FC 102/12

Finance Committee

Table of Contents

Introduction

Background

Capital Budgeting across the UN System

A Possible Approach to Capital Budgeting in FAO

Purpose
Mechanism
Expenditures and Governance
Sources of Funds

Conclusion and Recommendations

Introduction

1. At it last session, the Committee considered a suggestion, which had been included in the Medium Term Plan 2004-09 (MTP), to introduce capital budgeting in FAO. The Committee’s report reflects the discussion as follows:

20. The Committee was informed of the potential benefits to the Organization of capital budgeting for financing one-time capital items. While recognizing that it represented a well accepted practice, it requested further information in order to be in a position to consider the merits of this approach. It was informed that a more detailed document on capital budgeting would be prepared for its consideration.¹

2. In considering the MTP and the report of the Finance Committee, the Council at its 123^rd Session concluded:

58. The Council also noted that the MTP had broached the issue of capital budgeting for financing one-time items. It looked forward to continued examination of the matter by the Finance Committee, in order to assess its implications.²

3. This document examines the proposal in more depth and seeks the Finance Committee’s support for the initial introduction of a limited form of capital budgeting in 2004-05.

Background

4. Current times of rapid technological change, and the need to put in place new generations of better performing administrative systems at recurrent intervals, imply high-cost acquisitions by the Organization, concentrated in short periods. The same considerations apply to major acquisitions of Information Technology and Communication (ITC) equipment or to the enhancement of premises. However, FAO operates on the basis of a biennial budget, without possibility of carrying over or accumulating "reserves" at the end of the period.

5. Commercial companies can account for depreciation and may contemplate capital budgeting arrangements, while governments can make provision for exceptional one-time expenditures in public administration budgets without necessarily forcing the "absorption" of the cost within a fixed budget. FAO does not currently have these options but is still expected to deliver its programmes in a cost-effective, efficient and timely manner, something which can be disrupted by the above peaks in financial requirements, for which no reserves exist. Regrettably, it is forced to "scrape by", trying to balance resources to accommodate to accommodate the necessary one-time investments, within a fixed budget envelope. This has often led to delays and frustrations as well as budgetary transfers from substantive programmes. It has also, at times, led to less than optimal results. A recent example concerned the Oracle project, where significant implementation problems were attributed in large part to the lack of sufficient and assured resources.

6. It is noteworthy that at least two independent sources have recently recommended the introduction of capital budgeting in FAO.

7. KPMG, a major international accounting firm had been asked to examine the staffing structure of the Information Systems and Technology Division (AFI) and in doing so had identified several constraints to the efficient execution of its functions. In particular it concluded that:

The delivery of IT operations requires an up-to-date ICT infrastructure that needs to be maintained constantly. For sustaining the IT systems availability over a long-term, equipment and software replacement programmes should be implemented to ensure that the platforms and operating systems are upgraded periodically. A capital budgeting mechanism should ensure the funding for smooth migrations of platforms under the authority and responsibility of AFI.³

8. Coincidentally, the JIU in its “Review of Management and Administration in FAO” had drawn a similar conclusion:

The Council may wish to approve the proposals included in the Medium Term Plan 2004-2009 for the introduction of capital budgeting to ensure sufficient and stable funding for the further development of corporate administrative systems.⁴

Capital Budgeting across the UN System

9. A review of the financial statements and Financial Regulations of FAO, IAEA, ICAO, ILO, ITU, UNIDO, UNESCO, UPU, WFP and WHO in regard to special capital accounts or funds has been carried out. A table describing such accounts or funds, their sources of funding and purpose is shown as Annex 1 to this document. Data on IMO, WIPO and WMO was not readily available from their websites. The UN was excluded from the review because each sub-unit has different rules and the voluntary funded organizations (UNDP, UNHCR, UNICEF) tend not to be applicable as precedents for the specialized agencies because of their different governance structure and financing.

10. Seven of the ten organizations (ILO, ITU, UNIDO, UNESCO, UPU, WFP and WHO) listed in the Annex have established separate funds to cover major repairs and rehabilitation of owned premises. The ILO, ITU, UNESCO and WHO funds receive income from rentals. The ITU, UPU and UNIDO facilities are funded from budgetary appropriations. The purpose of the funds is to provide financial resources for emergency and planned repairs and renovations without regard to biennial restrictions. With the exception of the WHO Real Estate fund, expenditures from these funds do not appear to involve appropriations or conference authorization, though all report through their financial statements.

11. A few of the funds – ILO, IAEA and WHO – are credited with interest on unexpended balances.

12. IAEA did have an equipment replacement fund financed from a 1993 surplus but which has not been replenished. ILO was able to utilize its 1998-99 surplus to finance the ERP project using a separate fund not subject to biennial closure. The documents establishing the fund do not appear to limit its future use for other purposes assuming funds were available. The WFP SAP (WINGS) project was also treated as a separate fund without biennial closure. It had funding from budgetary provisions and from direct grants from the US and Japan. The unexpended balance of about $5.5 million has been transferred to a capital assets fund and WFP is working on rules for its use.

13. None of the ten agencies reviewed depreciates any of its fixed assets. The draