the first month of project implementation The following USAID transactions were occurred in the month of January 2013 SR no Date of Transaction Description Type of transaction Amount Rupees 1 07-01-2013 Funds received from USAID Bank 3,100,000 2 11-01-2013 Cost incurred for Focus group discussion Bank 425,000 3 17-01-2013 Cost incurred for One day seminar Credit 1,200,000 4 20-01-2013 Cash drawn from bank for petty expenses Bank 30,000 5 22-01-2013 Utility bills Cash 14,500 6 25-01-2013 Office supplies Cash 8,000 7 31-01-2013 Paid office rent for 6 months @ Rs 50,000 Bank 300,000 from 1 ST February to 31 st July 2013 8 31-01-2013 Accrual for monthly vehicle rentals of Jan 2013 Credit 50,000 9 31-01-2013 Consultancy fee paid for report writing Bank 250,000 10 31-01-2013 Grant income recognized on the basis of project implementation cost Non-cash transaction 1,947,500 Section A: Recording of financial transactions Transaction # 01: Funds received from USAID in the designated bank account ABC NGO Bank Receipt Voucher-BRV Voucher date: 07-01-2013 Voucher no: BRV 01/01/13 Account code Description Debit Credit Rupees Rupees 4001 Bank account 3,100,000 3000 Restricted funds account 3,100,000 Funds received from USAID Prepared by Checked by Approved by Signatures Signatures Signatures 83

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Transaction # 02: Program activity cost paid through bank channels ABC NGO Transaction # 3: Purchase of goods and services on credit Bank Payment Voucher-BPV Voucher date: 11-01-2013 Voucher ABC NGO no: BPV 01/01/13 Account code Description Debit Credit Journal Voucher-JV Rupees Rupees Voucher 1001 date: 17-01-2013 Focus group discussion meeting Voucher account no: JV 01/01/13 425,000 Account 4001 code Description Bank Account Debit 425,000 Credit Rupees Rupees 1002 One Funds day received seminar from USAID 1,200,000 3001 Payable to suppliers 1,200,000 Prepared by Checked by Approved by Signatures Cost of program activity not Signatures yet paid to supplier Signatures Prepared by Checked by Approved by Signatures Signatures Signatures Transaction # 4: Cash drawn from bank for petty expenses ABC NGO Bank Payment Voucher Voucher date: 20-01-2013 Voucher no: BPV 02/01/13 Account code Description Debit Credit Rupees Rupees 4002 Cash in hand account 30,000 4001 Bank account 30,000 Cash withdrawn from bank for petty expenses Prepared by Checked by Approved by Signatures Signatures Signatures Transaction # 5: Payment of utility bills ABC NGO Cash Payment Voucher-CPV Voucher date:22-01-2013 Voucher no: CPV 01/01-13 Account code Description Debit Credit 84 Rupees Rupees 1007 Utilities account 14,500 4002 Cash in hand account 14,500

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Transaction # 6: Office supplies purchased ABC NGO Cash Payment Voucher-CPV Voucher date: 25-01-2013 Voucher no: CPV 02/01-13 Account code Description Debit Credit Rupees Rupees 1008 Office supplies account 8,000 4002 Cash in hand account 8,000 Prepared by Checked by Approved by Signatures Signatures Signatures Transaction # 7: Paid office rent for 6 months @ Rs 50,000 per month ABC NGO Bank Payment Voucher-BPV Voucher date:31-01-2013 Voucher no: BPV 03-01-13 Account code Description Debit Credit Rupees Rupees 4003 Prepayments account 300,000 4001 Bank account 300,000 Prepared by Checked by Approved by Signatures Signatures Signatures Transaction # 8: Accruals for monthly vehicle rentals ABC NGO Journal Voucher-JV Voucher date: 31-01-2013 Voucher no: JV 02/01-13 Account code Description Debit Credit Rupees Rupees 1009 Vehicle rentals account 50,000 3001 Payable to suppliers 50,000 Prepared by Checked by 85 Approved by Signatures Signatures Signatures

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Transaction # 9: Consultancy fee paid for report writing ABC NGO Bank Payment Voucher-BPV Voucher date:31-01-2013 Voucher no: BPV 04-01-13 Account code Description Debit Credit Rupees Rupees 1006 Consultancy fee account 250,000 4001 Bank account 250,000 Prepared by Checked by Approved by Signatures Signatures Signatures Transaction # 10: Recognition of grant income on the basis of project implementation cost ABC NGO Journal Voucher-JV Voucher date: 31-01-2013 Voucher no: JV 03/01-13 Account Description Debit Credit code Rupees Rupees 3000 Restricted funds account 1,947,500 2000 Grant income account 1,947,500 Details of project implementation cost in the month of January 2013 Focus group discussion: Rs 425,000 Seminar cost : Rs 1,200,000 Utility bills: Rs 14,500 Office expenses: Rs 8,000 Vehicle rentals: Rs 50,000 Consultancy fee: Rs 250,000 Prepared by Checked by Approved by Signatures Signatures Signatures 86

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Section B: Posting of transactions in Ledgers Ledger of Restricted Funds ABC NGO Account title: Restricted funds Account code: 3000 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 7-01-13 BRV 01/01-13 Fund received 3,100,000 3,100,000 31-01-13 JV 03/01-13 Grant recognition 1,947,500 1,152,500 Ledger of Focus group discussion meeting ABC NGO Account title: Grant income Account code: 2000 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 31-01-13 JV 03/01-13 Grant income recognized 1,947,500 1,947,500 Ledger of Cash at bank ABC NGO Account title: Bank account Account code: 4001 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees Opening balance - 07-01-13 BRV 01/01-03 Funds received 3,100,000 3,100,000 11-01-13 BPV 01/01-13 Program cost paid 425,000 2,675,000 20-01-13 BPV 02/01-13 Cash withdrawn 30,000 2,645,000 31-01-13 BPV 03/01-13 Prepaid office rent 300,000 2,345,000 31-01-13 BPV 04/01-13 Consultancy fee paid 250,000 2,095,000 Ledger of Focus group discussion meeting ABC NGO Account title: Focus group discussion meeting Account code: 1001 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 11-01-13 BPV 01/01-13 Cost of program activity 425,000 425,000 87

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Ledger of Seminar ABC NGO Account title: Seminar account Account code: 1002 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 17-01-13 JV 01/01-13 Program activity on credit 1,200,000 1,200,000 Ledger of payable to suppliers ABC NGO Account title: Payable to supplier Account code: 3001 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 17-01-13 JV 01/01-13 Program activity on credit 1,200,000 1,200,000 31-01-13 JV 02/01-13 Accruals 50,000 1,250,000 Ledger of Cash in hand ABC NGO Account title: Cash in hand Account code: 4002 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 20-01-13 BPV 02/01-13 Cash drawn from bank 30,000 30,000 22-01-13 CPV 01/01-13 Utility bills paid 14,500 15,500 25-01-13 CPV 02/01-13 Office supplies paid 8,000 7,500 Ledger of Utilities ABC NGO Account title: Utilities Account code: 1007 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 22-01-13 CPV 01/01-13 Utility bills paid 88 14,500 14,500

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Ledger of Office supplies ABC NGO Account title: Office supplies Account code: 1008 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 25-01-13 CPV 02/01-13 Office supplies paid 8,000 8,000 Ledger of Prepayments ABC NGO Account title: Prepayments Account code: 4003 Ledger Date of Vehicle Voucher rentals no Description Debit Credit Balance Rupees Rupees Rupees 31-01-13 BPV 03/01-13 Prepaid office rent ABC NGO 300,000 300,000 Account title: Vehicle rentals Account code: 1009 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 31-01-13 JV 02/01-13 Accruals for rentals 50,000 50,000 Ledger of consultancy fee ABC NGO Account title: Consultancy fee Account code: 1006 Date Voucher no Description Debit Credit Balance Rupees Rupees Rupees 31-01-13 BPV 04-01-13 250,000 250,000 89

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Section C-Summarization of ledgers in the form of Trial Balance ABC NGO Trial balance for the period ended 31 st January 2013 Account code Account title Type of Debit Credit account Rupees Rupees 3000 Restricted funds account Liability 1,152,500 2000 Grant income account Income 1,947,500 4001 Bank account Asset 2,095,000 1001 Focus group discussion meeting Expense 425,000 1002 Seminar account Expense 1,200,000 3001 Payable to supplier account Liability 1,250,000 4002 Cash in hand account Asset 7,500 1007 Utilities account Expense 14,500 1008 Office supplies account Expense 8,000 4003 Prepayments account Asset 300,000 1009 Vehicle rentals account Expense 50,000 1006 Consultancy fee account Expense 250,000 Totals 4,350,000 4,350,000 90

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Section D-Financial statements Income and expenditure statement For the period ended 31 st January 2013 Rupees Income Grant income 1,947,500 Expenditures Focus group discussion meetings expense 425,000 Seminar expense 1,200,000 Utilities expense 14,500 Office supplies expense 8,000 Vehicle rentals expense 50,000 Consultancy fee expense 250,000 Total expenses 1,947,500 Surplus / (deficit) for the period ended - Balance sheet As on 31 st January 2013 Rupees Assets Non-current assets Fixed assets - Long term investments - - Current assets Prepaid office rent 300,000 Cash in hand 7,500 Cash at bank 2,095,000 Total assets 2,402,500 Funds and liabilities Accumulated funds 1,152,500 Non-current liabilities - Current liabilities Payable to suppliers 1,250,000 Total funds and liabilities 91 2,402,500

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 01 Exercise Transactions SR no Description Amount Rupees 1 Funds received from donor agency 500,000 2 Buy a car 55,000 3 Buy office supplies 45,000 4 Pay salaries 20,000 5 Pay office rent 40,000 6 Purchase office equipment on credit basis 58,000 7 Hire vehicle on credit basis 30,000 Required: Record transaction in double entry format Prepare Ledgers of financial transactions Prepare Trial Balance Financial Reporting System Overview For Fixed Obligation Grants grantee has to submit an invoice stating the milestones achieved along with its value for reimbursement. Reporting is the primary way you demonstrate that you are meeting the expectations of your award and complying with USAID requirements. Timely and accurate reporting contributes to building a strong relationship with the donor and providing evidence of the impact of your program. Often the day-to-day demands of running a program consume significant time and energy, and writing reports feels like a distraction from attending to program needs. However, in addition to being an important responsibility under the Cooperative Agreement, reporting can enhance the daily operations of your programs by helping you examine the financial health, programmatic strength, and performance of your organization and activities. It also gives you the opportunity to bolster ties with your partners. It is advisable to develop a reporting culture within your program by ensuring that all staff have the right tools and training to contribute appropriately. By viewing reporting as a management tool and process that can improve your ability to serve your beneficiaries and meet donor needs and expectations, you will come to experience its benefits. 92

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 Key Terms and Acronyms Allowable Cost an incurred cost determined to be an acceptable charge. Audit An independent review and examination of system records and activities. Burn Rate The rate at which an organization spends its award funds on a periodic basis, typically monthly. Finding The answer to an audit objective that is supported by sufficient, competent, and relevant evidence. Fiscal Year Sometimes called a financial year or budget year, a period used for calculating annual ( yearly ) financial statements in businesses and other organizations. It may or may not correspond to the calendar year, that is, January 1 through December 31. The USG fiscal year covers a 12-month period that begins October 1 and ends the following September 30. FMO USAID s Financial Management Office. Foreign Tax Report The report that all USG recipients must fill out annually to report the Value-Added Tax (VAT) that was paid to the host government. The reports are used to ensure that U.S. foreign assistance is not being taxed. Management Decision The evaluation of a recommendation by management and a decision on an appropriate course of action. Pipeline The amount of funds obligated but not yet spent, which is calculated by adding all funds spent to date and subtracting that amount from the total obligation to date. QPR Quarterly Performance Report. Five Tips for Outstanding Reporting 1. Do not be afraid to tell the truth. It is exciting and rewarding to report on your program s successes, but sometimes your reports will have some bad news, too. Do not try to hide the challenges you are facing. Your Agreement Officer s Technical Representative (AOTR) is on your side and wants to help, but he or she can only do so if you provide an honest assessment. Program managers who demonstrate they can overcome unforeseen challenges make positive impressions on donors. 2. Develop a reporting calendar and timeline. To ensure you have plenty of time to assemble good reports, list all of the requirements on a calendar and plan ahead so you will not be rushed. Make sure all staff and sub recipients who contribute to each report are aware of the timeline and due date. 3. Engage sub recipients early. Most reports require prime partners to gather information from sub recipients. When creating your reporting calendar, allow enough time for your sub recipients to give you meaningful input. This not only leads to a better report, but it also builds sub recipients capacity by involving them in the self-evaluation aspects of reporting and holding them accountable for data gathering and deadlines. Be sure to close the loop with sub recipients by sending them copies of the reports you submit to USAID. 4. Tell a consistent story in all of your reports. 93

OFT MANUAL: FM Accounting and Reporting Systems SECTION 4 There is a negative disconnect if your performance reports describe a financially healthy program, but your Federal Financial Reports show you are going through your funding more quickly than expected. All of your reports should be linked together, so that when your AOTR reviews your program documentation, he or she gets an accurate picture. Quantify all of your conclusions with data, and show how your program is meeting targets and staying on budget. This allows your AOTR to conclude that your program is doing well. 5. Do not surprise your AOTR or AO. Reports document various aspects of your program they are not the primary means of communicating with your funding agency. You should discuss major challenges with budget, staff, partnerships, or implementation strategies with your AOTR first, and document them later in your reports. 94

OFT MANUAL: FM Cash Management SECTION 5 What is Cash Management? Cash management is a broad term that covers a number of functions that help organizations to process receipts and payments in an organized and efficient manner. Overview of Cash Management in the Context of NGO Sector NGO Funding from donor agencies Organizational and Project Bank Accounts Organizational, Program and Project activities Internal Sources of Cash flows Cash Transactions Obligated funds Vs Approved Budgets Cash Management Objectives of Cash Management To ensure availability of sufficient cash for effective and efficient implementation of Program / Project To ensure utilization of cash as per grant agreements approved project proposal and budgets To develop correlation of cash management procedures with planning and monitoring systems To identify cash surplus and deficit at appropriate point of time 95

OFT MANUAL: FM Cash Management SECTION 5 Overview of cash Forecast and Program/Project Efficiency Funding Agency Project proposal Cash Resources Cash Forecast NGO Suppliers of services Suppliers of goods Program / Project target areas Beneficiaries of Program / Project 96

OFT MANUAL: FM Cash Management SECTION 5 Overview of preparation process of cash flow forecast / cash Budget Approved project proposal, budgets and donor agreements Funding Grid Obligated funds Vs Budgets Program / Project implementation plan Activity Budgets Master Budget Cash Forecast 97

OFT MANUAL: FM Cash Management SECTION 5 Format of Cash Budget / Cash Flow Forecast The cash budget is an essential element of cash management. The standard format of cash budget is mentioned below. 1 st Quarter 2 nd Quarter 3 rd Quarter 4 th Quarter Oct-Dec Jan-Mar Apr-Jun Jul-Sept Rs Rs Rs Rs Opening balance XXX XXX XXX XXX Cash inflows Grants XXX XXX XXX XXX Interest income XXX XXX XXX XXX Rental income XXX XXX XXX XXX Total cash inflows XXX XXX XXX XXX Cash outflows Salaries (XXX) (XXX) (XXX) (XXX) Fringe benefits (XXX) (XXX) (XXX) (XXX) Program activities (XXX) (XXX) (XXX) (XXX) Capital Expenditure (XXX) (XXX) (XXX) (XXX) Other direct cost (XXX) (XXX) (XXX) (XXX) Total cash outflows (XXX) (XXX) (XXX) (XXX) Closing Balance XXX XXX XXX XXX Under USAID regulation ADS 636, cash budget is imperative to obtain Program funded advances from agency. 98

OFT MANUAL: FM Cash Management SECTION 5 101Example The Program & Financial Planning team of Star NGO has prepared annual budget for the year ended 30 th September 2013 and its extracts are mentioned below Budget information Average monthly program activities cost Rs 2,500,000 Monthly salary expense Rs 1,200,000 NGO plans to purchase vehicle Rs 4,500,000 in the month of July 2013 Six advance office rent Rs 600,000 will be paid to Land Lord on 1-10-2012 and 1-04-2013 Monthly internet fee Rs 85,000 Monthly fuel cost Rs 250,000 Monthly security guard fee: Rs 32,000 Monthly vehicle rental cost Rs 100,000 Liquidity and other information Planning period: 1-10-2012 to 30-09-2013 Opening cash and bank balance as at 1-10-2012: Rs 8,000,000 Donor will disburse funds Rs 10,000,000 on 31 Dec 2012, 31 March 2013, 30 June 2013 and 30 Sept 2013 during the planning period. Required: Prepare annual cash budget for the planning period ended 30 th September 2013. The cash budget should be divided into quarters of 90 days each. 99

OFT MANUAL: FM Cash Management SECTION 5 Solution of Example 101 Star NGO Cash Flow Forecast Planning period: 1-10-2012 to 30-09-2013 1 st Quarter 2 nd Quarter 3 rd Quarter 4 th Quarter Oct-Dec Jan-Mar Apr-Jun Jul-Sept Rs Rs Rs Rs Opening balance 8,000,000 4,899,000 2,398,000 (703,000) Cash inflows Grants 10,000,000 10,000,000 10,000,000 10,000,000 Total cash inflows Cash outflows Program activities (7,500,000) (7,500,000) (7,500,000) (7,500,000) Salaries (3,600,000) (3,600,000) (3,600,000) (3,600,000) Capital expenditures (4,500,000) Office Rent (600,000) (600,000) Internet fee (255,000) (255,000) (255,000) (255,000) Fuel cost (750,000) (750,000) (750,000) (750,000) Security fee (96,000) (96,000) (96,000) (96,000) Vehicle rental cost (300,000) (300,000) (300,000) (300,000) Total cash outflows (13,101,000) (12,501,000) (13,101,000) (17,001,000) Closing Balance 4,899,000 2,398,000 (703,000) (7,704,000) 001 Exercise In the light of solution of example 101, please suggest appropriate course of action to governing body to deal with negative cash flow in the 3 rd and 4 th quarter of planning period. 100

OFT MANUAL: FM Cash Management SECTION 5 002Exercise The Program & Financial Planning team of Star NGO has prepared annual budget for the year ended 30 th September 2013 and its extracts stated as under Budget information Average monthly program activities cost Rs 3,500,000 Monthly salary expense Rs 1,800,000 NGO plans to purchase vehicle Rs 6,500,000 in the month of July 2013 Six advance office rent Rs 1,600,000 will be paid to Land Lord on 1-10-2012 and 1-04-2013 Monthly internet fee Rs 185,000 Monthly fuel cost Rs 350,000 Monthly security guard fee: Rs 74,000 Monthly vehicle rental cost Rs 500,000 Liquidity and other information Planning period: 1-10-2012 to 30-09-2013 Opening cash and bank balance as at 1-10-2012: Rs 12,000,000 Donor will disburse funds Rs 15,000,000 on 31 Dec 2012, 31 March 2013, 30 June 2013 and 30 Sept 2013 respectively Required: Prepare annual cash budget for the planning period ended 30 th September 2013. The cash budget should be divided into quarters of 90 days each. 101

OFT MANUAL: FM Cash Management SECTION 5 Controls over Actual Cash Flows The management exercise control over actual cash flow through petty cash book, bank book and bank reconciliation statement. Petty cash book There are two ways of keeping petty cash: fixed float or imprest system variable or non-imprest system Fixed Float or Imprest Method With the imprest system you have a fixed float of, say, Rs 25,000 and when the cash balance gets low, you top up the float by exactly the same amount that you have spent since the float was last reimbursed. Example: Receipts/vouchers for cash spent total: Rs 22,000 Cash remaining in cash box counted: Rs 3,000 TOTAL FLOAT: Rs 25,000 Reimbursement cheque written for: Rs 22,000 An advantage of this system is that at any time you count the money plus vouchers, they should always add up to the fixed float amount. Also, it is much easier to incorporate petty cash spending into the accounts as the reimbursement cheque is entered in the analysed Bank Book. 102

OFT MANUAL: FM Cash Management SECTION 5 Variable float or non-imprest method An alternative is to draw cash from the bank in round sums as required. Daily cash count The daily cash count should be performed to reconcile the cash in hand balance as per physical cash count and petty cash book. Format of cash count sheet Star NGO Cash count sheet Date of cash count: 26-11-2012 Time of cash count: 6:00 pm Denomination Quantity Amount Rupees 5,000 2 10,000 1,000 1 1,000 500 1 500 100 5 500 50 4 200 20 5 100 10 10 100 5 2 10 Coins 100 Cash in hand as per physical count 12,510 Cash in hand as per petty cash book 12,510 Difference Surplus / (Short) Nil Signatures of responsible officials Physical cash counted by Manager Finance Cash count sheet reviewed by Director Finance Bank Book The Bank Book or Cash Book or Cash Analysis Book is the main book of account for recording bank transactions (ie cash transactions). In the NGO sector the separate bank account has been opened for each project as per donor regulations. The separate bank account provides requisite assurance to funding agencies 103

OFT MANUAL: FM Cash Management SECTION 5 regarding the transparency and accountability pertains to the utilization of funds for the accomplishment of project objectives. 003Exercise Transactions SR no Description Amount Rupees 1 Funds received from donor agency 50,000,000 2 Buy a car 5,000,000 3 Buy office supplies 45,000 4 Pay salaries 3,300,000 5 Pay office rent 200,000 6 Pay security guard fee 30,000 7 Buy Laptops 450,000 8 Pay honorarium to resource persons 150,000 9 Pay medical reimbursement to employees 35,000 10 Pay staff development allowance to employees 100,000 11 Buy generators 2,500,000 12 Pay printing cost of annual News Letter 800,000 13 Pay office renovation and refurbishment 400,000 14 Pay vehicle rentals 125,000 15 Pay post paid mobile charges to Telenor 250,000 104

OFT MANUAL: FM Cash Management SECTION 5 Format of Bank Reconciliation Statement Star NGO Bank Reconciliation Statement For the month of November 2012 Bank Name: Muslim Commercial Bank Limited, Bank Account #: 9010349726 GL Account code of Bank Book: 1024, Currency code: PKR Opening balance as per bank book Add deposits Deduct period disbursements Ending balance as per bank book xxx xxx (xxx) xxx Balance as per bank statement xxx Deduct outstanding cheques (xxx) Add outstanding deposits xxx Other reconciling items xxx Adjusted balance xxx Difference between adjusted balance and bank book - Area of responsibility Designation Signatures Prepared by Finance Officer Reviewed by Manager Finance Approved by Citizen Chief of Voice Party Project 105

OFT MANUAL: FM Cash Management SECTION 5 Purpose of bank reconciliation statement To check the accuracy of cash at bank by reconciling the bank balance as per bank book and bank statement Bank statement The bank prepares statements for its clients from its own point of view. The bank statement enables the managers to cross verify the cash inflows and outflows during the period under review. Reasons of differences Timing differences Transactions in bank statement not on bank book Errors Examples of differences Timing differences Outstanding cheques Out deposits / lodgments Items on bank statement not in bank book Bank charges Standing orders Direct debits Direct credits Dishonored cheques Errors Bank book errors Bank statement errors 1. Casting errors 2. Transpositions 3. Omissions 4. Duplications Cheques may be dishonored due to following reasons Posted dated cheques Stale cheques Discrepancy in writing amounts[narrative and numerical] Stop payment instructions to bank from payer Insufficient funds in the bank account of payer Direct debits: An authority given by NGO management to third party to debit the payer s bank account on specified date. 106

OFT MANUAL: FM Cash Management SECTION 5 Standing orders: Instructions given by NGO management to bank to pay fixed amount on predefined date to third party. Procedures for the preparation of bank reconciliation statement 1. Monthly bank reconciliation statement of each bank account should be prepared, reviewed and approved by relevant responsible officials. 2. Compare deposits listed in the bank statement with the deposits shown in the bank book. Any deposits not yet recorded by the bank are deposits in transit and should be added to the balance shown in the bank statement. 3. Compare each cheque on bank statement with the corresponding entry in the bank book. Any cheque issued but not yet paid by the bank should be listed as outstanding cheque to be deducted from the balance reported in the bank statement. 4. Deduct to the balance any credit memoranda issued by the bank that have not been recorded by the depositor. 5. Make appropriate adjustments to correct any errors in either the bank statement or bank book. 6. Determine that the adjusted balance of the bank statement is equal to the bank book balance. 102Example The Star NGO has opened separate bank for Democratic Education Project in Muslim Commercial Bank Ltd. The Manager Finance presented following bank book for the month of November 2012 to Director Finance and Chief of Party for review purposes Debit Credit Balance Rs Rs Rs Funds received from donor agency 50,000,000 50,000,000 Buy a car 5,000,000 45,000,000 Buy office supplies 45,000 44,955,000 Pay salaries 3,300,000 41,655,000 Pay office rent 200,000 41,455,000 Pay security guard fee 30,000 41,425,000 Buy Laptops 450,000 40,975,000 Pay honorarium to resource persons 150,000 40,825,000 Pay medical reimbursement to employees 35,000 40,790,000 Pay staff development allowance to employees 100,000 40,690,000 Buy generators 2,500,000 38,190,000 Pay printing cost of annual News Letter 800,000 37,390,000 Pay office renovation and refurbishment 400,000 36,990,000 Pay vehicle rentals 125,000 36,865,000 Pay paid mobile charges to Telenor 250,000 36,615,000 Total 50,000,000 13,385,000 Finance officer also obtained bank statement for the month of November 2012 from Muslim Commercial Bank Ltd. The Finance Officer identified following difference between bank book and bank statement. Suppliers of generator, laptop and office supplies have not yet presented cheques to bank for payment Cheque of telenor was dishonored due to discrepancy in writing amounts in narration and numbers Bank has credited bank profit of Rs 320,000 but it is not recorded in the bank book 107

OFT MANUAL: FM Cash Management SECTION 5 Bank has deducted bank charges on cash withdrawals of Rs 55,000 but it is also not accounted in the bank book Balance as per bank statement as at 30 th November 2012: Rs 40,125,000 Required: Director Finance instructed manager finance to prepare bank reconciliation statement for review and approval purposes Solution of Example 102 Star NGO Bank Reconciliation Statement For the month of November 2012 GL code 1050168 Currency Code PKR Bank Name Muslim Commercial Bank Ltd Bank Account No 7A-8506750 Amount Opening balance as per bank book Nil Add deposits 50,000,000 Deduct period disbursements 13,385,000 End balance as per bank book 36,615,000 Balance as per bank statement as at 30-11-2012 40,125,000 Deduct outstanding cheques (3,245,000) Add outstanding deposits - Other reconciling items Bank charges 55,000 Bank profits (320,000) Adjusted Balance 36,615,000 Difference between adjusted balance and bank book Nil Signatures of responsible personnel Area of responsibility Designation Signatures Dated Prepared by Manager Finance 03-12-2012 Reviewed by Director Finance 03-12-2012 Approved Chief of Party 03-12-2012 108

OFT MANUAL: FM Cash Management SECTION 5 003Exercise The XYZ NGO has opened separate bank for Democratic Education Project in ASKARI Commercial Bank Ltd. The Manager Finance presented following bank book for the month of November 2012 to Director Finance and Chief of Party for review purposes Debit Credit Balance Rs Rs Rs Funds received from donor agency 75,000,000 75,000,000 Buy a car 8,000,000 67,000,000 Buy office supplies 178,000 66,822,000 Pay salaries 6,750,000 60,072,000 Pay office rent 800,000 59,272,000 Pay security guard fee 125,000 59,147,000 Buy Laptops 950,000 58,197,000 Pay honorarium to resource persons 350,000 57,847,000 Pay medical reimbursement to employees 68,000 57,779,000 Pay staff development allowance to employees 1,250,000 56,529,000 Buy generators 5,000,000 51,529,000 Pay printing cost of annual News Letter 1,700,000 49,829,000 Pay office renovation and refurbishment 1,400,000 48,429,000 Pay vehicle rentals 2,300,000 46,129,000 Pay paid mobile charges to Telenor 670,000 45,459,000 Total 75,000,000 29,541,000 Finance officer also obtained bank statement for the month of November 2012 from ASKARI Commercial Bank Ltd. The Finance Officer identified following difference between bank book and bank statement. Suppliers of car, Rent A CAR Company and Land Lord have not yet presented cheques to bank for payment Salary cheque was dishonored due to discrepancy in writing amounts in narration and numbers Bank has credited bank profit of Rs 720,000 but it is not recorded in the bank book Bank has deducted bank charges on cash withdrawals of Rs 234,000 but it is also not accounted in the bank book Balance as per bank statement as at 30 th November 2012: Rs 63,795,000 Required: Director Finance instructed manager finance to prepare bank reconciliation statement for review and approval purpose 109

OFT MANUAL: FM Payroll Management SECTION 6 Overview of Payroll Management - Personal files -Advances and Loans to employees -Leave records -Income tax deductions Employment contracts NGO policies for employee benefits Payroll Management Approved salary budgets Attendance sheets and / or Time Summary Sheets Post employment benefits; Provident fund and gratuity fund Recording and payment of salaries 110

OFT MANUAL: FM Payroll Management SECTION 6 Definition of payroll management The administration of the financial record of employees' salaries, incentives, deductions, net pay, and contributions Objectives of payroll management To ensure that salaries are paid in accordance with employment contracts, approved budgets and policies of NGO To ensure that complete and accurate record of salary payments have been maintained To ensure that appropriate level of controls exist over statutory and non-deductions To ensure that proper record of employee benefits such provident fund and gratuity fund has been maintained Payroll Procedures The payroll procedures encompass following elements 1. Personal files 2. Salary advances and loans 3. Preparation of payroll 4. Part-time employees 5. Accounting entries 6. Incentives 111

OFT MANUAL: FM Payroll Management SECTION 6 Personal Files The Human Resource department should maintain proper personal files of employees. The main sources of information for personal files encompass; Engagement letters Notification of changes in basic pay Leave entitlement Discharges Disciplinary actions Promotion notifications The HR department should regularly check the personal files to ensure completeness and reliability of HR data Salary advance and loans Policy and procedures for salary advance and loan should be designed by CEO and approved by governing body Policy should encompass the legitimate reasons for loans and advances, maximum amount of advances / loans, repayment schedule and mode of payment The standard forms should be used for requesting and payment of loans / advances The loan / salary advance application forms should be reviewed and approved by the appropriate competent authorities Loan / advance salary should be paid by cross cheque or electronic funds transfer Receipt acknowledgement should be signed by requesting employee 112

OFT MANUAL: FM Payroll Management SECTION 6 Effort Reporting / Timekeeping Timekeeping Systems: Key Points Employees are responsible for preparing their own timecard/sheet Employees should be provided with instructions how their work is to be charged Timecards/sheets must be prepared in ink or on a spreadsheet Time record must be completed as work is performed Timecard/sheet or spreadsheet should be signed by employee and supervisor Corrections should be cross-out and new entry with no erasures or whiteouts -Corrections should be signed by employee and supervisor -An explanation for correction should be properly recorded 113

OFT MANUAL: FM Payroll Management SECTION 6 Format of Standard Timekeeping Sheet Name of Employee Designation Department Reporting week Mr.Stevenson Program Manager Program 26 to 30 Nov 2012 Description of task performed Total daily Date Democratic Education Women Rights Peace building hours Project # Project # Project # worked DIFD-001 UN-314 AID-842 Allocation of hours Prepare monthly program activity plan 3 hour 26-11-12 1 hour 1 hour 1 hour Discuss monthly activity plan with 1 hour 26-11-12 1 hour Program Director for review and approval purposes Prepare work done report of last 3 hour 26-11-12 1 hour 1 hour 1 hour week (19 to 23 Nov 2012) Review work done report of program 1 hour 26-11-12 1 hour officers Prepare monthly performance report 6 hour 27-11-12 6 hour for donor agencies Meeting with CEO 1 hour 27-11-12 1 hour Attend weekly Program Management 1 hour 27-11-12 1 hour Team Organize one day seminar on 8 hour 28-11-12 8 hour democratic education Organize focus group discussion with 3 hour 29-11-12 3 hour community members and implementing partners Field visits in target areas 1 hour 29-11-12 1 hour Prepare draft narrative report for 4 hour 29-11-12 4 hour DIFD Prepare News letter for Women 4 hour 30-11-12 4 hour Rights Project Prepare training manual 3 hour 30-11-12 3 hour Review narrative of Sub-Grantees 1 hour 30-11-12 1 hour Total 40 hour 7 hour 12 hour 21 hour Prepared by employee: Mr.Stevenson dated 30-11-2012 Reviewed by supervisor: Ms Donaguhe dated 30-11-2012 114

OFT MANUAL: FM Payroll Management SECTION 6 Test your understanding Under USG regulation; OMB A-122: Cost Principle the project allowable expenses should fulfill the criteria of reasonability and allocability. Let s understand cost principles with following scenario The total weekly salary Rs. 54,000 of Program Manager Actual hours worked on USAID project are 21 hours during the reporting week from Nov 26 to Nov 30 2012. Which of the following methods of computation and allocation of salary expense are acceptable and justifiable under OMB A-122? Option Computation Allocated cost to USAID A Rs 54,000 / No of Projects Rs 18,000 B Rs 54,000 Rs 54,000 C Rs 54,000 / 40 hours x 21 hours Rs 28,350 D Rs 54,000 / 40 hours x 19 hours Rs 25,650 Test your understanding The Star NGO has been implementing 9 projects with different donor agencies The total monthly salary Rs. 550,000 of CEO Total 176 working hours of CEO in the month of November 2012 He spent 80 hours on USAID project during the reporting month; Nov 01 to Nov 30 2012. Which of the following methods of computation and allocation of salary expense are acceptable and justifiable under OMB A-122 and other best practices for allocation of expenses? Option Computation Allocated cost to USAID A Rs 550,000 / 9 Projects Rs 61,111 B Rs 54,000 Rs 550,000 C Rs 54,000 / 176 hours x 96 hours Rs 300.000 D Rs 54,000 / 176 hours x 80 hours Rs 250,000 115

OFT MANUAL: FM Payroll Management SECTION 6 Payroll Preparation HR Department should prepare and submit the list of incoming and outgoing employees to Finance Department HR Department should provide leave deduction details to Finance Department Administration should provide time summary sheets to HR and Finance department for review and processing Salary rates should be consistent with employment contracts. Finance team should exercise due care during the computation of statutory and non-statutory deductions Statutory deductions should be deposited into Government Treasury within the prescribed time. Payroll sheets should be reviewed and approved by competent authorities Salaries should be paid by cross cheque or electronic funds transfer Salary slips should be provided to employees for information and record purposes 116

OFT MANUAL: FM Payroll Management SECTION 6 101Example On 1 st November 2012, Star NGO hired following employees for Democratic Education Project Basic salary per month Rupees Chief of Party 333,333 Grant Manager 138,889 Manager Finance 83,333 Director Finance 388,889 Donor agency and governing body have approved following allowances of project staff House rent allowance 45% of basic salary Conveyance allowance 10% of basic salary Medical allowance 10% of basic salary Cost of living allowance 15% of basic salary Non-statutory deductions Loan Rs 10,000 from the salary of Manager Finance Advance salary Rs 20,000 from the salary of Grant Manager Required: Prepare salary sheet for the month of November 2012 Solution Star NGO Payroll sheet for the month of November 2012 Designati on COP GM Basic Allowances Gross Deductions Net salary COL HR Travel Medical salary Loan Advance salary Rupees 333,33 3 50,000 150,000 33,333 33,333 600,000 600,000 138,88 9 20,833 62,500 13,889 13,889 250,000 20,000 230,000 MF 83,333 12,500 37,500 8,333 8,333 150,000 10,000 140,000 388,88 DF 9 58,333 175,000 38,889 38,889 700,000 700,000 Total 944,44 4 141,66 7 425,00 0 94,444 94,444 1,700,00 0 10,000 20,000 1,670,00 0 117

OFT MANUAL: FM Payroll Management SECTION 6 001 Exercise On 1 st November 2012, Star NGO hired following employees for Democratic Education Project Basic salary per month Rupees Chief of Party 444,444 Grant Manager 166,667 Manager Finance 250,000 Director Finance 361,111 Donor agency and governing body have approved following allowances of project staff House rent allowance 45% of basic salary Conveyance allowance 10% of basic salary Medical allowance 10% of basic salary Cost of living allowance 15% of basic salary Non-statutory deductions Loan Rs 100,000 from the salary of Manager Finance Advance salary Rs 120,000 from the salary of Grant Manager Required: Prepare salary sheet for the month of November 2012 102Example On 1 st July 2012, Star NGO hired following employees for Democratic Education Project Basic salary per month Annual Tax exemption up to10% of Basic Salary Gross salary per month Rupees Rupees Rupees Chief of Party 444,444 533,333 800,000 Grant Manager 166,667 200,000 300,000 Manager Finance 250,000 300,000 450,000 Director Finance 361,111 433,333 650,000 The donor agency and governing body have approved following allowances of project staff House rent allowance 45% of basic salary, conveyance allowance 10% of basic salary, utilities allowance 10% of basic salary and provident fund allowance 15% of basic salary The CEO has entrusted you the task to calculate total annual salary income, taxable salary income, tax liability and per month tax deduction under section 149 of Income Tax Ordinance 2001 118

OFT MANUAL: FM Payroll Management SECTION 6 Current Tax year: 1-07-2012 to 30-06-2013 Tax rates as per clause IA of division I of Part I of the First Schedule, Income Tax Ordinance 2001 SR Taxable income Rate of tax no 1. 0 to Rs.400,000 0% 2. Rs.400,000 to Rs.750,000 5% of the amount exceeding Rs. 400,000 3. Rs.750,000 to Rs.1,500,000 Rs. 17,500+10% of the amount exceeding Rs.750,000] 4. Rs.1,500,000 to Rs.2,000,000 Rs.95,000+15% of the amount exceeding Rs.1,500,000 5. Rs. 2,000,000 to Rs.2,500,000. Rs. 175,000 + 17.5% of the amount exceeding Rs.2,000,000/- 6. Rs.2,500,000 and above Rs.420,000+ 20% of the amount exceeding Rs. 2,500,000/- Under Income Tax Law, the employees of NGO can claim exemption of medial allowance up to 10% of basic salary. Required: Calculate income tax deduction and prepare payroll sheet for the month of July 2012 Solution of Example 102 Tax computation schedule 1 2 3=2 x 12 4 5=3-4 6 7=5-6 8 9 10=7 x 9 Taxable Taxable Tax Tax Per income income liability liability mont up to above up to above h Annual Medic Taxable 2.5 2.5 2.5 Rate 2.5 salary salary al salary million million million of tax million 11=8+1 0 Total Annual Tax liability 12=11/1 2 Per month tax liability COP GM MF DF 800,00 0 9,600,000 533,333 9,066,667 2,500,000 6,566,667 420,000 20% 1,313,333 1,733,333 144,144 300,00 0 3,600,000 200,000 3,400,000 2,500,000 900,000 420,000 20% 180,000 600,000 50,000 450,00 0 5,400,000 300,000 5,100,000 2,500,000 2,600,000 420,000 20% 520,000 940,000 78,333 650,00 0 7,800,000 433,333 7,366,667 2,500,000 4,866,667 420,000 20% 973,333 1,393,333 116,111 119

OFT MANUAL: FM Payroll Management SECTION 6 Star NGO Payroll sheet for the month of November 2012 Designat ion Basic salary Allowances Gross Deductions PF HR Travel Utility salary PF Tax Net salary Rupees COP 444,444 66,667 200,000 44,444 44,444 800,000 66,667 144,144 589,189 GM 166,667 25,000 75,000 16,667 16,667 300,000 25,000 50,000 225,000 MF 250,000 37,500 112,500 25,000 25,000 450,000 37,500 78,333 334,167 DF 361,111 54,167 162,500 36,111 36,111 650,000 54,167 116,111 479,722 1,222,22 183,33 550,00 122,22 122,22 2,200,00 183,33 388,58 1,628,07 Total 2 3 0 2 2 0 3 8 9 002Exercise On 1 st October 2012, Star NGO hired following employees for Democratic Education Project Basic salary per month Tax exemption up to 10% of Basic Salary ( October 2012 to June 2013) Gross salary per month Rupees Rupees Rupees Chief Executive Officer-CEO 250,000 225,000 450,000 Director Programs 166,667 150,000 300,000 Director HR 111,111 100,000 200,000 Director Finance 77,778 70,000 140,000 The donor agency and governing body have approved following allowances of project staff House rent allowance 45% of basic salary, conveyance allowance 10% of basic salary, utilities allowance 10% of basic salary and provident fund allowance 15% of basic salary.the Governing body has entrusted you the task to calculate total annual salary income, taxable salary income, tax liability and per month tax deduction under section 149 of Income Tax Ordinance 2001 120

OFT MANUAL: FM Payroll Management SECTION 6 Current Tax year: 1-07-2012 to 30-06-2013 Tax rates as per clause IA of division I of Part I of the First Schedule, Income Tax Ordinance 2001 SR Taxable income Rate of tax no SR Taxable income Rate of tax no 1. 0 to Rs.400,000 0% 2. Rs.400,000 to Rs.750,000 5% of the amount exceeding Rs. 400,000 3. Rs.750,000 to Rs.1,500,000 Rs. 17,500+10% of the amount exceeding Rs.750,000] 4. Rs.1,500,000 to Rs.2,000,000 Rs.95,000+15% of the amount exceeding Rs.1,500,000 5. Rs. 2,000,000 to Rs.2,500,000. Rs. 175,000 + 17.5% of the amount exceeding Rs.2,000,000/- 6. Rs.2,500,000 and above Rs.420,000+ 20% of the amount exceeding Rs. 2,500,000/- Under Income Tax Law, employees of NGO can claim exemption of medial allowance up to 10% of basic salary. Required: Calculate income tax deduction and prepare payroll sheet for the month of October 2012 121

OFT MANUAL: FM Payroll Management SECTION 6 Payroll Control Statement The finance department prepares payroll control statement to control and reconcile encompass the movements in the work force strength, funding and budgeting of payroll cost and reconciliation of total basic salary, deductions, net salary and payments Format of payroll control statement Section A: Analysis of variation in the workforce Departments November 2012 October 2012 Difference Increase / (Decrease) No of employees Program 100 110 (10) Finance 15 12 3 HR & Administration 20 20 - Total 135 142 (7) Section B: Comparison of Approved budget and funding secured Departments Annual Approved Budged- Funding obligated or Funding surplus / (gaps ) July 2012 to June 2013 received Rupees Program 85,000,000 40,000,000 (45,000,000) Finance 20,000,000 14,000,000 (6,000,000) HR & Administration 35,000,000 10,000,000 (25,000,000) Total 140,000,000 64,000,000 (76,000,000) Section C: Budget and actual payroll cost to date Departments Annual Approved Salary expense to date Budget balance Budged Rupees Program 85,000,000 20,000,000 65,000,000 Finance 20,000,000 5,000,000 15,000,000 HR & Administration 35,000,000 8,000,000 27,000,000 Total 140,000,000 33,000,000 107,000,000 Section D: Salary sheet analysis of current reporting month Gross salary Deductions Net salary Paid by CHQ Paid by EFT Paid by Cash Total Salary 7,500,000 800,000 6,700,000 1,700,000 5,000,000-122

OFT MANUAL: FM Payroll Management SECTION 6 103Example The Finance department presented following salary sheets to CEO for review purposes. Payroll sheet for the month of November 2012 Departme nt No of employees Basic salary Allowances COL HR Travel Utility Gross salary Loan Net salary Program 50 1,666,667 250,000 750,000 166,667 166,667 3,000,000 80,000 2,920,000 Finance 5 444,444 66,667 200,000 44,444 44,444 800,000 40,000 760,000 HR & ADM 15 666,667 100,000 300,000 66,667 66,667 1,200,000 150,000 1,050,000 Total 70 2,777,778 416,667 1,250,000 277,778 277,778 5,000,000 270,000 4,730,000 Payroll sheet for the month of October 2012 Departme nt No of employees Basic salary Allowances COL HR Travel Utility Gross salary Loan Net salary Program 45 1,388,889 208,333 625,000 138,889 138,889 2,500,000 80,000 2,420,000 Finance 3 277,778 41,667 125,000 27,778 27,778 500,000 40,000 460,000 HR & ADM 11 500,000 75,000 225,000 50,000 50,000 900,000 150,000 750,000 Total 59 2,166,667 325,000 975,000 216,667 216,667 3,900,000 270,000 3,630,000 The details of annual budget, funds obligated and salary cost in the month of July 2012, August 2012 and September 2012 are stated as under Departments Annual budget Funds obligated July 2012 August 2012 September 2012 Rs Rs Rs Rs Rs Program 30,000,000 15,000,000 1,400,000 2,000,000 2,500,000 Finance 10,000,000 8,000,000 400,000 400,000 500,000 HR & Administration 15,000,000 10,000,000 600,000 600,000 900,000 Total 55,000,000 33,000,000 2,400,000 3,000,000 3,900,000 The Star NGO has been paying salaries through electronic funds transfer process. Required: The CEO entrusted you a task to prepare payroll control sheet for the review of audit committee 123

OFT MANUAL: FM Payroll Management SECTION 6 Solution of Example 103 Star NGO Payroll Control Statement For the month of November 2012 Section A: Analysis of variation of work force Department November 2012 October 2012 Difference Increase ( Decrease) Number of Employees Program 50 45 5 Finance 5 3 2 HR & Administration 15 11 4 Total 70 59 11 Section B: Comparison of approved budget with obligated / received funds Department Annual Approved Budged-July 2012 to June 2013 Funding obligated or received Funding surplus / (gaps ) Rs Rs Rs Program 30,000,000 15,000,000 15,000,000 Finance 10,000,000 8,000,000 2,000,000 HR & Administration 15,000,000 10,000,000 5,000,000 Total 55,000,000 33,000,000 22,000,000 Section C: Budgeted and actual payroll cost Department Annual Approved Salary expense Budget balance Budged to date Rs Rs Rs Program 30,000,000 11,400,000 18,600,000 Finance 10,000,000 2,600,000 7,400,000 HR & Administration 15,000,000 4,200,000 10,800,000 Total 55,000,000 18,200,000 36,800,000 Section D: Salary sheet analysis of current reporting month Department Gross Deductions Net Paid by Paid by Paid by Cash salary salary CHQ EFT Rs Rs Rs Rs Rs Rs Program 3,000,000 80,000 2,920,000 2,920,000 Finance 800,000 40,000 760,000 760,000 HR & ADM 1,200,000 150,000 1,050,000 1,050,000 Total 5,000,000 270,000 4,730,000 4,730,000 124

OFT MANUAL: FM Payroll Management SECTION 6 Recording and payment entries for payroll, deductions and contributions Journal voucher should be prepared for recording gross salary, deductions and net salary as per payroll sheet Payment voucher should be prepared for the net pay salary and deposit of contribution & deductions Standard accounting entries scheme for payroll transactions Transaction Description Debit Credit Recording of salary expense Salary Expense account Income tax payable account Provident fund payable account Advance salary account Loan account Accrued salary account Rupees xxx Rupees xxx xxx xxx xxx xxx Payment of salaries Accrued salary account Bank account xxx xxx Employer s contribution for provident fund Provident fund expense account Provident fund payable account xxx xxx Deposit of income tax deductions into government treasury Income tax payable account Bank account xxx xxx Deposit of provident fund contributions into designated bank account of Fund Provident fund payable account Bank account xxx xxx xxx 125

OFT MANUAL: FM Payroll Management SECTION 6 104Example Record accounting entries of payroll as per payroll information stated in the example 102 Further information The employer and employee provident fund contribution is equal as per the approved policy Provident fund contributions have been deposited within 5 working days Income tax deductions have been deposited within the prescribed statutory time frame Solution Transaction Description Debit Credit Rupees Rupees Recording of salary expense Payment of salaries Salary Expense account Income tax payable account Provident fund payable account Accrued salary account Accrued salary account Bank account 2,200,000 1,686,945 329,722 183,333 1,686,945 1,686,945 Employer s contribution for provident fund Provident fund expense account Provident fund payable account 183,333 183,333 Deposit of income tax into government treasury Income tax payable account Bank account 329,722 329,722 Deposit of provident fund contribution into designated bank account of Fund Provident fund payable account Bank account 366,666 366,666 126

OFT MANUAL: FM Payroll Management SECTION 6 Part time employees HR department should hire part-time employees with the prior written approval of competent authority HR department should take into consideration the program needs and availability of budget at time of recruitment of part-time employees HR department should maintain proper register of part-time employees Work done and hours of part-time employees should be reviewed by respective line manager Payment claim forms should be completed and submitted by the part-time employees to HR Department for review HR department should forward payment claim forms to Finance for payment processing Payment claims should be settled through cross cheque or electronic funds transfer process Receipt acknowledgement forms should be signed by part-time employees for payment evidence purposes 127

OFT MANUAL: FM Payroll Management SECTION 6 Incentives / employee benefits Incentive schemes should be formalized and documented in the policies and procedures manual The incentive strategies should be widely communicated and equitably applied Incentives should only be paid once earned or achieved. Incentives should not be paid in advance. Incentive / employee benefits encompass: Paid annual and sick leaves, staff development allowance, medical expense reimbursement and nonmonetary benefits such as health insurance, life assurance, housing and cars; Post-employment benefits such as gratuity fund and provident fund; Long-service leave or other long-service benefits and long-term disability benefits; Termination benefits such redundancy compensation 128

OFT MANUAL: FM Payroll Management SECTION 6 Post employment benefits The NGOs have been paying following key post employment benefits to employees Provident fund Gratuity fund Standard policies and procedures for Provident fund 1. The contributory provident fund should be established under the terms and conditions of duly approved trust deed from governing body 2. Trustees of provident fund should be nominated and appointed by governing body 3. The membership of provident fund should be remained optional for employees 4. The equal provident fund contributions should be made by NGO and employee 5. The rate of provident fund can only be revised with the prior written approval of governing body 6. Separate bank account should be opened and operated for provident fund 7. Separate books of accounts should be maintained for provident fund 8. The monthly provident fund contributions should be deposited in designated bank account 9. The proceeds of provident fund should only be invested in profitable and secured investment schemes 10. The withdrawals can be made from provident fund for approved legitimate and admissible purposes such as purchase of plot, construction of house, purchase of personal vehicle marriage of brother/sister and children. 11. Provident fund should be paid to outgoing employees subject to the submission of satisfactory final clearance documents and as per the prescribed provisions of trust deed of fund Standard accounting treatment for provident fund Section A: Accounting entries in the books of accounts of NGO Transaction Description Debit Credit Rupees Rupees Employee s contribution of provident fund Salary Expense account Provident fund payable account xxx xxx Employer s contribution for provident fund Provident fund expense account Provident fund payable account xxx xxx Deposit of provident fund contribution Provident fund payable account Bank account xxx xxx 129

OFT MANUAL: FM Payroll Management SECTION 6 Section B: Accounting entries in the books of accounts of Provident Fund Transaction Account titles Debit Credit Rupees Rupees Receipt of periodic provident fund contributions Bank account Provident fund account xxx xxx Investment of provident fund proceeds Investment account Bank account xxx xxx Withdrawals from provident fund at the time of retirement Provident fund account Bank account xxx xxx Withdrawals from provident fund at the time of approval of loan against PF contributions Employee Loan account Bank account xxx xxx Receipt of bank profit or dividend on invested funds Bank account Provident fund account xxx xxx Format of Provident Fund Schedule Star NGO Provident Fund Schedule As at 30 th November 2012 1 2 3 4 5 6 7 8 Nam e Designatio n Openin g balance PF contributio n of Employee PF contributio n of employer Withdrawal s Return on investmen t Closin g balanc e Rs Rs Rs Rs Rs Rs Mr. A COP xxx xxx xxx (xxx) xxx xxx Mr. B MF xxx xxx xxx (xxx) xxx xxx Mr. C GM xxx xxx xxx (xxx) xxx xxx Mr. D DF xxx xxx xxx (xxx) xxx xxx Total xxx xxx xxx (xxx) xxx xxx 130

OFT MANUAL: FM Payroll Management SECTION 6 105Example On 1 st November 2012,Star NGO established separate provident fund as per requirements of trust deed Provident fund has been controlled and monitored by board of trustees As per approved PF policy both employer and employee contributes equally at the rate of 15% Separate bank account and books of accounts have been maintained for provident fund NGO invests proceeds of provident funds in the saving bank account COP obtains loan Rs 100,000 against his provident fund balance as per the approval of competent authority Director finance withdraws provident fund Rs 60,000 as per the rules of trust deed Bank profit Rs 40,000 received on 30 th June 2012 and it will be distributed to employees on pro-rata basis Details of Employee s Provident Fund contributions are stated as under 1 2 3 4 5 6 7 8 Total Nov Dec Jan Feb March April May June Rupees COP 66,667 66,667 66,667 66,667 66,667 66,667 66,667 66,667 533,336 GM 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 200,000 MF 37,500 37,500 37,500 37,500 37,500 37,500 37,500 37,500 300,000 DF 54,167 54,167 54,167 54,167 54,167 54,167 54,167 54,167 433,336 Total 183,333 183,333 183,333 183,333 183,333 183,333 183,333 183,333 1,466,664 Required: Prepare accounting entries in the books of accounts (NGO and Fund) and provident fund schedule as per the given scenario 131

OFT MANUAL: FM Payroll Management SECTION 6 Solution of Example 105 Section A: Accounting entries in the books of accounts of NGO Transaction Description Debit Credit Employee s contribution of provident fund Salary Expense account Provident fund payable account Rupees 1,466,664 Rupees 1,466,664 Employer s contribution for provident fund Provident fund expense account Provident fund payable account 1,466,664 1,466,664 Deposit of provident fund contribution Provident fund payable account Bank account 2,933,328 2,933,328 Section B: Accounting entries in the books of accounts of Provident Fund Transaction Account titles Debit Credit Rupees Rupees Receipt of periodic provident fund contributions Bank account Provident fund account 2,933,328 2933,328 Investment of provident fund proceeds Investment account Bank account 2,933,328 2,933,328 Director Finance withdrawals provident fund Provident fund account Bank account 60,000 60,000 COP obtains loan against provident fund balance Employee Loan account Bank account 100.000 100,000 Receipt of bank profit Bank account Provident fund account 40,000 40,000 132

OFT MANUAL: FM Payroll Management SECTION 6 Solution of Example 105 Star NGO Provident Fund Schedule As at 30 th June 2013 1 2 3 4 5 6=2+3+4-5 7 8=6+7 Openin g balance Withdra w Closing balance PF contributio n of Employee PF contributio n of Employer Balance before profit distributio n Distributio n of profit on pro-rata basis Rs Rs Rs Rs Rs Rs Rs COP - - MF - GM - DF - 003Exercise 533,336 533,336 1,066,672 14,849 1,081,52 1 200,000 200,000 400,000 5,568 405,568 300,000 300,000 600,000 8,353 608,353 433,336 433,336 60,000 806,672 11,230 817,902 40,000 2,913,34 1,466,664 1,466,664 60,000 2,873,344 4 On 1 st January 2013,Star NGO established separate provident fund as per the requirements of trust deed As per approved PF policy both employer and employee contributes equally to fund Separate bank account and books of accounts have been maintained for provident fund NGO invests proceeds of provident funds in the saving bank account COP obtains loan Rs 120,000 against his provident fund balance as per the approval of competent authority Director finance withdraws provident fund Rs 100,000 as per the rules of trust deed Bank profit Rs 130,000 received on 30 th June 2012 and it will be distributed to employees on pro-rata basis Details of Employee s Provident Fund contributions are stated as under 1 2 3 4 5 6 Total Jan Feb March April May June COP 80.000 80.000 80.000 80.000 80.000 80.000 480,000 GM 70.000 70.000 70.000 70.000 70.000 70.000 420,000 MF 50,000 50,000 50,000 50,000 50,000 50,000 300,000 60,000 60,000 60,000 60,000 60,000 60,000 360,000 133

OFT MANUAL: FM Payroll Management SECTION 6 DF Total 260,000 260,000 260,000 260,000 260,000 260,000 1,560,000 Required: On 30 June 2013, prepares accounting entries in the books of accounts (NGO and Fund) and also prepares provident fund schedule for the review of audit committee Standard policies and procedures of gratuity fund 1. The gratuity fund should be established under the terms and conditions of duly approved trust deed from governing body 2. Trustees of gratuity fund should be nominated and appointed by governing body 3. Trustees should defined the eligibility criteria for the membership of gratuity fund 4. Eligibility criteria encompasses length of service, performance record, recommendation from line manager and approval from competent authority 5. Formulae of gratuity fund; Length of service x last draw salary 6. Separate bank account should be opened for gratuity fund 7. Separate accounting records should be maintained for gratuity fund 8. NGO management should deposit periodic proceeds in the designated bank account of gratuity fund under the prescribed terms and conditions of trust deed 9. The proceeds of gratuity fund should only be invested in profitable and secured investment schemes 10. The withdrawals can only be made from gratuity fund for approved legitimate and admissible purposes such as purchase of plot, construction of house, purchase of personal vehicle marriage of brother/sister and children. 11. Gratuity fund should be paid to outgoing employees subject to the submission of satisfactory final clearance documents and prescribed provisions of trust deed Standard accounting treatment for Gratuity Fund Section A: Accounting entries in the books of accounts of NGO Transaction Description Debit Credit Rupees Rupees Annual Provision for gratuity fund Gratuity fund expense account Gratuity payable account xxx xxx Deposit of gratuity fund proceeds in separate bank account of Fund Gratuity payable account Bank account xxx xxx 134

OFT MANUAL: FM Payroll Management SECTION 6 Section B: Accounting entries in the books of accounts of Gratuity Fund Transaction Account titles Debit Credit Rupees Rupees Receipt of proceeds from NGO for gratuity fund Bank account Gratuity fund account xxx xxx Investment of gratuity fund proceeds Investment account Bank account xxx xxx Withdrawals from gratuity fund at the time of retirement Gratuity fund account Bank account xxx xxx Withdrawals from gratuity fund at the time of approval of loan against gratuity fund Employee Loan account Bank account xxx xxx Receipt of bank profit or dividend on invested funds Bank account Gratuity fund account xxx xxx 135

OFT MANUAL: FM Payroll Management SECTION 6 106Example On 1 st June 2012,Star NGO established separate gratuity fund as per the requirements of trust deed As approved policy the gratuity fund as computed as length of service multiplied by last draw basic salary Separate bank account and books of accounts have been maintained for gratuity fund NGO invests proceeds of gratuity funds in the saving bank account Bank profit Rs 150,000 received on 30 th June 2012 and it should be distributed to employees on prorata basis Details of length of service and last draw basic salary are stated as under Designations 1 2 3 Date of Length of service as Basic salary appointment at 30 th June 2013 Months Rupees Chief of Party 01-07-2011 25 80.000 Grant Manager 01-07-2011 25 70.000 Manager Finance 01-07-2011 25 50,000 Director Finance 01-07-2011 25 60,000 Required prepare gratuity fund schedule as at 30 th June 2003 and accounting entries for the books of accounts of NGO and Fund Solution of Example 106 Designations 1 2 3 4 5 6 Date of Provision Distribution appointment for gratuity of bank profit Length of service as at 30 th June 2013 Basic salary as at 30 th June 2013 Gratuity fund as at 30 June 2012 Years Rupees Rupees Rupees Rupees Chief of Party 01-07-2011 2.08 250,000 520,83 61,927 582,760 Grant Manager 01-07-2011 2.08 166,667 347,223 41,284 388,507 Manager Finance 01-07-2011 2.08 111,111 231,481 27,523 259,004 Director 162,038 19,266 181,304 Finance 01-07-2011 2.08 77,778 Total 1,261,575 150,000 1,411,575 136

OFT MANUAL: FM Payroll Management SECTION 6 Section A: Accounting entries in the books of accounts of NGO Transaction Description Debit Credit Rupees Rupees Annual Provision for gratuity fund Gratuity fund expense account Gratuity payable account 1,261,575 1,261,575 Deposit of gratuity fund proceeds in separate bank account of Fund Gratuity payable account Bank account 1,261,575 1,261,575 Section B: Accounting entries in the books of accounts of Gratuity Fund Transaction Account titles Debit Credit Rupees Rupees Receipt of proceeds from NGO for gratuity fund Bank account Gratuity fund account 1,261,575 1,261,575 Investment of gratuity fund proceeds Investment account Bank account 1,261,575 1,261,575 Receipt of bank profit or dividend on invested funds Bank account Gratuity fund account 150,000 150,000 137

OFT MANUAL: FM Financial Audits SECTION 7 FINANCIAL AUDITS 8.1 Introduction to Audit of General Purpose Financial Statements 8.1.1 Why do NGOs need audit? Audits are important for NGOs as they demonstrate a commitment to transparency and accountability and bring credibility to the NGO. It is also a legal requirement in most countries to have the financial statements reviewed by an independent auditor once a year. NGO operations and audit Submission of Project application for funding Internal controls and compliance requirements with applicable laws, regulations and contractual terms Disburement of funds to employees, beneficiaries, sub-conractors / subrecipients, suppliers of goods and services Approval of project proposal and budget Implemnetation of project activities Submission of narrative Performance and financial reportsto donor agencies Acquisiton or assistance agreement between NGO and donor agency Receipt of funds from donor agencies Audit of Finanical Statements 138

OFT MANUAL: FM Financial Audits SECTION 7 8.2 What is assurance? The governing body, regulators, donor agencies and other stakeholders need assurance from independent practitioner regarding the truthfulness and fairness of reported financial figures pertain to transactions and events of NGOs. 8.2.1 Definition of assurance An engagement in which a practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject matter against criteria 8.2.2 Five Elements of assurance The definition of assurance contains following five key elements Tripartitie relationship Subject matter Criteria Sufficient and appropirate evidence Written report 8.2.3Example of 5 elements of assurance engagement A. Tripartite relationship; USAID, Prime Recipient and Auditors B. Subject under scrutiny; Project financial report, organizational financial statements, Internal controls, compliance with applicable Laws, Regulations and contractual terms, cost sharing financial information and Schedule of computation of indirect cost rates C. Suitable criteria; Laws, Regulations, OMB Circulars A-122, FAR, CFR, ADS,AIDAR, GAAP, Guidelines of OIG for financial audits contracted by foreign recipients, CIBs and AAPDs 139

OFT MANUAL: FM Financial Audits SECTION 7 D. Sufficient appropriate audit evidence; project transactions should be supported by adequate, reliable and relevant accounting records E. Written report; Submission of written audit reports to intended users (Federal Audit Clearinghouse / USAID). Auditor gives assurance on Fund Accountability Statement, Internal Controls, Compliance with laws, regulations and contractual terms, Schedule of computation of Indirect Cost Rate, General Purpose Financial Statements of Recipient and Cost Sharing Schedule Exercise to identify 5 elements of assurance engagement NGO management succeeded to obtain donor funding for the implementation of peace building project. NGO management spent Rs 34,144,000 (Equivalent USD 352,000) during the fiscal year; 1 st October 2011 to 30 th September 2012. The Governing body and donor agency approved appointment of English Chartered Accountants as auditors for the financial audit of financial statements for the year ended 30 th September 2012. The appointment letter contains scope of audit; fund accountability statement, internal controls, compliance with statutes, regulations, contractual terms, indirect cost rates, cost sharing and organizational financial statements. Under the terms of award, the written report should be submitted to USAID within 30 day of receipt of audit report or after 9 months from the end of fiscal year 30 th September 2012 (30 th June 2013) whichever is earlier. Requirement: Identify 5 elements of assurance from given scenarios 8.2.4 Types of assurance Type of assurance Reasonable assurance Limited assurance High level assurance Moderate assurance Positive report Negative report 140

OFT MANUAL: FM Financial Audits SECTION 7 Reasonable assurance engagements-audit of Funds Accountability Statement / Project Financial Report In a reasonable assurance engagement, the practitioner gathers sufficient appropriate evidence It means that the practitioner has to do enough work to be able to draw rational conclusions concludes that the subject matter conforms in all material respects with identified suitable criteria The important point for you to understand is that the practitioner is not saying that everything is absolutely correct, but that, broadly speaking, the information given is reliable gives his report in the form of positive assurance Limited assurance engagement-review of Funds Accountability Statement The practitioner: gathers sufficient appropriate evidence to be satisfied that the subject matter is plausible in the circumstances gives his report in the form of negative assurance Example of negative assurance report takes the form: Nothing has come to our attention that causes us to believe that the financial statements are not prepared, in all material respects, in accordance with an applicable financial reporting framework 141

OFT MANUAL: FM Financial Audits SECTION 7 8.3 Who is eligible to perform external audit To be eligible to act as auditor, a person must be: member of a Recognized Supervisory Body (RSB), e.g. Institute of Chartered Accountants of Pakistan And allowed by the rules of ICAP to be an auditor Or Someone directly authorized by the state. Individuals who are authorized to conduct audit work may be: sole practitioners partners in a partnership members of an LLP To be eligible to act as auditor, a firm must be: controlled by members of a suitably authorized accountancy body Or a firm directly authorized by the state. 142

OFT MANUAL: FM Financial Audits SECTION 7 8.3.1 Who may not act as auditor Excluded by law The law in most countries excludes those involved with managing the organization and those who have business or personal connections with them. For example; an officer (Director or secretary) of the NGO an employee of the NGO a business partner or employee of the above. Excluded by professional ethics Business relations Personal relations Non audit services Long association with client / NGO Fee dependency Examples to understand eligibility and / or non-eligibility to act as an auditor - Mr Blue is a very experienced accountant and business consultant. He has a degree but no professional qualifications. He is not allowed to act as an auditor. - Ms Green is a qualified CA but has always worked in the accounting and finance departments of large NGO and INGOs. She is not allowed to act as an auditor. - Mr Red, FCA is a partner in an accounting practice and is authorized by the ICAP to conduct audits. He may be allowed to act as an auditor. - Mr Red s brother runs a successful NGO in the town and asks Mr Red to become his auditor. Mr Red must refuse because the relationship with his brother would bring his independence into question. Mr Red is also a non-executive director of a large local company Euphonium Ltd. Neither he, his firm, his partners, nor any members of his staff, may act as auditor for Euphonium Ltd. 143

OFT MANUAL: FM Financial Audits SECTION 7 8.4 Audit objectives of financial statements Audit objectives of financial statements Identify material misstatement in financial statements Ensure preparation of financial statements as per applicable financial reporting framework Overstatement of project implementation cost Understatement of funds/ cash and bank balances 1. Applicable statutes and regulations 2. Agreements with donor agencies 3. Agreements with implementing partners 4. Contracts with suppliers of goods and services 5. Approved project proposal and budgets 6. Standard operating procedures 7. Donor regulations for instance USAID rules and regulations encompass OMB circulars, FARs, CFRs, AIDARs, ADS, AAPDs and CIBs 8. Generally Accepted Accounting Principles-GAAP 144

OFT MANUAL: FM Financial Audits SECTION 7 8.4.1 Materiality What is materiality? Information is material if its omission or misstatement could influence the economic decisions of taken by Funding agency n the basis of the fund accountability statements Calculating materiality Firms typically have a standard method for calculating a baseline materiality figure as part of the planning process. Common measures are: ½ 1% of Grant income / Project incurred cost 1 2% of assets But these are up to the judgment of the auditor. As a result, different firms use different measures. 145

OFT MANUAL: FM Financial Audits SECTION 7 8.4.2 Risk-based and procedural approaches to auditing Procedural audit approach Risk based audit approach Pre-determined audit procedures Risk based Audit procedrues designed on the basis of risk assessment exercise 146

OFT MANUAL: FM Financial Audits SECTION 7 8.4.3Definition of audit risk Audit risk is defined as: The risk of that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is further defined by way of a formula: Audit Risk Inherent risk Control risk Detection risk 8.4.3.1 Inherent risk The risk of errors or misstatements due to the nature of the company and its transactions. 8.4.3.2 Control risk Control risk is the risk of errors or misstatements because the company s internal controls are not strong enough to prevent, detect and correct them. 8.4.3.3 Detection risk This is the risk that the auditor s procedures do not pick up material misstatements. 147

OFT MANUAL: FM Financial Audits SECTION 7 8.5 Minimum audit evidence requirements Financial statements and accounting records Donor files and internal control manual 1. Prepare final draft of financial statements 2. Financial statements reconciled with Trial balance & general ledger 1. Complete donor files containing approved project proposal, budgets, correspondence and progress reports 2. Approved manual of policies and procedures 3. Complete files of vouchers 4. Reconciled payroll records and with HR Files 5. Finalize the reconciliations of fixed assets and inventory records 6. Bank reconciliation statements and cash count sheets Program, M&E unit and Internal Audit Function 1. Accurate and complete record of sub-grantees 2. Correspondence file of M&E 3. Reports of M&E unit 4. Database of sub-grantees HR records 1. Complete Updated personal files of all employees 2. List of appointments and outgoing employees 3. Proper documentation of increments and promotions 4. File of time summary sheets 5. Leave record of employees 5. Terms of reference of internal audit function 6. Internal audit reports Administration 1. Procurement files 2. Files of contracts with suppliers of goods and services 3. Memorandum record of fixed assets and inventory 4. Minutes of board and donor meeting 148

OFT MANUAL: FM Financial Audits SECTION 7 8.6 Stage in external audit Selection and appointment of external auditors Audit report Audit planning Completion and review Audit Evidence gathering-test of controls Audit Evidence gathering-substantive procedrues 8.6.1 Selection and appointment of external auditors The constitution of NGO contains procedure for the appointment of external auditors. The governing body delegates the authority to audit committee to identify suitable audit firm and thereafter formally negotiated and finalize the terms and conditions for the acquisition of audit services. The level of confidence of governing body, regulators and donor agencies increases when A rated audit firms of RAB perform and issue audit report on financial statements of NGOs. The names of big six audit firms; KPMG, A.F.Ferguson, Deloitte, Ernst & Young, Grant Thornton and BDO Chartered Accountants The NGO management and external auditors finalized the terms of appointment in the audit engagement letter and its details are stated as under. 149

OFT MANUAL: FM Financial Audits SECTION 7 8.6.2 Audit engagement letter / Audit services contract Audit scope Standards Audit fee Audit deliveables 8.6.2.1 Key consideration for audit engagement letter The engagement letter will be sent before the audit. It specifies the nature of the contract between the audit firm and the client. It minimizes the risk of any misunderstanding of the auditor s role. It should be reviewed every year to ensure that it is up to date but does not need to be reissued every year unless there are changes to the terms of the engagement. The auditor must isse a new engagement letter if the scope or context of the assignment changes after initial appointment. Many firms of auditors choose to send a new letter every year, to emphasize its importance to clients. 150

OFT MANUAL: FM Financial Audits SECTION 7 8.6.2.2 Contents of audit engagement letter The contents of a letter of engagement for audit services will include the following. Objective of the audit. Management s responsibility for the financial statements. The scope of the audit including reference to legislation and professional standards. A description of audit procedures including their inherent limitations (e.g. for the discovery of fraud and irregularities) The form of reports to be issued. Use of the work of internal audit. Risk assessment matters. The auditor s use of specialists. Deadlines. Access to information. Communications between the auditor and the client (e.g. form of audit report, management representations, letter of weakness, etc.). A reference to other services (normally covered in a separate letter). The basis of fees. Complaints procedures and jurisdiction. The need for co-operation and agreement of terms. 151

OFT MANUAL: FM Financial Audits SECTION 7 8.6.1 Audit Planning Audit planning process Risk assessment Audit Strategy Audit Plan Materiality level Law and regulations Fraud Going concern Information Technology Design audit procedures 8.6.1.1 The planning process The planning process consists of a number of phases and activities: assessing risk developing the audit strategy selecting the audit team assessing materiality selecting appropriate audit procedures. 152

OFT MANUAL: FM Financial Audits SECTION 7 8.6.2 Assessing risk It s all about risk The whole of the next chapter of these materials is devoted to the concept of risk, but it is vital that you understand that it is the auditor s assessment of risk which underpins the whole audit. It is the assessment of risk which determines: the audit strategy who should be on the audit team the potential impact of fraud the nature of the procedures to be carried out how much evidence needs to be gathered so everything in the planning process is about the auditor s response to assessed risk. Relationship between risk and materiality the greater the risk of material misstatement the lower the level of materiality. 153

OFT MANUAL: FM Financial Audits SECTION 7 8.6.3 Audit Strategy Knowledge of the NGO operations and projects Assess Risk Analytical review Scope Timing Direction Audit strategy Select the audit team Deadlines and budgets Audit approach 8.6.4 Audit Plan Audit strategy Audit plan Audit procedures 8.7 Audit Evidence Information used by the auditor in arriving at the conclusions on which the auditor s opinion is based. Audit evidence includes both information contained in the accounting records underlying the financial statements and other information. 8.7.1 Sufficient Appropriate Audit Evidence 154

OFT MANUAL: FM Financial Audits SECTION 7 The auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence. 8.7.2 Sufficient audit evidence The sufficiency and appropriateness of audit evidence are interrelated. Sufficiency is the measure of the quantity of audit evidence. The quantity of audit evidence needed is affected by the auditor s assessment of the risks of misstatement (the higher the assessed risks, the more audit evidence is likely to be required) and also by the quality of such audit evidence (the higher the quality, the less may be required). Obtaining more audit evidence, however, may not compensate for its poor quality. 8.7.3 Appropriate audit evidence Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its reliability in providing support for the conclusions on which the auditor s opinion is based. The reliability of evidence is influenced by its source and by its nature, and is dependent on the individual circumstances under which it is obtained. 155

OFT MANUAL: FM Financial Audits SECTION 7 8.7.4 Sources of audit evidence Audit evidence Substantive procedures Test of controls Analytical procedures Test of details Control procedrues 8.8 Definition of Internal Controls Internal control The process designed, implemented and maintained by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of an entity s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations. The term controls refers to any aspects of one or more of the components of internal control. 156

OFT MANUAL: FM Financial Audits SECTION 7 8.8.1 Components of Internal Control 8.8.1.1 Control environment The auditor shall obtain an understanding of the control environment. As part of obtaining this understanding, the auditor shall evaluate whether: (a) Management, with the oversight of those charged with governance, has created and maintained a culture of honesty and ethical behavior; and (b) The strengths in the control environment elements collectively provide an appropriate foundation for the other components of internal control, and whether those other components are not undermined by deficiencies in the control environment. 8.8.1.2 Risk Assessment The auditor shall obtain an understanding of whether the entity has a process for: (a) Identifying business risks relevant to financial reporting objectives; (b) Estimating the significance of the risks; (c) Assessing the likelihood of their occurrence; and (d) Deciding about actions to address those risks. If the entity has established such a process, the auditor shall obtain an understanding of it, and the results thereof. If the auditor identifies risks of material misstatement that management failed to identify, the auditor shall evaluate whether there was an underlying risk of a kind that the auditor expects would have been identified by the entity s risk assessment process. If there is such a risk, the auditor shall obtain an understanding of why that process failed to identify it, and evaluate whether the process is appropriate to its circumstances or determine if there is a significant deficiency in internal control with regard to the entity s risk assessment process. If the entity has not established such a process or has an ad hoc process, the auditor shall discuss with management whether business risks relevant to financial reporting objectives have been identified and how they have been addressed. The auditor shall evaluate whether the absence of a documented risk assessment process is appropriate in the circumstances, or determine whether it represents a significant deficiency in internal control. 8.1.3 Information systems The information system, including the related business processes, relevant to financial reporting, and communication The auditor shall obtain an understanding of the information system, including the related business processes, relevant to financial reporting, including the following areas: 157

OFT MANUAL: FM Financial Audits SECTION 7 (a) The classes of transactions in the entity s operations that are significant to the financial statements; (b) The procedures, within both information technology (IT) and manual systems, by which those transactions are initiated, recorded, processed, corrected as necessary, transferred to the general ledger and reported in the financial statements; (c) The related accounting records, supporting information and specific accounts in the financial statements that are used to initiate, record, process and report transactions; this includes the correction of incorrect information and how information is transferred to the general ledger.the records may be in either manual or electronic form; (d) How the information system captures events and conditions, other than transactions, that are significant to the financial statements; (e) The financial reporting process used to prepare the entity s financial statements, including significant accounting estimates and disclosures; and (f) Controls surrounding journal entries, including non-standard journal entries used to record non-recurring, unusual transactions or adjustments. The auditor shall obtain an understanding of how the entity communicates financial reporting roles and responsibilities and significant matters relating to financial reporting, including: (a) Communications between management and those charged with governance; and (b) External communications, such as those with regulatory authorities. 8.8.1.4 Control activities relevant to the audit The auditor shall obtain an understanding of control activities relevant to the audit, being those the auditor judges it necessary to understand in order to assess the risks of material misstatement at the assertion level and design further audit procedures responsive to assessed risks. An audit does not require an understanding of all the control activities related to each significant class of transactions, account balance, and disclosure in the financial statements or to every assertion relevant to them. In understanding the entity s control activities, the auditor shall obtain an understanding of how the entity has responded to risks arising from IT. 8.8.1.5 Monitoring of controls The auditor shall obtain an understanding of the major activities that the entity uses to monitor internal control over financial reporting, including those related to those control activities relevant to the audit, and how the entity initiates remedial actions to deficiencies in its controls. 8.9 Standard control procedures / activities 1. Authorization 2. Segregation of duties 3. Reconciliations 4. Comparison 5. Control documents 158

OFT MANUAL: FM Financial Audits SECTION 7 6. Physical controls 7. Computer controls 8.10 Audit procedures 1. Enquiry 2. Inspection 3. Re-calculations 4. Re-performance of procedures 5. Observation 6. Analytical procedures 7. External confirmations (Positive and Negative) 8.10.1 Inquiry Inquiry consists of seeking information of knowledgeable persons, both financial and non-financial, within the entity or outside the entity. Inquiry is used extensively throughout the audit in addition to other audit procedures. Inquiries may range from formal written inquiries to informal oral inquiries. Evaluating responses to inquiries is an integral part of the inquiry process. Responses to inquiries may provide the auditor with information not previously possessed or with corroborative audit evidence. Alternatively, responses might provide information that differs significantly from other information that the auditor has obtained, for example, information regarding the possibility of management override of controls. In some cases, responses to inquiries provide a basis for the auditor to modify or perform additional audit procedures. Although corroboration of evidence obtained through inquiry is often of particular importance, in the case of inquiries about management intent, the information available to support management s intent may be limited. In these cases, understanding management s past history of carrying out its stated intentions, management s stated reasons for choosing a particular course of action, and management s ability to pursue a specific course of action may provide relevant information to corroborate the evidence obtained through inquiry. In respect of some matters, the auditor may consider it necessary to obtain written representations from management and, where appropriate, those charged with governance to confirm responses to oral inquiries. See ISA 580 for further guidance. 8.10.2 Inspection Inspection involves examining records or documents, whether internal or external, in paper form, electronic form, or other media, or a physical examination of an asset. Inspection of records and documents provides audit evidence of varying degrees of reliability, depending on their nature and source and, in the case of internal records and documents, on the effectiveness of the controls over their production. An example of inspection used as a test of controls is inspection of records for evidence of authorization. Some documents represent direct audit evidence of the existence of an asset, for example, a document constituting a financial instrument such as a stock or bond. Inspection of such documents may not necessarily provide audit evidence about ownership or value. In addition, inspecting an executed contract may provide audit evidence relevant to the entity s application of accounting policies, such as revenue recognition. 159

OFT MANUAL: FM Financial Audits SECTION 7 Inspection of tangible assets may provide reliable audit evidence with respect to their existence, but not necessarily about the entity s rights and obligations or the valuation of the assets. Inspection of individual inventory items may accompany the observation of inventory counting. 8.10.3 Recalculation Recalculation consists of checking the mathematical accuracy of documents or records. Recalculation may be performed manually or electronically. 8.10.4 Re-performance Re-performance involves the auditor s independent execution of procedures or controls that were originally performed as part of the entity s internal control. 8.10.5 Observation Observation consists of looking at a process or procedure being performed by others, for example, the auditor s observation of inventory counting by the entity s personnel, or of the performance of control activities. Observation provides audit evidence about the performance of a process or procedure, but is limited to the point in time at which the observation takes place, and by the fact that the act of being observed may affect how the process or procedure is performed. 8.10.6 Analytical Procedures Analytical procedures consist of evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. 8.10.7 External Confirmation An external confirmation represents audit evidence obtained by the auditor as a direct written response to the auditor from a third party (the confirming party), in paper form, or by electronic or other medium. External confirmation procedures frequently are relevant when addressing assertions associated with certain account balances and their elements. However, external confirmations need not be restricted to account balances only. For example, the auditor may request confirmation of the terms of agreements or transactions an entity has with third parties; the confirmation request may be designed to ask if any modifications have been made to the agreement and, if so, what the relevant details are. External confirmation procedures also are used to obtain audit evidence about the absence of certain conditions, for example, the absence of a side agreement that may influence revenue recognition. 160

OFT MANUAL: FM Financial Audits SECTION 7 8.11 Overview of Audit Reports True and fair view and compliance with Financial Reporting Framework Material and Pervasive Material Material and Pervasive Unmodified audit report Opinion of disclaimer- Scope limitation Qualified opinion Adverse opinion- Disagreement 8.11.1 Sections of Unmodified Audit Report ISA 700 describes the elements that make up the audit report as: Title The title should be appropriate. The use of Independent Auditor s Report distinguishes this report from any other report produced internally or by other non-statutory auditors. Addressee The report should be addressed to the intended user of the report which is usually the shareholders, board of directors or other party defined in the engagement or local regulations. This varies from country to country, but is usually addressed to the members of the company. This is to prevent other parties relying on the report when it is not intended for their use. Introductory paragraph Identifies the financial statements which have been audited (see below), by name or by the use of page numbers, and stating the period they cover. This is in order to distinguish such information from other documents that have not been subject to audit (e.g. the Directors Report). 161

OFT MANUAL: FM Financial Audits SECTION 7 Statement of responsibilities of management Preparation of the financial statements which show a true and fair view or present fairly in all material respects and In accordance with the applicable financial framework. Designing and implementing an effective internal control system. Applying appropriate accounting policies Making reasonable accounting estimates. Statement of responsibilities of the auditors Express opinion. Assess the risk of material misstatement. The fact that the audit was planned and performed to obtain reasonable assurance about whether the financial statements are free from material misstatement. 162

OFT MANUAL: FM Financial Audits SECTION 7 8.11.2 Modified Audit Reports 8.11.2.1 Material and pervasive ISA 700 uses the phrase 'material and pervasive' and we know that unless the matter is material, it will not cause the report to be qualified at all. (Although you should remember that materiality can be about an item s nature as well as its value.) So the nature of the qualification depends on the degree of effect that the auditor considers it may have on the financial statements. To be considered pervasive, it must affect the view given by the financial statements as a whole. As such: if the circumstance is a limitation of scope it will leave the auditor unable to form an opinion at all. If it is a disagreement, it will be of such significance that the financial statements do not give a true and fair view. 8.11. 2.2 Four types of qualified audit reports Limitation of scope Except for. Disclaimer. Disagreement Except for. Adverse. 163

OFT MANUAL: FM Financial Audits SECTION 7 8.12 Internal Control weakness letter Auditors should communicate material weaknesses in internal control in writing to those charged with governance the audit committee (if one exists) or management in general. The form, timing and addressees of this communication should be agreed at the start of the audit, as part of the terms of the engagement. This report has traditionally been known as a management letter or report to management and is usually sent at the end of the audit process. Recent revision of audit standards has added other matters that should be communicated. A report on audit independence. A report at the planning stage, identifying key audit risks and the work to be performed. At the end of the audit, a report covering: expected audit report unadjusted errors and misstatements comments on accounting practices and policies in use by the company any other relevant matters. However, this section of the Notes will concentrate on internal control issues. 8.12.1 Reporting on controls Where the auditor is reporting weaknesses, it should be made clear that: the report is not a comprehensive list of weaknesses, but only those that have come to light during normal audit procedures the report is for the sole use of the company no disclosure should be made to a third party the without written agreement of the auditor no responsibility is assumed to any other parties. 164

OFT MANUAL: FM Financial Audits SECTION 7 The usual structure of the report is: covering letter (which will include the above list of points) appendix, noting the weaknesses, consequences, and recommendations (often with a space left for management to respond with their planned action). 165

OFT MANUAL: FM Financial Audits SECTION 7 8.13 Overview of USAID specific financial audits Financial audits U.S. based recipients Foreign recipients Audit threshold US $ 500,000 spent in fiscal year Audit threshold US $ 300,000 spent in fiscal year Agency contracted audits Recipient contracted audit Agency contracted audit Recipient contracted audit OMB Circular A-133 OIG Guidelines for Financial Audits contracted by Foreign Recipients 166

OFT MANUAL: FM Financial Audits SECTION 7 8.14 Structure of OIG Guidelines for Financial Audits contracted by Foreign Recipient STRUCTURE OF OIG GUIDELINES FOR FINANCIAL AUDITS CONDUCTED BY FOREIGN RECIPIENT Chapter 01: purpose of guidelines Chapter 06: example of fund accountability statement, cost sharing schedule and schedule of computation of indirect cost rate Chapter 02: selection of independent auditors Chapter 03: audit objectives Chapter 07: illustrative reports Chapter 08: illustrative statement of work for recipient contracted audit Chapter 04: audit scope Chapter 09: model audit agreement with supreme audit institutions Chapter 05: audit reports Chapter 10: technical proposal for qualification of public accounting firm CHAPTER 11: USAID INSPECTOR GENERAL CONTACT INFORMATION 8.15 Purpose of OIG Guidelines for financial audits contracted by Foreign Recipients Key Questions 8.15.1 WHO IS RESPONSIBLE TO MAKE CONTRACT WITH INDEPENDENT AUDITORS? It is the grantee s responsibility to contract independent auditors acceptable to USAID. USAID does reserve the right to conduct audits using its own staff, despite acceptable audits being performed by other auditors, in cases where special accountability needs are identified. 8.15.2 WHO MUST BE AUDITED UNDER OIG GUIDELINES? 167

OFT MANUAL: FM Financial Audits SECTION 7 1. An audit must be performed annually in accordance with these Guidelines when the Non-US recipient expends $300,000 or more in USAID awards in its fiscal year. 2. SUB-RECIPIENTS - Non-U.S. recipients have to ensure that audits of sub-recipients are performed annually, in accordance with these Guidelines, for sub-recipients expending $300,000 or more in USAID awards in their fiscal year. 8.15.3 HOW SCENARIO OF MULTIPLE AGREEMENTS AND SUBRECIPIENTS MUST BE DEALT? A. If a non-u.s. organization is only a sub-recipient of a U.S. recipient organization then it is: Subject to monitoring by the prime U.S. recipient, which must comply with the requirements of paragraph 1.5 of OIG Guidelines for RCA. B. If a foreign recipient receives direct USAID assistance and receives USAID funding as a sub-recipient of a U.S. recipient organization, then: The annual audit must be performed in accordance with these Guidelines and must include the funding passed through by the U.S. recipient organization; and If the foreign recipient also receives assistance from other donors, consideration should be given to including the other donors' assistance in the USAID audit, provided an agreement and cost-sharing arrangement can be negotiated with the other donors. C. If a recipient receives direct funding from USAID under more than one agreement and also indirect assistance from USAID as a sub-recipient from either foreign or U.S. recipients then: The recipient must have one annual recipient-contracted audit performed that would cover all USAID funding to the recipient from all sources. The recipient should contract only one audit firm to perform the annual audit. D.Recipients must send their audit contracts for approval to the nearest USAID mission with which they have an agreement. This USAID mission will act as the designated cognizant mission, unless the recipient is otherwise directed by USAID. The designated cognizant mission will coordinate the audit efforts with any other USAID missions that have agreements with the recipient. E. If a U.S. sub-recipient expends $500,000 or more in USAID awards in its fiscal year it is subject to Circular A-133 audit requirements 8.15.4 WHAT ARE THE RESPONSIBILIITIES OF USAID MISSION AND OIG? 1. USAID mission monitor and ensure the submission of required recipient-contracted audit reports. 2. RIG monitors the quality of such audits. 3. RIG maintains a list of independent auditors eligible to perform audits of USAID agreements. The list of eligible independent auditors is divided into regular and conditional 4. USAID mission ensure that the audit agreements between recipients and independent auditors contain a standard statement of work containing all the requirements of these Guidelines. Accordingly, recipients must 168

OFT MANUAL: FM Financial Audits SECTION 7 send all prospective audit contracts to the USAID mission for approval prior to finalization and must indicate which USAID agreements will be covered by the audit. 5. The USAID missions will provide the independent auditors with data regarding any USAID direct procurements for use by the recipient and will confirm the amounts disbursed (advances and reimbursements) to the recipient. 6. The cognizant USAID mission will be responsible for distributing audit reports to the other USAID missions and resolving a recipient's organization-wide internal control and compliance deficiencies. Each USAID mission will also be responsible for acting upon findings and recommendations applicable to its agreements with the recipient. 7. RIG will conduct quality control reviews of the audit documentation for a selected sample of audits. These reviews will determine whether audit work was performed in accordance with these guidelines. The RIG will notify USAID, recipient and independent auditors of the results of these reviews. 8.15.5 WHO WILL BEAR AUDIT COST? A. Recipients may charge to the USAID agreements all costs for performing the specific audit of their USAID-funded programs. B. The costs to be charged to the USAID agreements for auditing the recipient's general purpose financial statements will be a matter for negotiation between USAID and the recipient C. No audit costs may be charged to a USAID agreement if audits are not performed in accordance with these Guidelines, it is incumbent upon the auditor to produce a final product that meets this requirement. D. USAID will consider appropriate sanctions against a recipient in the event of their continued inability or unwillingness to have an audit performed in accordance with these Guidelines, these may include: D.1. Suspension of disbursements to the recipient until a satisfactory audit is performed D.2. USAID will refer independent auditors to appropriate regulators, professional authorities, and U.S.- affiliated firms for significant inadequacies or repeated instances of substandard performance D.3. Auditors submitting unacceptable work may be removed from USAID s approved list of firms 8.16 Selection of Independent Auditors Key Questions 8.16.1 WHAT ARE THE KEY SELECTION CONSIDERATIONS FOR AUDIT FIRM? The recipient can select audit firm from the list of eligible audit firms maintained by the cognizant RIG. The selection of audit firms is based on following factors. Past performance Independence from organization Experience and credentials of audit engagement team Cost Reference checks 8.16.2 IS IT POSSIBLE FOR NGO MANAGEMENT TO APPOINT LOCAL AUDIT FIRM? 169

OFT MANUAL: FM Financial Audits SECTION 7 Local firms may be conditionally accepted when they are the regular auditors of a recipient's general purpose financial statements and are recommended by the USAID mission. The recommendation may be based on prior experience, other acceptable client assurance or a pre-qualification review by USAID. Conditionally accepted firms must be separately approved for each recipient they audit under these Guidelines. In determining acceptability of proposed audit firms, USAID gives first priority to firms that have partnership agreements with firms located in the United States. Audit firms who have authority to use the letterhead and sign audit reports in the name of a U.S. audit firm are required to do so. USAID will give second priority to affiliates or representatives of firms located in the United States that are subject to standard audit quality control procedures and reviews. Local firms that are not affiliated with firms located in the United States may be accepted when there is a high degree of assurance of professional quality based upon prior experience with an international organization or other acceptable client assurance. 8.16.3 WHAT ARE THE PRIOR APPROVAL REQUIREMENTS OF USAID REGARIDNG THE SELECTION PROCESS OF AUDIT FIRM? The USAID mission must approve the audit firm prior to execution of the audit services contract and hence the preferred procedure is for the recipient to: A. Select audit firms from the list of firms determined to be eligible by USAID and obtain proposals. B. Submit a draft contract to the USAID for approval C. USAID will verify that the firm selected is on the list of firms eligible to perform audits of USAID funds and that the statement of work contained in the contract complies with these Guidelines (USAID has the authority to establish a limit on the maximum number of years that a recipient can be audited by the same audit firm). D. It is the responsibility of the contracted audit firms to perform audits pursuant to these Guidelines and to present audit reports in a timely manner. E. If USAID rejects the work of an audit firm due to noncompliance with these Guidelines, the audit costs may not be charged to the USAID agreements until such time as USAID finds the report to be acceptable. If audit firm fail to make its report acceptable, either a different recipient contracted audit firm or the Regional Inspector General (RIG) must perform another audit. 8.16.4 WHAT ARE THE SUBMISSION DEADLINES FOR AUDIT REPORT? Six (6) copies of the audit report in English and one copy of the report in the recipient country's official language (if considered appropriate) must be submitted to USAID within 30 days after completion of the audit. The audit shall be completed and submitted to USAID no later than nine (9) months after the end of the recipients year end. Alternatively, electronic copies of the audit report can be submitted to USAID if requested. 8.17 AUDIT OBJECTIVES KEY QUESTIONS 8.17.1 WHAT KIND OF FINANCIAL INFORMATION AND SYSTEMS MUST BE AUDITED? A. The financial audit must include a specific audit of all the recipient s USAID-funded programs. The fund accountability statement is the basic financial statement to be audited that presents the recipient's 170

OFT MANUAL: FM Financial Audits SECTION 7 revenues, costs incurred, cash balance of funds provided to the recipient by USAID, and commodities and technical assistance directly procured by USAID for the recipient's use. The fund accountability statement should be reconciled to the USAID funds included in the general purpose financial statements by a note to the financial statements or the fund accountability statement. B The cost share schedule must be reviewed (if applicable) C. The auditors must review and evaluate the recipient's internal control related to USAID programs to obtain a sufficient understanding of the design of relevant control policies and procedures and whether those policies and procedures have been placed in operation (Auditors Report on Internal Controls). D. Determine whether the recipient complied in all material respects with agreement terms and laws and regulations related to the USAID funded program (Auditors Report on Compliance). E. Perform an audit of the indirect cost rate(s) if the recipient has been authorized to charge indirect costs to USAID using provisional rates and USAID has not yet negotiated final rates with the recipient. F. The financial audit should also include an audit of the recipient s general purpose financial statements on an organization-wide basis (balance sheet, income statement, and cash flow statement) if the recipient has been authorized to charge indirect costs, or if the mission specifically requests such an audit. 8.17.2 WHAT IS THE REPORTING CURRENCY OF FUND ACCOUNTABILITY STATEMENT? All currency amounts in the fund accountability statement, cost-sharing schedule, and the report findings, if any, must be stated in US$. The auditors should indicate the exchange rate(s) used in the notes to the fund accountability statement. 8.18 AUDIT SCOPE KEY QUESTIONS 8.18.1 WHAT ARE THE PRE-AUDIT REVIEW DOCUMENTS? 1. The agreements between USAID and the recipient 2. The sub-agreements between the recipient and other implementing entities, as applicable. 3. Contracts and subcontracts with third parties, if any. 4. The budgets, implementation letters, and written procedures approved by USAID. 5. USAID Automated Directives System Chapter 636 Program Funded Advances. 6. OMB Circular A-122 "Cost Principles for Nonprofit Organizations." 7. OMB Circular A-21 "Cost Principles for Educational Institutions." 8. Federal Acquisition Regulation (FAR), Part 31 Contract Cost Principles and Procedures. 9. USAID Acquisition Regulation (AIDAR), which supplements the FAR. 10. Mandatory Standard Provisions for Non-U.S. Nongovernmental Grantees (USAID Automated Directives System, Series 300). 11. Standard Provisions Annex for Agreements with Foreign Governments (USAID Automated Directives System, Series 200). 12. All program financial and progress reports; charts of accounts; organizational charts; accounting systems descriptions; procurement policies and procedures; and receipt, warehousing and distribution procedures for materials, as necessary, to successfully complete the required work. 171

OFT MANUAL: FM Financial Audits SECTION 7 8.18.2 HOW THE FUND ACCOUNTABILITY STATEMENT SHOULD BE VERIFIED BY AUDIT FIRM AS PER OIG GUIDELINES? The auditor must: 8.18.2.1. Perform the audit in accordance with U.S. Government Auditing Standards 8.18.2.2. Express an opinion on the fund accountability statement for the USAID-funded programs 8.18.2.3. Determine if the recipient has taken adequate corrective action on prior audit report recommendations. 8.18.2.4. Provide reasonable assurance of detecting situations or transactions in which fraud or illegal acts have occurred or are likely to have occurred as a result of inadequate internal controls. If such evidence exists, the auditors must contact USAID and should exercise due professional care in pursuing indications of possible fraud and illegal acts so as not to interfere with potential future investigations or legal proceedings. 8.18.2.5. Examine the fund accountability statement for USAID programs including: a. The budgeted amounts by category and major items b. The revenues received from USAID for the period covered by the audit c. The costs reported by the recipient as incurred during that period; and d. The commodities and technical assistance directly procured by USAID for the recipient's use. 8.18.2.6. Include all USAID funds identified by each specific program or agreement and separately identify those revenues and costs applicable to each specific USAID agreement. 8.18.2.7. Not include cost-sharing contributions provided from the recipient's own funds or in-kind as a separate cost-sharing schedule must be included and reviewed. 8.18.2.8. Review direct and indirect costs billed to and reimbursed and pending reimbursement by USAID 8.18.2.9. Determine whether specific costs incurred are allowable, allocable, and reasonable under the agreement terms, including (but not limited to): a. Review direct salary charges to determine if reasonable for that position, in accordance with those approved by USAID when USAID approval is required, and supported by appropriate payroll records. b. Determine if overtime was charged to the program and whether it was allowable under the terms of the agreements. c. Determine whether allowances and fringe benefits received by employees were in accordance with the agreements and applicable laws and regulations. d. Review travel and transportation charges to determine whether they were adequately supported and approved. e. Review commodities (such as supplies, materials, vehicles, equipment, food products, tools, etc.), whether procured by the recipient or directly procured by USAID for the recipient's use. 172

OFT MANUAL: FM Financial Audits SECTION 7 f. Review technical assistance and services, whether procured by the recipient or directly procured by USAID for the recipient's use. The auditors should determine if used for their intended purposes in accordance with the terms of the agreements. The cost of technical assistance and services not properly used in accordance with terms of the agreements must be questioned in the fund accountability statement. 8.18.2.10. Identify and quantify any questioned costs. All material questioned costs resulting from instances of noncompliance with agreement terms and applicable laws and regulations must be included as findings in the report on compliance. Also, the notes to the fund accountability statement must briefly describe both material and immaterial questioned costs and must be cross-referenced to any corresponding findings in the report on compliance. Questioned costs must be presented in the fund accountability statement in two separate categories: a. Ineligible costs these are costs that are unreasonable; prohibited by the agreements or applicable laws and regulations; or not program related; and b. Unsupported costs - these are costs not supported with adequate documentation or did not have required prior approvals or authorizations. 8.18.2.11. Review general and program ledgers 8.18.2.12. Review the procedures used to control the funds and review the bank accounts and the controls on those bank accounts. Perform positive confirmation of balances, as necessary. 8.18.2.13. Ensure that all funds received by the recipient from USAID are appropriately recorded in the recipient's accounting records and that those records were periodically reconciled with information provided by USAID. 8.18.2.14. Review procurement procedures to determine whether sound commercial practices including competition were used, reasonable prices were obtained, and adequate controls were in place over the qualities and quantities received. 8.18.2.15. On closeout audits the auditor must: a. Review un-liquidated advances to the recipient and pending reimbursements by USAID b. Ensure that the recipient returned any excess cash to USAID c. Ensure that all assets (inventories, fixed assets, commodities, etc.) procured with program funds were disposed of in accordance with the terms of the agreements. The auditors should present, as an annex to the fund accountability statement, the balances and details of final inventories of nonexpendable property acquired under the agreements. This inventory should indicate which items were titled to the U.S. Government and which were titled to other entities. 8.18.2.16. Determine whether program income (if applicable) was added to funds used to further eligible project or program objectives, to finance the non-federal share of the project or program, or deducted from program costs, in accordance with USAID regulations, other implementing guidance, or the terms and conditions of the award. 8.18.2.17. Review the allocation method to determine that the indirect cost pool and distribution base include only allowable items in accordance with agreement terms and regulations when indirect costs were charged to USAID using provisional rates. The auditors should be aware that costs that are unallowable as 173

OFT MANUAL: FM Financial Audits SECTION 7 direct charges to USAID agreements (e.g., fundraising) must be allocated their share of indirect costs if they represent activities that (1) include the salaries of personnel, (2) occupy space, and (3) benefit from the organization s indirect costs. Indirect cost rates must be calculated after all adjustments have been made to the pool and base. 8..18.2.18. While the auditors may prepare or assist the recipient in preparing the fund accountability statement from the books and records maintained by the recipient, but the recipient must accept responsibility for the statement's accuracy before the audit commences. 8.18.3 HOW THE COST SHARING SCHEDULE SHOULD BE CHECKED BY AUDIT FIRM AS PER THE OIG GUIDELINES? USAID agreements may require cost-sharing contributions by the recipient. Most agreements establish a lifeof-project budget for such contributions; however, some agreements may establish annual budgets for those contributions. The review of the costs sharing schedule must be approached differently depending on whether the cost-sharing budget is a life-of project budget or an annual budget (please see guidelines for detailed account for both cost shares). In either case, the review consists principally of inquiries of recipient personnel and analytical procedures applied to financial data supporting the cost-sharing schedule. And in essence the audit should: 8.18.3.1. Determine whether cost-sharing contributions were provided and accounted for by the recipient in accordance with the terms of the agreements. 8.18.3.2. Clearly state whether or not cost-sharing contributions were required by the agreement. 8.18.3.3. Review the cost-sharing schedule to determine if the schedule is fairly presented in accordance with the basis of accounting used by the recipient to prepare the schedule. 8.18.3.4. Question all cost-sharing contributions that are either ineligible or unsupported costs. a. All questioned costs must be briefly described in the notes to the cost-sharing schedule. Notes to the costsharing schedule must be cross-referenced to the corresponding findings in the report on compliance b. Material questioned costs must be included as findings in the report on compliance. c. Reportable internal control weaknesses related to cost-sharing contributions must be set forth as findings in the report on internal control. 8.18.3.5. For close out audits of awards with life-of-project Cost Share Budgets, and audits of awards with Annual Cost Share Budgets, the cost-sharing schedule must identify the budgeted amounts required by the agreements, the amounts actually provided, and any cost-sharing shortfalls 8.18.3.6. State that the review was conducted in accordance with AICPA standards, and it should also explain that a review is more limited in scope than an examination performed in accordance with AICPA standards, and hence an opinion on the schedule is not expressed. 8.18.3.7. While the auditors may prepare or assist the recipient in preparing the cost-sharing schedule from the books and records maintained by the recipient. The recipient must, however, accept responsibility for the schedule's accuracy before the review commences 8.18.4 HOW INTERNAL CONTROLS OF RECIPIENTS MUST BE TESTED BY AUDITORS? 174

OFT MANUAL: FM Financial Audits SECTION 7 8.18.4.1 The auditors must review and evaluate the recipient's internal control related to USAID funded programs and any cost-sharing contributions (if required) to obtain a sufficient understanding of the design of relevant control policies and procedures and whether those policies and procedures have been placed in operation. This will include but not limited to: a. Ensuring charges to the program are proper and supported b. Managing cash on hand and in the bank account c. Procuring goods and services d. Managing inventory e. Managing personnel f. Managing and disposing of commodities purchased g. Ensuring compliance with agreement terms and applicable laws and regulations 8.18.4.2. The auditor's report on internal controls must include as a minimum: a. The scope of the auditor's work in obtaining an understanding of internal control and in assessing risk, and; b. Identifying the reportable conditions including identifying material weaknesses in the internal controls. Reportable conditions, including material weaknesses, must be described in the report on internal control as findings while Non reportable conditions should be included in a separate management letter to the recipient. 8.18.5 HOW AUDITORS ENSURE COMPLIANCE WITH AWARD TERMS, LAWS AND REGULATIONS? 8.18.5.1. The auditor must ensure that the recipient complied (in all material respects) with the agreement (including cost sharing, if applicable) and applicable laws and regulations. All material instances of Noncompliance and all illegal acts that have occurred or are likely to have occurred should be identified as findings in the report on compliance while nonmaterial instances of noncompliance should be communicated to the recipient in a separate management letter that should be sent with the audit report Also, the notes to the fund accountability statement that describe both material and immaterial questioned costs must be cross referenced to any corresponding findings in the report on compliance. 8.18.5.2. In planning and conducting the tests of compliance the auditors must amongst others: a. Identify the agreement terms and pertinent laws and regulations that if not observed could have material effect on fund accountability statement b. Determine if payments have been made in accordance with agreement terms and applicable laws and regulations. c. Determine if funds have been expended for purposes not authorized. If so, the auditors must question these costs in the fund accountability statement. d. Identify any costs not considered appropriate, classifying and explaining why these costs are questioned. 175

OFT MANUAL: FM Financial Audits SECTION 7 e. Determine whether commodities, whether procured by the recipient or directly procured by USAID for the recipient's use, exist or were used for their intended purposes in accordance with the terms of the agreements. If not, the cost of such commodities must be questioned. f. Determine whether any technical assistance and services, whether procured by the recipient or directly procured by USAID for the recipient's use, were used for their intended purposes in accordance with the agreements. If not, the cost of such technical assistance and services should be questioned. g. Determine if the amount of cost-sharing funds was calculated and accounted for as required by the agreements or applicable cost principles, quantify any shortfalls. h. Determine whether those who received services and benefits were eligible to receive them. i. Determine whether the recipient s financial reports (including those on the status of cost sharing contributions) and claims for advances and reimbursement contain information that is supported by the books and records. j. Determine whether the recipient held advances of USAID funds in interest-bearing accounts, and whether the recipient remitted to USAID any interest earned on those advances, with the exception of up to $250 a year that the recipient may retain for administrative expenses. 8.18.6 WHAT IS THE STANDARD FORMAT OF INTERNAL CONTROLS AND COMPLIANCE REPORTS? The findings contained in the reports on internal control and compliance related to USAID-funded programs must include: 8.18.6.1. A description of the condition (what it is) and 8.18.6.2. The criteria (what should it be) 8.18.6.3. The cause (why it happened) and 8.18.6.4. The effect (what harm was caused by not complying with the criteria) 8.18.6.5. In addition, the findings must contain a recommendation that corrects the cause and the condition, as applicable. It is recognized that material internal control weaknesses and noncompliance found by the auditors might not always have all of these elements fully developed. The auditors must, however, at least identify the condition, criteria and possible effect to enable management to determine the effect and cause. This will help management take timely and proper corrective action. 8.18.6.6. Findings that involve monetary effect must: a. Be quantified and included as questioned costs in the fund accountability statement, the Auditor s Report on Compliance, and cost-sharing schedule (cross-referenced). b. Be reported without regard to whether the conditions giving rise to them were corrected. c. Be reported whether the recipient does or does not agree with the findings or questioned costs. 176

OFT MANUAL: FM Financial Audits SECTION 7 d. Contain enough relevant information to expedite the audit resolution process (e.g., number of items tested, size of the universe, error rate, corresponding U.S. dollar amounts, etc.). 8.18.6.7. Also, after each recommendation, pertinent views of responsible recipient officials concerning the auditor's findings and actions taken by the recipient to implement the recommendations should be obtained if possible in writing. When the auditors disagree with management comments opposing the findings, conclusions or recommendations, they must explain their reasons for this. Conversely, the auditors should modify their report if they find the comments valid. 8.18.6.8. Any evidence of fraud or illegal acts that have occurred or are likely to have occurred must be included in a separate written report if deemed necessary by USAID. This report must include an identification of all questioned costs as a result of fraud or illegal acts, without regard to whether the conditions giving rise to the questioned costs have been corrected or whether the recipient does or does not agree with the findings and questioned costs. In reporting material fraud, illegal acts, or other noncompliance, the auditors must place their findings in proper perspective. To give the reader a basis for judging the prevalence and consequences of these conditions, the instances identified should be related to the universe or the number of cases examined and is quantified in terms of U.S dollar value, if appropriate. 8.18.7 HOW THE SCHEDULE OF COMPUATATION OF INDIRECT COST RATE (if applicable) SHOULD BE VERIFIED? The auditor should prepare a schedule of computation of indirect cost rate (see Example 6.3 of these Guidelines) and the auditors report on the schedule of computation of indirect cost rates which is a separate report (see Example 7.4 of these Guideline). Auditors should determine the actual indirect cost rates for the year if the recipient has used provisional rates to charge indirect costs to USAID. The audit of the indirect cost rates should include tests to determine whether the: a. Distribution or allocation base includes all costs that benefited from indirect activities. b. Distribution or allocation base is in compliance with the governing USAID Negotiated Indirect Cost Rate Agreement, if applicable. c. Indirect cost pool includes only costs authorized by the USAID agreements and applicable cost principles. d. Indirect cost rates obtained by dividing the indirect cost pool by the base are accurately calculated. e. Costs included in this calculation reconcile with the total expenses shown in the recipient's audited general purpose financial statements. f. The results of the audit of the indirect cost rate should be presented in a schedule of computation of indirect cost rate (see Example 6.3 of these Guidelines). This schedule should contain: i. A listing of costs included in each indirect cost pool ii. The distribution base, and iii. The resultant indirect cost rate calculation. The costs in the schedule should reconcile with the total expenses shown in the recipient's general purpose financial statements. U.S. Office of Management and Budget (OMB) Circular A-122 provides additional guidance on allocation of indirect costs and determination of indirect cost rates. 8.18.8 WHAT ARE SOME OF THE OTHER AUDIT RESPONSIBILITIES? 177

OFT MANUAL: FM Financial Audits SECTION 7 The auditors must perform the following steps: 8.18.8.1. Hold entrance and exit conferences with the recipient. USAID should be notified of these conferences in order that USAID representatives may attend, if deemed necessary. 8.18.8.2. During the planning stages of an audit, communicate information to the auditee regarding the nature and extent of the planned testing and reporting on compliance with laws and regulations and internal control over financial reporting. Such communication should state that the auditors do not plan to provide opinions on compliance with laws and regulations and internal control over financial reporting. Written communication is preferred. 8.18.8.3. Institute quality control procedures to ensure a reasonable basis for an opinion regarding the financial statements under audit. While auditors may use their standard procedures for ensuring quality control, those procedures must, at a minimum, ensure that: a. Audit reports and supporting working papers are reviewed by an auditor, preferably at the partner level, who was not involved in the audit. This review must be documented. b. All quantities and monetary amounts involving calculations are footed and cross-footed. c. All factual statements, numbers, conclusions and monetary amounts are cross-indexed to supporting working papers. 8.18.8.4. Determine whether the recipient ensured that audits of its sub-recipients were performed to ensure accountability for USAID funds passed through to sub-recipients (see paragraph 1.6 of the Guidelines). If sub-recipient audit requirements were not met, the auditors should disclose this in the fund accountability statement and consider qualifying their opinion. 8.18.8.5. Obtain a management representation letter signed by the recipient s management. 178

OFT MANUAL: FM Financial Audits SECTION 7 8.19 Audit Reports as per OIG Guidelines for financial audits contracted by foreign recipient Types of Reports Auditors report on Fund Accountability Statement Auditors report on general purpose financial statement Auditors report on internal controls Auditors report on compliance Auditors report on schedule of computation of indirect cost rate Auditors report on cost sharing Reference material ADS 590 ADS 591 Guidelines for Financial Audits contracted by Foreign Recipients 179

OFT MANUAL: FM Project Closeouts SECTION 8 Award Closeout 9.1 Award Definition Close-Out of award refers close-out to all of the activities that the USG requires grantees to do at the end of their award period: Program related activities Human resource related activities Financial management-related activities Administrative activities 9.2 USG and Agency Regulations for award close-outs U.S. based NGOs Foreign NGOs Overall close-out procedures 22 CFR 226.71 Program Performance 22 CFR 226.51 Terms of award Financial Reporting 22 CFR 226.52 Record, extension and access 22 CFR 226.53 Audit 22 CFR 226.26 OIG Guidelines for Financial Audits contracted by Foreign Recipients 9.3 Programmatic issues at award close-outs 9.3.1 Exit strategies OMB Circular A 133 Phasing down: gradual reduction of program activities 9.3.2 Final Completion Report The final performance report is somewhat similar to the Quarterly Performance Report, though it covers the entire award period. Your COTR may give you a specific outline or template to follow. At a minimum, your final performance report will include final outcomes, lessons learned, and conclusions. Be sure to submit the report to your COTR and the Development Experience Clearinghouse (DEC) (http://dec.usaid.gov) within 90 days of the end of the award. Many organizations choose to take the final performance report one step further and create something long-lasting that they can share with beneficiaries, the community, sub-recipients, and other NGOs. 180

OFT MANUAL: FM Project Closeouts SECTION 8 This allows an organization to highlight its successes and document its lessons learned and contribute to the ongoing effort to improve interventions in that focus area. Your organization s experiences may even help other communities struggling with the same challenges. Some organizations share this document with Webbased communities of practice, within their NGO network, or at regional and international conferences, or they submit it to relevant publications. To create this report, you will want to develop a separate document from the one you provided to USAID, but you will still need to credit USAID, the same way you would on other project-related public communication products An end-of-project evaluation that objectively documents the impact of your project and provides an independent analysis of your project s success will greatly enhance the quality of this report. Checklist for Final Completion Report Project name and number Brief description of the project Partners Goals and OBJECTIVES A comparison of actual accomplishments with the goals and objectives established for the grant period Reasons why objectives were not met The output and outcomes of project Success stories Lessons learn When appropriate, analysis and explanation of cost overruns or high unit costs Continuation of the project Evaluation findings (if evaluation done) 9.3.3 Project Evaluation Costs versus budget Organizational outcomes achieved versus planned outcomes; any unplanned outcomes Effectiveness of project planning Effectiveness of project implementation Team s compilation of project documents, evaluations and lessons learned Identification of best practice 181

OFT MANUAL: FM Project Closeouts SECTION 8 9.3.4 Archive program activities Semi-annual and annual reports Master/original work plan Monitoring and evaluation plan Performance monitoring reports Evaluation reports Success stories and newspaper articles Conference, FGDs, Seminar and Training of Trainers workshop reports Manuals, publications Consultant reports 9.3.5: USAID Specific Regulations for Program close-outs Reference material: 22 CFR 226.51 226.51 Monitoring and reporting program performance. a) Recipients are responsible for managing and monitoring each project, program, sub award, function or activity supported by the award. Recipients shall monitor sub awards to ensure sub-recipients have met the audit requirements as delineated in Section 226.26. (b) The terms and conditions of the agreement will prescribe the frequency with which the performance reports shall be submitted. Except as provided in paragraph 226.51(f), performance reports will not be required more frequently than quarterly or, less frequently than annually. Annual reports shall be due 90 calendar days after the award year; quarterly or semi-annual reports shall be due 30 days after the reporting period. USAID may require annual reports before the anniversary dates of multiple year awards in lieu of these requirements. The final performance reports are due 90 calendar days after the expiration or termination of the award. c) If inappropriate, a final technical or performance report shall not be required after completion of the project. (d) Performance reports shall generally contain, for each award, brief information on each of the following: (1) A comparison of actual accomplishments with the goals and objectives established for the period, the findings of the investigator, or both. Whenever appropriate and the output of programs or projects can be readily quantified, such quantitative data should be related to cost data for computation of unit costs. (2) Reasons why established goals were not met, if appropriate. 182

OFT MANUAL: FM Project Closeouts SECTION 8 (3) Other pertinent information including, when appropriate, analysis and explanation of cost overruns or high unit costs. (e) Recipients shall submit the original and two copies of performance reports. (f) Recipients shall immediately notify USAID of developments that have a significant impact on the awardsupported activities. Also, notification shall be given in the case of problems, delays, or adverse conditions which materially impair the ability to meet the objectives of the award. This notification shall include a statement of the action taken or contemplated, and any assistance needed to resolve the situation. (g) USAID may make site visits, as needed. (h) USAID shall comply with clearance requirements of 5 CFR 1320 when requesting performance data from recipients 9.4 Human Resource Close Out Close out can be a stressful time when managers are trying to maintain a balance between meeting contractual obligations and considering the individual needs of staff. Historically, the focus in close out has been on fulfilling contractual obligations. However, this may be perceived as insensitivity to staff who are concerned about their future, particularly as the project ends. Communication is key to sustaining a high level of performance. All staff should be informed of the close-out process and the HR close-out plan, including a clear indication of any efforts to retain staff. When you address personnel issues fairly, your organization is seen as a good employer, so that when there is a new project, former employees, even if they cannot be retained now, will be keen to rejoin. If you do not handle personnel issues well, there is the risk of complaints, low morale, lack of concentration, and poor performance. 9.4.1 Reassignment options Where possible, try to retain employees by reassigning them to other projects. Focus on staff with strong skills and competencies that drive performance. If opportunities exist, consider promoting staff to more senior positions. Reassignment should be to further mission and based on clear criteria 9.4.2 Best Practices Human Resource Close Out Clear and consistent communication about the change process Staff training on CV writing, financial management and counseling on stress Timely notification of termination/reassignment 9.4.3 HR Information Legal Requirements on final payments and Contractual Obligations The organization Recommendation must follow letters the termination laws of the country ensuring payment of severance and other benefits as delineated by law. Managing expectations Recognition of performance and commitment 183

OFT MANUAL: FM Project Closeouts SECTION 8 Staff have a right to receive a certificate of service. This can be as basic as providing name of employer, staff name, date of commencement of work, date of termination, and location of work. Within the rules pertaining to the country of employment, staff need to receive their final salary, payment of any outstanding expense claims, outstanding leave days not taken, service/loyalty or severance payments, and other payments mandated by your organization. Additionally, staff needs to be able to transfer their pension contributions. Where staff are eligible for repatriation, all the costs need to be incurred prior to the project completion date, with shipping costs being agreed before the end date. 9.4.4 Team and Interpersonal Dynamics Low morale due to departing employees Focus on finding next job Competition for open positions within organization and at other organization Need to recognize and celebrate team (party, gifts)s Succession planning and handover Some employees will resign before the end of project for other opportunities Consider offering retention bonuses (if allowable and funding permits) Challenge to manage gaps in staffing consider consultants, reassigning people, HQ support. 9.4.5 Terminal Payments. Final payment calculation should take into account the following: Outstanding work-related expense claims Un-reconciled advances (travel, educational benefits, medical, etc.) Final month salary Post employment benefits if applicable 9.5 Financial Close Out Twelve months before the end of the award, your organization s Program Manager must develop a work plan and budget for the project s final year that includes costs for all close out related activities. Not only is this a requirement, but it also will make the close-out process easier for you. 184

OFT MANUAL: FM Project Closeouts SECTION 8 There are several key components to financial close out, including finalizing total expenditures, preparing a final financial report, and maintaining documentation. Before you can complete these steps, however, you must finalize all billing related to the award, including all final payments to sub-recipients. Once you complete this process and complete a final SF-270 or SF-1034, you can finalize your total expenditures and prepare your closing financial report. 9.5.1 Final Request for Funds As your award end date approaches, start thinking about your final request for funds. Three months before the end of the award, you should submit the final Standard Form-270 (SF-270) Request for Advance or Reimbursement or the final Standard Form-1034 (SF-1034), according to the arrangements laid out by the Financial Management Office (FMO). In addition, some agreements may require a final. SF-425 within 90 days of the award end date. If your organization is not operating on a quarterly advancedfunding basis, review the SF-270 and SF-1034 deadlines. At this time, it is also best to keep a close eye on remaining award funds and outstanding costs. If your accounting system is cash-based, rather than accrual-based, set up a special spreadsheet to track funds during the last three months of your award. 9.5.2 Finalizing Total Expenditures The first step in financial close out is to finalize total expenditures. This process helps to determine whether any funds are remaining and to make sure your organization has contributed the total minimum required cost share. As you will recall from chapter 4, award funding is obligated in stages and then disbursed to your organization through advances or reimbursements. Determine your totals for the following categories: Total USAID-Award Amount This is the ceiling or total estimated cost of your award (not including any cost share). Total Obligations The sum of all USAID funds obligated to you under this award. Total Disbursements The total amount you actually received from your funding agency under this award (that is, the amount of funds transferred to your organization s bank account through the SF-270 or SF-1034 requests). Be sure to include all final disbursements. Total Expenditures The total amount you spent on the award. Total Expenditures Charged to USAID A total of all expenditures that you charged to USAID under this award. This excludes costs covered by cost share or other donor contributions. Total Cost-Share Requirement (if any) This is the amount included in your original agreement budget. Total Cost-Share Contribution The sum of in-kind and cash contributions contributed toward the award. 9.5.3 Remaining Funds This section uses several example calculations based on the sample data. Sample Data on Remaining Award Funds 185

OFT MANUAL: FM Project Closeouts SECTION 8 Total Obligations US$3,400,000 Total Disbursements US$3,200,000 Total Expenditures US$3,989,100 Total Expenditures Charged to USAID US$3,089,100 Total Cost-Share Requirement US$1,000,000 Total Cost-Share Contribution US$ 900,000 There are three important categories of remaining funds to calculate: Unobligated funds; Remaining obligation; and Unspent advanced funds. The first two categories are funds you may still be eligible to receive before the end of the award. The third category is unspent funds that you will have to return to USAID unless you receive a non-funded extension or other modification that allows you to spend the funds. Toward the end of your award, it is important to determine what funds, if any, remain that you have not disbursed. These include both unobligated and obligated funds. Unobligated Funds Unobligated funds are the difference between funds that have been obligated and the total award amount. This amount is calculated as follows Total USAID Award Total Obligation =Unobligated Funds Example: US$3,500,000 US$3,400,000 =US$100,000 USAID has no obligation to disburse any funds it has not obligated. These funds are made available to you based on the availability of funds and continued need for program activities. If you make any expenditures above the obligated amount, you do so at your own risk. 186

OFT MANUAL: FM Project Closeouts SECTION 8 Remaining Obligation A remaining obligation is any amount of obligated funds that have not been disbursed. This amount is calculated as follows: Total Obligation Total Disbursements = Remaining Obligation Example: US$3,400,000 US$3,200,000 = US$200,000 It is critical that you track this amount, especially in the final months of your award. If you need to complete any final award activities before the end of the award, you can draw on your remaining obligation to cover these costs. It also may be possible for your organization to receive a non-funded extension to continue your program if part of your obligation is remaining. Unspent Advanced Funds The final category of remaining funds is money advanced to you that you have not spent. This amount is calculated as follows: Total Disbursements Total Expenditures (USAID Share) = Unspent Advanced Funds Example: US$3,200,000 US$3,089,100 = US$120,900 If your organization has been advanced funds that you have not spent by the time the award ends, then you must return those remaining funds. When calculating this, be sure to list all final expenditures, including all final invoices and expenses from contractors, suppliers, and sub-recipients. 9.5.4 Meeting Your Cost- Share Requirement If your organization committed to contributing a cost-share amount to the award, then you must account for and document it. The calculation to ensure you have met the cost-share requirement is: Cost-Share Requirement Total Cost-Share Contribution = Cost-Share Balance Example: US$1,000,000 US$900,000 = US$100,000 In this example, the organization committed US$1 million in cost share, but only contributed US$900,000 during the life of the award. This leaves a US$100,000 cost-share balance. As your organization is contractually obligated to meet your cost-share requirement, you will be required either to reimburse USAID for the balance or have the amount deducted from any final reimbursement request. 187

OFT MANUAL: FM Project Closeouts SECTION 8 9.5.5 Final Federal Financial Report (SF-425) Your final Federal Financial Report is due 90 days after the award end date and may be subject to NICRA adjustments based on your own or a USAID audit. The report includes the final quarter of activity, all final transactions and expenditures, and the cumulative totals for your entire award. This report is submitted using the Standard Form (SF)-425 the same form used to submit your quarterly financial reports. 9.5.6 Final Foreign Tax Reporting In the 90 days following the end of the award, you are required to submit a final Foreign Tax (VAT) Report to the office listed in your Agreement under the Reporting of Foreign Taxes standard clause. The VAT report should cover all taxes your organization paid and for which the host government reimbursed you since the last tax reporting cycle through the end of your award. If you receive reimbursements later, you must submit these funds to USAID. 9.5.7 Final Audit One fiscal year after the end of the award, conduct a final audit covering the last year of your award. You may conduct this simultaneously with the end of your organization s fiscal year and submit it as you would other audits in accordance with the terms of your agreement. 9.6 Administrative Close Out Administrative close out consists of completing nonfinancial tasks that may have financial implications. You must: Ensure compliance with USAID standards on the types of documents that need to be retained. (Remember, you must be able to provide documents should USAID request them.) Close bank account set up specifically for this program when it is no longer needed. Terminate leases (if appropriate) on rented office space that you do not plan to use after the award. Terminate supply contracts (including office supplies, leases). Terminate utilities (including electricity, water, gas, phone, Internet, fuel). Terminate other service providers (including mobile phones, security, insurance, storage contracts, shipping, cleaning, banks). Obtain a receipt from each vendor indicating its acceptance of the notice of termination Maintain the office work environment as long as allowable. Settle any obligations related to closing your office or other program facilities. For example, if you shared the office with other programs and had agreements in place covering shared office costs, be sure to cancel these agreements and inform the remaining occupants of your intention to vacate. Please remember that you cannot charge for any services provided beyond the end date of the project, so it is important to ensure that all services you receive are closed out in time. 188

OFT MANUAL: FM Project Closeouts SECTION 8 9.6.1 Maintaining Documentation Your organization is required to retain all accounting records related to your award for at least three years following submission of the final expenditure report. USAID retains the right to audit your organization any time during those three years. Maintaining documentation also helps if you need to address litigation or claims. Your sub-recipients must maintain the same documentation for three years following the end of your award. Work with them to make sure they understand their obligations and retain all documentation in a safe location. Note that some countries have their own records retention requirements that are longer than USAID s, so make sure that both you and your sub-recipients are aware of the provisions. 9.6.2 Post-Award Use of USAID-Funded Goods and Commodities At its discretion, USAID determines the disposition of all USAID-funded goods and commodities. As a grantee, you should review the regulations (22 CFR 226.34, http://edocket.access.gpo.gov/cfr_2007/aprqtr/ pdf/22cfr226.34.pdf) regarding the sale or use of equipment outside of award-related activities three months before the award end date. After reviewing the regulations, prepare a disposition plan a detailed description of what you propose to do with equipment or unused supplies when the award ends. You must submit this to your AO, who will either approve your proposal or provide further instructions. 9.6.3 Sale of Property and Equipment The following regulations are specified for USAID grantees: USAID reserves the right to transfer the title to USAID or a third party. The AO must identify the equipment appropriately or otherwise make it known to the recipient in writing. When USAID exercises its right to take the title, the equipment will be subject to the Standard Provision, called Title to and Care of Property. If you are instructed to dispose of the equipment, USAID will reimburse you for reasonable expenses incurred in shipping the equipment to a new location. You will need to follow procurement rules regarding competitive bidding to get the lowest-cost service. If you do not receive instructions within 120 calendar days after submitting your disposition plan, you can sell the equipment and reimburse USAID for its share. You may deduct and retain US$500 from the USAID share, or if the item is worth more than US$5,000, you may retain 10% of the proceeds for selling and handling expenses. Titles to supplies and other consumable equipment are vested with your organization when you acquire them. If the value of the remaining new and unused supplies exceeds US$5,000 at completion of the program, and the supplies are not needed for any other USG-sponsored projects, then you may retain the supplies, but you must compensate USAID for its share of the cost. You may not use supplies acquired with USAID funds to provide services to outside organizations for a fee that is less than private companies charge for equivalent services, unless the USG specifically authorizes you to do so. You must, at a minimum, provide the same type of insurance coverage for real property and equipment acquired with USG funds as you provided to your organization s other property. Your AO will give you special instructions if your agreement allows you to purchase any real estate, including land or buildings. 189

OFT MANUAL: FM Project Closeouts SECTION 8 9.6.4 Final Inventory Report Within 90 calendar days after the award end date, you must submit a final inventory that lists all equipment you acquired with award funds or received from USAID. The inventory is due, along with the final report, and must be completed in accordance with the terms of your agreement and the disposition plan approved by USAID. The final inventory must include: list of equipment costing US$5,000 or more with a useful life of one year or more you purchased with USAID funds, and any unused supplies that cost US$5,000 or more. For each item listed, include: original cost; USAID share of the cost (for example, if your organization paid for part of the purchase with cost share or matching, please note that); current location and condition of the equipment and/or how it is being used; and Detailed proposal of what you did or intend to do with that property. While the previous list includes the standard requirements, Grant Agreements may vary. For example, instead of listing equipment that costs US$5,000 or more, your organization may be required to list all equipment that costs US$500 or more. 9.6.5 Other Close-Out Considerations In addition to the key reports and activities that take place throughout the close-out phase, you must address a number of other tasks before close out is complete. These tasks may not apply to everyone, but when appropriate your organization should: Terminate Leases (if appropriate) Terminate leases on rented office space that you do not plan to use after the award. Insurance Policies Cancel no-longer needed insurance policies. Outstanding Contracts Close out any outstanding contracts with vendors, consultants, and other contractors. Office/Facility Close Out Be sure to take care of any obligations relating to closing your office or other program facilities. For example, if you shared the office with other programs and had agreements in place covering shared office costs, be sure to cancel these agreements and inform the remaining occupants of your intention to vacate. 9.6.6 Letter to USAID The final step of the entire close-out process is to send a letter to your CO confirming that you have completed key close-out actions, including submitting the final invoice, inventory, and all other reports to appropriate parties as well as closing out all subcontracts and sub-agreements. Keep this letter on file, as USAID may request an update on your close out, and you can resend the original letter. 190

OFT MANUAL: FM Project Closeouts SECTION 8 Reference material 22 CFR 226.71 22 CFR 226.26 22 CFR 226.31 to 226.37 22 CFR 226.51 22 CFR 226.52 22 CFR 266.53 ADS 540 CIB 90-12 191

OFT MANUAL: FM Financial Sustainability of CSOs SECTION 9 FINANCIAL SUSTAINABILITY OF CIVIL SOCIETY ORGANISATIONS 10.1 Financial Sustainability Conventional Funding Sources; DIFD, UN, USAID and EU etc Corporate donors; Listed Public Limited Companies Funding Portfolio of NGOs Management of grantees can obtain approved NGO status and tax exemption under the relevant provisions of Income Tax Ordinance 2001 Reserve Fund 10.2 Key details of corporate funding Section 61 of income Tax Ordinance 2001 encourages the Listed Public Limited Companies to pay donations to approved charities Donations to approved charitable reduces the annual tax liability of listed Public Limited Companies under section 61 of Income Tax Ordinance 2001 The grantee management should take proactive steps to obtain approved NGO status and tax exemption from tax authorities of Pakistan Corporate funding will diversify the existing conventional funding base of NGO Corporate funding will enable the grantee management to increase the quantum of endowment fund for financial sustainability purposes 10.3 Establish Reserve Fund To establish reserve fund as per the relevant provisions of constitutional documents of organization and applicable registration statute Relevant applicable registration statutes for civil society organizations in Pakistan 1. Societies Registration Act 1860 192 2. Trust Act 1882

OFT MANUAL: FM Financial Sustainability of CSOs SECTION 9 10.4 Benefits of Reserve Fund It is the responsibility of governing body and executive management to establish reserve fund to achieve following strategic objective 1. To ensure financial sustainability in the foreseeable future 2. To ensure continuity of program and project activities for beneficiaries in the selected geographical areas 3. To retain and utilize requisite human resources for the accomplishment of organizational objectives during the defined strategic planning timeframe 4. To ensure perpetual succession of organization 10.5 Method to increase quantum of Reserve Fund 193

OFT MANUAL: FM Financial Sustainability of CSOs SECTION 9 To negotiate non-earmarked /unrestricted funding agreements with identified relevant donor agencies To incorporate management fee in the budgets of project proposals To design and increase the strategic program implementation scope / thematic areas in the light of emerging grant environment in Pakistan To formulate grant strategy for obtaining corporate funding from listed Public Limited Companies 194

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 US AGENCY REGs/INTERNAL CONTROLS & INCOME TAX LAW 10.1 Overview Relevant Tax Provisions Approved NGO Status Civil Society Organization Tax exemptions Compliance with section 2 (36) of Income Tax Ordinance 2001 Compliance with sub clause 3 of clause 58 of I Part of second schedule of income Tax Ordinance 2001 10.2 Benefits of approved NGO status and tax exemption certificate Section 2(36) of the ITO 2001 The Income Tax Ordinance, 2001 has for the first time introduced the term, non-profit organization. One major distinction between the 1979 and 2001 Ordinance is that the former exempted income through a process granting such exemption. The latter, on the other hand, recognizes the organization as a non-profit organization and the exemption accrues automatically. This recognition not only exempts the income of the organizations, but also the donation given by any taxpayer to such organizations. Section 2 (36) states that: Non-profit organization means any person other than an individual, which is (a) Established for religious, educational, charitable, welfare or development purposes, or for the promotion of an amateur sport; (b) Formed and registered under any law as a non-profit organization; (c) approved by the Commissioner for specified period, on an application made by such person in the prescribed form and manner, accompanied by the prescribed documents and, on requisition, such other documents as may be required by the Commissioner; and none of the assets of such person confers, or may confer, a private benefit to any other person. 195

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 Since the term charitable purposes had not been defined in the 2001 Ordinance, this was introduced through an amendment contained in the Finance Ordinance 2002 by the addition of clause 11(A) in Section 2 which reads charitable purposes includes relief of the poor, medical relief and the advancement of any other object of general public utility. Section 61 of the ITO 2001 Section 61 of the Ordinance specifies the extent and scope of tax benefit. An organization that has been approved by the commissioner under Section 2(36) of Income Tax gets a done status, meaning that any donation (in cash or kind) are tax deductible subject to the conditions specified in section 61 of the Ordinance. Specifically speaking, the done status conferred by this provision does not benefit the NPO directly. In fact, it grants a fiscal benefit to the donor of an NPO. It acts as an incentive to an NPO having a done status rather than an NPO without it. On the part of the government, recognition factor also contributes to the public benefit character of the NPO concerned. Section 61 states: (1) A person shall be entitled to a tax credit in respect of any sum paid, or any property given by the person in the tax year as a donation to - (a) any board of education or any university in Pakistan established by, or under, a Federal or a Provincial law; (b) any educational institution, hospital or relief fund established or run in Pakistan by Federal Government or a Provincial Government or a [Local Government]; or (c) any non-profit organization (2) The amount of a person s tax credit allowed under sub-section (1) for a tax year shall be computed according to the following formula, namely: (A/B) x C Where A is the amount of tax assessed to the person for the tax year before allowance of any tax credit under this Part; B is the person s taxable income for the tax year; and C is the lesser of (a) The total amount of the person s donations referred to in subsection (1) in the year, including the fair market value of any property given; or (b) Where the person is (i) an individual or association of persons, thirty per cent of the taxable income of the person for the year; or (ii) a company, [twenty] per cent of the taxable income of the person for the year. (3) For the purposes of clause (a) of component C of the formula in subsection (2), the fair market value of any property given shall be determined at the time it is given. (4) A cash amount paid by a person as a donation shall be taken into account under clause (a) of component C of sub-section (2) only if it was paid by a crossed cheque drawn on a bank. [(5) The [Board] may make rules regulating the procedure of the grant of approval under sub-clause (c) of clause (36) of section 2 and any other matter connected with, or incidental to, the operation of this section.] Section 159 of the ITO 2001 When income of a CSO is exempt from tax or when a CSO is not likely to pay tax for a tax year for any reason i.e. business tax losses, the CSO is entitled to exemption from withholding tax. In this case, CSO applies to the Commissioner for a withholding tax exemption certificate. After making necessary inquiries, the Commissioner shall issue a withholding tax exemption certificate. Consequently, tax will not be withheld 196

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 from payments to the CSO as authorized by the commissioner. Section 159 states: (1) Where the Commissioner is satisfied that an amount to which Division II or III of this Part or Chapter XII applies is (a) Exempt from tax under this Ordinance; or (b) Subject to tax at a rate lower than that specified in the First Schedule, The Commissioner shall, upon application in writing by the person, issue the person with an exemption or lower rate certificate. (1A) The Commissioner shall, upon application from a person whose income is not likely to be chargeable to tax under this Ordinance, issue exemption certificate for the profit on debt referred to in clause (c) of sub-section (1) of section 151. (2)A person required to collect advance tax under Division II of this Part or deduct tax from a payment under Division III of this Part or deduct or collect tax under Chapter XII] shall collect or deduct the full amount of tax specified in Division II or III or Chapter XII, as the case may be, unless there is in force a certificate issued under sub-section (1) relating to the collection or deduction of such tax, in which case the person shall comply with the certificate. (3) The Board may, from time to time, by notification in the official Gazette (a) Amend the rates of withholding tax prescribed under this Ordinance; or (b) Exempt persons, class of persons, goods or class of goods from withholding tax under this Ordinance. (4) All such amendments shall have effect in respect of any tax year beginning on any date before or after the commencement of the financial year in which the notification is issued and shall not be applicable in respect of income on which tax withheld is treated as discharge of final tax liability. (5) The Board shall place all notifications issued under sub-section (3) in a financial year before both Houses of Majlis-e-Shoora (Parliament). Clause 58 of II Schedule of ITO 2001 The tax benefits under clause 58 of II Schedule of the Income Tax Ordinance are granted to the NPOs by the Regional Commissioner of the Income Tax. Section 2(11B) of ITO 2001 defines Chief Commissioner as a person appointed as Chief Commissioner Inland Revenue under section 208 and includes a Regional Commissioner of Income Tax and a Director General of Income Tax and Sales Tax. Applications are made to the Chief Commissioner office or any of his designated functionaries. This clause basically provides exemption on the business income of an NPO. Business income includes income from donations, grants by national and international donors, grants by the government, subscriptions, membership contributions, house rent, profit on bank accounts, investments in the securities of the federal Government etc. Exemption is available on the funds expended in Pakistan on carrying out the stated public benefit activities of the NPO. Clause 58 of II Schedule states: (1) Any income of a trust or welfare institution or non-profit organization specified in sub-clauses (2) and (3) from donations, voluntary contributions, subscriptions, house property, investments in the securities of the Federal Government and so much of the income chargeable under the head "Income from business as is expended in Pakistan for the purposes of carrying out welfare activities: Provided that in the case of income under the head "Income from business", the exemption in respect of income under the said head shall not exceed an amount which bears to the income under the said head the same proportion as the said amount bears to the aggregate of the incomes from the aforesaid sources of income. (2) A trust administered under a scheme approved by the Federal Government in this behalf and established in Pakistan exclusively for the purposes of carrying out such activities as are for the benefit and welfare of- (i) Ex-servicemen and serving personnel, including civilian employees of the Armed Forces, and their dependents; or 197

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 (ii) ex-employees and serving personnel of the Federal Government or a Provincial Government and their dependents, where the said trust is administered by a committee nominated by the F Federal Government or, as the case may be, a Provincial Government. (3) A trust or welfare institution or non-profit organization approved by Regional Commissioner of Income Tax for the purposes of this sub-clause. 10.3 Prescribed procedures to obtain approved NGO status and tax exemption In order to obtain approval, a CSO is required to follow certain procedures. Income Tax Rules (ITR) 2002 has classified these approvals in two categories; an approval under section 2(36), these cases are dealt by Commissioner (Legal) in the Regional Tax Offices (RTOs) and an approval for purpose of sub-clause (3) of clause 58 of Part I of the Second Schedule, these cases are dealt by the Chief Commissioner Office in the RTOs. In both cases, a CSO is required to an application to the concerned authorities in a prescribed form. 10.3.1 Procedure/Essential requirements under section 2(36) of the ITO 2001 Rule 211 of the ITR 2002 prescribes the procedure for the processing of an application for the approval of an NPO under section 2(36). It means that approval is accorded in accordance with the clause (36) of section 2 of the ITO 2001 and Rules 211 to 220 of ITR 2002. This category of charity for the purposes of ITO 2001 is referred to as NPO. Rule 211 states: (1) An institution, fund, trust, society or any other non-profit organization (hereinafter referred to in this Chapter as organization) established in Pakistan for religious, educational, charitable, welfare or development purposes or for the promotion of an amateur sport requiring approval of the Commissioner under clause (36) of section 2 of the Ordinance, shall make an application to the Commissioner in the following form, namely: 198

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 APPLICATION FOR APPROVAL FOR THE PURPOSES OF CLAUSE (36) OF SECTION 2 OF THE INCOME TAX ORDINANCE, 2001 To, The Commissioner of Income Tax, Zone, (City) 1. With reference to clause (36) of section 2 of the Income Tax Ordinance, 2001 (XLIX of 2001), I the undersigned, hereby apply, on behalf of (name of the organization) for its approval for the purposes of the said clause for the tax year ending on. 2. Necessary particulars are set out below, and in the schedule to this application. 3. The following documents required under sub-rule (2) of rule 211 of the Income Tax Rules, 2002, are enclosed. Signature Name (in block letters) Designation Application must be signed either by the President or the Secretary of the organization or by a Trustee, of the trust. SCHEDULE PARTICULARS 1. Name of the organization (in block letters) 2. Full address of the organization (in block letters) 3. Date of registration of the organization 4. Its aims and objects. (a) (b) (c) (d) 5. Whether the organization has been registered under the Societies Registration Act, 1860 (XXI of 1860), or the Voluntary Social Welfare Agencies (Registration and Control) Ordinance, 1961 (XLVI of 1961), or any other law in substitution thereof relating to the registration of welfare organization or established in pursuance of a Trust Deed. Please give/state the law and the number and date of registration. 6. Whether constitution, memorandum and articles of association, trust deed, rules and regulations or byelaws, as the case may be, conform(s) to the provisions of sub-rule (1) of rule 213. If so, please give the number of Article/ Clause/ Rule etc., for each provision. 7. Whether the organization ensures for the benefit of the general public or a particular community or class of persons only (give full details). 8. The number of members /trustees of the organization on the date of application. 9. Accounting year of the organization commences on and ends on. 10. The following books of accounts are being regularly maintained by the organization and are open for inspection without any hindrance to the general public. i) ii) iii) Signature Name (in block letters) Designation (2) An application under sub-rule (1) shall be accompanied by 199

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 a) duly attested copy of the constitution, memorandum and articles of association, rules and regulations or bye laws, as the case may be, of the organization specifying the aims and objects for which it is established; b) A certified copy of the registered trust deed, in case of a Trust; c) a certified copy of certificate of registration in the case of an organization registered under the Societies Registration Act, 1860 (XXI of 1860), the Voluntary Social Welfare Agencies (Registration and Control) Ordinance, 1961 (XLVI of 1961), or under any other law in substitution thereof relating to the registration of welfare organization as applicable; d) duly attested copies of the balance sheet and of revenue accounts of the organization as audited by a qualified accountant for the year immediately preceding the year in which the application is made; e) the names and addresses of the promoters, directors, trustees, president, secretary, treasurer, manager and other office bearers, as the case may be, of the organization, and indicating clearly their family relationships, if any, with each other; f) For the purposes of clause (d), qualified accountant means, - i. a retired audit, accounts, treasury or taxation officer of the Government not below BPS- 17 or a bank manager, where the annual receipts of the organization do not exceed Rs. 0.5 million; ii. Omitted iii. in other cases, a Chartered Accountant as defined under the Chartered Accountants Ordinance, 1960 (X of 1960) or a Cost and Management accountant as defined under the Cost and Management Accountants Act, 1966 (XIV of 1966) or a firm of Chartered Accountants as defined under the Chartered Accountants Ordinance, 1960 (X of 1960) or a firm of Cost and Management Accountants as defined under the Cost and Management Accountants Act, 1966 (XIV of 1966);] g) a detailed report with regard to the performance of the organization for achieving its aims and objects during the 3[preceding financial year] preceding the date on which application is made, duly evaluated and certified by an independent certification agency approved by an authority designated by the Government of Pakistan for this purpose or, till that authority is established, under arrangements made by the or Commissioner of Income Tax. Provided that till the approval of two such agencies, the applicant organization shall have an option to get its performance appraised by Director-General, Regional Tax Office or Large Taxpayers Unit. Provided further that Director-General or Officers of Regional Tax Office or Large Taxpayer Unit, shall apply the same parameters on applicant organizations for the purpose of aforesaid evaluation as are approved by the FBR to be applied by the certification agency. In addition to above mentioned information given in the application, the Commissioner may require further information as he considers necessary. An approval by the Commissioner is notified in the official gazette and is valid until 30th June of the following tax year. The approval may be subject to certain conditions as the Commissioner considers necessary. The Commissioner is required to dispose of an application within two months of receipt of it. 10.4 Procedure/Essential requirements under sub-clause (3) of clause (58) of Part I of the Second Schedule 200

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 Rule 220-A of the ITR 2002 prescribes the procedure for the processing of an application for the approval of an NPO for the purpose of sub-clause (3) of clause (58) of Part I of the Second Schedule. It describes the detailed procedure for the processing of case of approval under sub-clause (3) of clause (58) of Part I of the Second Schedule. The Chief Commissioner s Office of the RTOs entertains the applications under this category. A CSO approved by the Regional Commissioner of Income Tax (RCIT) under this sub-clause is additionally entitled to tax exemption on its property, income and that part of its business income as is expended in Pakistan for welfare activities. Broadly speaking, taxable business income is computed after deducting tax admissible expenditure and allowances from the gross amount of revenue. Expenditure directly related to taxable business income is tax deductable in entirety. Any expenditure that cannot be entirely related to business income for being partly related to income from any other source will be apportioned between business income and income from other sources on a reasonable basis. Expenditure apportioned to business income only will be tax deductible against taxable business income. The gross tax liability computed with reference to taxable income for a tax year will be reduced by the sum total of the following: a) Taxes withheld from payments b) Taxes paid with utility bills c) Taxes paid in advance d) Unpaid tax refunds After adjusting the amount of gross tax liability for the above, the net resultant will be paid with the tax return. In case, the sum total of a) to d) above is in excess of the tax liability for the tax year, the excess amount will be refundable. Tax exemption in relation to business income is restricted according to the following formula: A *A/ B Where A is income from business; and B is the aggregate of income from following sources: a) Donations, voluntary contributions and subscriptions b) Property income c) Profit (interest) from Government securities d) Business income Rule 220-A states: (1)An organization established in Pakistan requiring the approval of the Regional Commissioner of Income Tax under sub-clause (3) of clause (58) of Part I of the Second Schedule to the Ordinance, shall; A. makes an application to the 4[Regional Commissioner of Income Tax] in Form I annexed to this rule; B. the application shall be accompanied by (i) a duly attested copy of the constitution, memorandum and articles of association, rules and regulations or bye-laws, as the case may be, of the organization specifying the aims and objects for which organization is established; (ii) A certified copy of the registered trust deed, in case of a Trust; (iii) a certified copy of the certificate of registration in the case of an organization registered under the Societies Registration Act, 1860 (XXI of 1860), or the Voluntary Social Welfare Agencies (Registration and Control) Ordinance, 1961 (XLVI of 1961), or under any other law in substitution thereof relating to the registration of welfare organizations as applicable; (iv) duly attested copies of balance sheets and of revenue accounts of organization as audited by a qualified accountant for the three years immediately preceding the tax year in which the application is made; 201

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 (v) the names and addresses of the promoters, directors, trustees, president, secretary, treasurer, manager and other office bearers, as the case may be, of the organization and indicating clearly their family relationships, if any, with each other; and (vi) A detailed report with regard to the performance of the organization, for achieving its aims and objects during the three financial years immediately preceding the date of the application duly evaluated and certified by an independent certification agency approved and appointed by the Federal Board of Revenue. Provided that the Director-General, Regional Tax Office or Large Taxpayers Unit shall also receive applications for performance appraisal and certification of applicant organizations till at least two such agencies have been appointed: Provided further that Director-General or Officers of Regional Tax Office or Large Taxpayer Unit shall apply the same parameters on applicant organizations for the purpose of aforesaid evaluation as are approved by the FBR to be applied by the certification agency. (2)(a) On receipt of an application for registration under this rule, the Regional Commissioner of Income Tax, subject to the requirements and conditions specified in sub-rule (3) and after such inquiry as it may deem necessary, grant approval to the organization if --- i. the organization has been formed for the purpose of establishing hospitals or providing education or for community welfare or development; ii. it has operated and functioned anywhere in Pakistan, for a period of not less than three years and has complied with minimum acceptable standards of internal governance, accountability, transparency and efficiency prescribed by any law for the time being in force; iii. Its area of operation is wholly within Pakistan; and iv. Its books of accounts are maintained regularly and in accordance with the generally accepted accounting principles and satisfactory arrangements exist for their inspection by interested members of the public. The above mentioned application form is applicable in this case with the difference of mentioning respective sub-clause of Second schedule and addressing application to the RCIT. An approved NPO by the RCIT is notified in the official gazette. The approval granted under rule 220-A (2) will remain in force for subsequent years unless withdrawn under sub-rule 7 of rule 220-A. For the purposes of the rule 220-A, qualified accountant has the same meaning as assigned to it in clause (f) of sub rule (2) of rule 211.The RCIT can relax or modify any requirement or condition in any individual case as he may consider necessary. According to 2nd schedule Part I clause 59 and 60, income from the following sources is exempt from tax regardless of the fact whether the CSO is an unapproved CSO or is approved by the Commissioner or by the RCIT. Gross income of a CSO will be split between income from exempt sources and income from taxable sources: Voluntary contributions Profit (interest) from schedule banks Profit (interest) from investment in securities of the federal Government Grants received from the Federal, Provincial or District Government Foreign grants Income from property held under trust Income of a CSO from the following sources is considered taxable: Profit (interest) from non-scheduled banks and financial institutions Dividend Capital gains Income from property not held under trust Taxable business income 202

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 10.5 PCP Certification Model Pakistan Centre for Philanthropy (PCP), established in 2001 under section 42 of The Companies Ordinance, 1984, is an independent, nonprofit, support organization created to facilitate collaboration among the philanthropists, nonprofits organizations (NPOs) and the government for social development in Pakistan. It is led by an independent Board of Directors, comprising eminent citizens and leaders from the corporate sector and civil society. Its mission is to promote the volume and effectiveness of philanthropy for social development in Pakistan. The Centre runs a number of program to achieve its objectives. The NPO Certification Program is its flagship program. The certification regime developed by PCP in 2002-03 endeavors to set sector wide standards of good internal governance, transparent financial management and effective program delivery. The purpose is to strengthen the civil society by bridging the information and credibility gap that exists between the donors and recipient organizations. The Government of Pakistan in the Revenue Division authorized PCP as the first NPO Certification Agency vide notification no 1116(1)/2003 dated December 18, 2003. An organization may wish to obtain certification for enhancing its credibility in the wider public (including donors) view or for obtaining tax benefits from the Central Board of Revenue (CBR 1 ) or for both. The Certification Model (which contains the standards and process of evaluation) applies in either case. PCP s certification focuses on the examination of structures, systems, procedures and processes put in place by an organization to deliver the services it promises and to ensure sustainability of its programs. It falls beyond the mandate of certification process to evaluate the degree of success of programs except to the extent it is reflected in the standards of program implementation. Some important points about the certification regime are given below: 1) The pre-requisites for consideration of an application for PCP certification are contained in Section I. An application by an NPO will only be processed if it meets these requirements. 2) An NPO applying for certification for the purpose of availing tax benefits (under Section 2(36) and/or under Clause 58 of the 2 nd Schedule of Income Tax Ordinance, 2001) must also comply with the requirements of the Income Tax Ordinance, 2001 and the Income Tax Rules 2, 2002. Although it is the prerogative of the relevant authorities in the CBR to finally check an organization s compliance with these requirements, PCP will also examine the applicant organization s status viz a viz these provisions and submit its observations and recommendations to the NPO concerned. 3) PCP s Certification Model consists of standards organized in three categories (Section II) against which an NPO is assessed. The three categories relate to NPO s internal governance, financial management and program delivery. 4) Fulfillment of these standards fetches scores for the NPO. A maximum score is assigned to each standard. In most cases, score assigned to a standard is further divided into smaller components depending upon the ingredients of the standard and various aspects like degree of compliance etc. 5) Wherever expressly provided an NPO is assigned score on a standard on a defined range. The maximum attainable score for all standards is 1000. Details of these standards and the scoring system are given in Section II. An NPO must attain a total score of at least 600 (and a minimum 50% score in each individual category) to be certified by PCP. 1 The term CBR, wherever used in this Model, also includes its field offices, unless the context provides to the contrary. 2 Relevant provisions from the Income Tax Ordinance, 2001 and the Income Tax Rules, 2002 are available on PCP web site (www.pcp.org.pk). 203

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 6) Applicability of standards varies according to the size of the NPO. This is highlighted in the second last column of each table of Section II. For this purpose, the NPOs are divided into small, medium or large organizations as under 3 : a) If the average of total annual receipts of an NPO during the last three years is less than Rs. 1.0 million, it is a small NPO; b) If the average of total annual receipts of an NPO during the last three years is more than Rs. 1.0 million but less than Rs. 5.0 million, it is a medium NPO; and c) If the average of total annual receipts of an NPO during the last three years is more than Rs. 5.0 million, it is a large NPO. 7) In case a standard (or its component) does not apply to an NPO being evaluated, marks will be assigned on a pro-rata basis for such not-applicable standard (or component thereof). 8) Appendix I and II display the workflow of certification process. These charts indicate that: a) When an NPO applies to PCP for certification, a team of evaluators (comprising a Program Officer (PO) and an evaluator) is assigned to the case. For the purposes of evaluation two basic instruments are applied the Desk Review and the Field Evaluation. Desk Review involves examination of application and supporting documents furnished by the NPO. The Field Evaluation (comprising a visit to the organization (including any branches or facilities/ outlets) on a mutually convenient date) involves examining the field records; reviewing program delivery; and meetings with governing body members, the executive head(s), and managerial and program staff of the organization. A brief beneficiary feedback survey is also conducted. b) The Desk Review of the applicant NPO is conducted first. If the organization meets the prerequisites as contained in Section I, its application is processed further. If not, the application is returned to the organization and the reason(s) for doing so are specified. c) If the organization has applied for certification for seeking tax exemptions, its compliance with the tax related provisions given in Section I is also checked. If the organization complies, PCP proceeds further with the evaluation of the organization. If not, the application is returned to the organization and the reason(s) for doing so are specified. d) The NPO s case is then assessed and scored against standards contained in Section II. Once the Desk Review is completed, Field Evaluation of the organization is conducted and the NPO is awarded score on relevant standards. e) Both Desk Review and Field Evaluation, evaluate the NPO s performance in achieving its aims and objectives during the last three years. f) On the basis of such evaluation, the PO prepares a detailed report. The detailed report contains an assessment of the NPO s performance in the areas of internal governance, financial management and program delivery, the scores obtained by the organization on all the standards and its financial highlights over the last three years. g) Once finalized, the report is shared with the concerned organization and its comments/observations/reservations/feedback on the report is duly considered. h) The assessment report along with the feedback received by the organization is then placed before the Certification Panel, which is the final authority to grant or refuse the certification application of an NPO. The Panel is a five-member independent body, three of which are nominees of the PCP 3 This categorisation of NPOs derives from the general consensus of various stakeholders expressed in the consultative process that led to the development of this Model. 204

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 Board of Directors and two represent the Government of Pakistan 4. The Certification Panel deliberates upon the report and recommendation of PCP 5 and examines the comments received from the organization. The Panel may or may not concur with PCP s recommendation in any given case or it may send the case back to PCP for re-evaluation. i) If the Certification Panel decides to grant the NPO s application for certification, PCP issues a certificate to the NPO in the prescribed format. If, however, the Certification Panel decides to refuse the application for certification, it will advise PCP to regret issuance of the certificate to the NPO. The Panel may also decide to defer the NPO s application for certification for a certain period of time ranging to a maximum of 1 year. This provides the NPO concerned an opportunity to make up some of the deficiencies and qualify for certification. In case of either deferral or rejection, the Panel s reason(s) for doing so are also duly recorded. j) The Panel may, on PCP s recommendation or the NPO s request or on the basis of its own judgment, defer its decision regarding an organization. However this deferral is for a period not exceeding one year. k) Once an organization has been certified, PCP designs its web profile and places it on the Centre s website. The profiles are derived from the evaluation conducted and prepared in consultation with the certified NPO. PCP periodically publishes these profiles in the form of a Directory of Certified NPOs. l) In the event of applying for tax exemptions the NPO is required to furnish the certificate and the detailed evaluation report to CBR authorities (i.e. Chief Direct Tax Operations, CBR or the Zonal Commissioners of Income Tax) along with other required documents. 9) Every effort is made to complete the process of certification within 10-12 weeks of the NPO furnishing it s duly filled in application. This, however, might take longer in case of NPOs that do not furnish some of the documents required with the application or if they do not submit their response to PCP s evaluation report within the prescribed time. 10) Certification is valid for three years following the date on which certificate is issued. All subsequent renewals of certification are also valid for the same period of time. The renewal is based on a fresh evaluation. 11) A certified organization should apply to PCP for renewal of certification within three months of the expiry of validity of certification earlier granted. 12) PCP informs the CBR and any other Certification Agencies of the names of certified, deferred and rejected organizations, immediately after the Panel decision. 13) All information provided by an organization applying for certification is deemed public information unless specified otherwise. 14) The Certification Panel may withdraw certification in case of NPO s dissolution, bankruptcy, failure to comply with mandatory reporting requirements, utilizing the funds or property of the NPO for the benefit of people other than the stated beneficiaries, any of the information provided by the NPO having been proved to be false, or any of the material information proved to have been deliberately concealed by the organization. Certification, however, shall not be withdrawn without giving the NPO concerned an opportunity of explaining its position in this regard. 205

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 15) Certification is a highly subsidized process and the applicant NPO pays a small proportion of the total cost of evaluation and certification (depending upon its size), the rest being borne by PCP. The subsidy is provided on a graduated scale so that the largest subsidy goes to the smallest NPO 6. 16) In addition to certification, PCP also plays a role in the development and promotion of NPOs. a) Capacity building is an important part of the certification regime. The capacity of an organization is built during the certification process itself. In case of those organizations that do not meet the required standards for certification, PCP facilitates linkages with specialized capacity building organizations. b) If the certified NPO intends to apply for tax exemptions under relevant laws, PCP also provides assistance in preparing required documents for submission to the CBR. 17) The Model is a living document, which is reviewed periodically in consultation with all stakeholders. The first such review was conducted in 2005-06. 18) Certain concepts and definitions used in this Model are explained below: a) Benchmark is a measurement or standard that serves as a point of reference by which process performance is measured. b) Beneficiaries are the men and women, communities, or organizations expected to benefit from the projects or programs. c) Best Practices are the processes, practices, or systems identified in organizations that performed exceptionally well and are widely recognized as improving an organization s performance and efficiency in specific areas. Successfully identifying and applying best practices can reduce expenses and improve organizational efficiency. d) Budget means an estimate of future incoming funds, expenditure and other applications of funds for a particular accounting period. e) By laws are the rules governing the operation of a nonprofit organization. By laws often provide the methods for the selection of directors, the creation of committees, the conduct of meetings and other matters of similar nature. f) Capacity means all the resources available to an organization, including people, money, equipment, expertise, linkages and information. g) Capacity building is a coordinated process of deliberate interventions by insiders and/or outsiders of a given organization leading to (i) skill upgrading, both general and specific; (ii) procedural improvements; and (iii) organizational strengthening. Capacity building refers to investment in people, systems, institutions, and practices that will, together, enable organizations to achieve their development objective. Capacity is effectively built when these activities are sustained and enhanced with decreasing levels of external dependence accompanied by increasing levels of goal achievement. h) Charitable organization is an organization that is created and operated exclusively for religious, scientific, literary, educational, athletic, public safety, social development, rights advocacy or community service purposes, and does not distribute earnings, profits or surpluses to its members or staff. i) Charter means a description in writing of the purposes, aims, objects and the mode of functioning of an organization. These may include the constitution, memorandum or articles of association, or the trust deed, depending upon the law whereby the NPO is registered. 206

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 j) Chief Executive Officer means the executive head of the organization working under the supervision and control of the governing body. k) Directory means a Directory of organizations certified by PCP. This document contains detailed organizational and program information about NPOs included therein with an intent of promoting them from PCP platform. l) Disclosure for the purposes of this Model, means disclosure to the general public, notwithstanding any legal or statutory requirement to do so. There could be different means and modes of disclosure. For evaluation purposes, information or data shall be deemed to have been publicly disclosed once it is: I. Published in a document which is meant for wide distribution; or II. Placed on a website; or III. Submitted to a government department as public information. m) A donor is the one who gives something without receiving consideration for the transfer. n) Endowment is the principal amount of gifts and bequests that are accepted subject to a requirement that the principal be maintained intact and invested to create a source of income for an organization. o) Evaluation means an assessment of an organization, its program(s) or project(s) (irrespective of whether the same have concluded or not). Evaluation also involves articulation of opinion and comments on the organizational structures and on the state of program delivery of an NPO. It is a management tool that is built around a formal process for evaluating performance and impact that help measure progress towards achieving intermediate targets or ultimate goals. p) External evaluation means any evaluation conducted by an individual or organization that is external to the NPO being evaluated. The Terms of Reference (ToRs) are defined by an external commissioning authority, and the evaluation report is primarily for an audience external to the organization. Internal evaluation, on the other hand, means any evaluation conducted by an individual or organization, either internal or external to the NPO, for primarily the internal audience of an NPO. Typically, the ToRs for an internal evaluation are also defined by the Board or the management of the organization. q) Financial System is an information system, comprised of one or more applications, that is used for any of the following: collecting, processing, maintaining, transmitting and reporting data about financial events; supporting financial planning or budgeting activities; accumulating and reporting cost information; or supporting the preparation of financial statements. r) Fixed assets include land, building, vehicles and equipment. s) Governing body (GB) means the body, board, council or committee of directors, trustees or executives, as the case may be, in which control of the NPO is vested. Its name, for any given NPO, may depend upon the law whereby the NPO is registered or owes its juristic personality (e.g. for an NPO registered under section 42 of The Companies Ordinance, the Board of Directors is the governing body). For the purposes of this Model, any subcommittee of governing body formed with a specific mandate is deemed to be the governing body for that purpose. t) Grievance Settlement Procedure is a procedure for staff to object to and seek redressal against an order from a colleague or a senior officer that they believe to be illegal, unethical or counterproductive. u) Indicator is a feature or phenomenon that can be objectively measured in quantitative or qualitative terms as a means of gauging progress toward achieving a goal or measuring the impact of a specific intervention. 207

OFT MANUAL: FM Internal Controls and Income Tax SECTION 10 v) Managerial staff or management of an NPO includes all persons performing organizational functions which are (wholly or in part) supervisory in nature. w) Monitoring is a continuous activity to keep track of and record what actually happens in a project or program. Monitoring systems comprise procedural arrangements for data collection, analysis and reporting. It also defines reporting channels and requirements. x) Nonprofit Organization is an organization that is formed and registered under any law for religious, educational, health, environment, charitable, welfare or development purposes, promotion of amateur sport or for any other purpose of general public benefit. It is a nonprofit distributing concern i.e. all its income, commodities, property and other assets are applied solely towards the promotion of its objectives and none of its assets or income are paid or transferred directly or indirectly by way of dividend, bonus, remuneration, grant of other benefits by way of profit or otherwise howsoever; to any of its member or the relative or relatives of a member or members. y) Outcome is the ultimate, long-term resulting effect both expected and unexpected of the beneficiaries use or application of the organization s outputs. z) Outputs are direct products of a program s activities, generally measured in relation to inputs. They are quantitative and are typically measured by how many, how often and over what duration. aa) Output Indicators are the specific characteristics or behaviors measured to track a program s success in achieving its outputs. They further define outputs and make them measurable. bb) Overall salary structure includes (but is not limited to) any established brackets or grades of salary and perks applicable on the employees of the NPO, and average salary of managerial and secretarial staff. cc) Policy means a document, duly approved by the governing body (or a sub-committee or the management, whosoever is authorized for such approval), which provides the details of procedures and processes to be adopted by the management of NPO to address any given issue on a specific subject, e.g. personnel policy, recruitment policy. For the purposes of this Model, following aspects of any given policy of an NPO are included in the definition of policy per se: I. Approval procedure II. Extent of implementation III. Mechanism to put it into practice IV. Wide knowledge among the staff that the policy exists dd) Pursuance of personal gain would include using official position in the organization for obtaining any kind of material benefit either directly or indirectly, other than the payment for services provided. ee) Staff unless specified otherwise includes all paid workers, consultants and advisors of the NPO. ff) Transparency involves sharing information and acting in an open manner. Transparency allows stakeholders to gather information that may be critical to uncovering abuses and defending their interests. Transparent systems have clear procedures for decision-making and open channels of communication between stakeholders and organizations, and make a wide range of information accessible. gg) Unrelated persons are those who are not related to each other by relation of blood or marriage. For the purposes of this Model, relations by blood include parents, siblings, children, grandparents and real uncles/ aunts: Relations by marriage include spouse, brothers/ sisters-in-law and parents-inlaw. 208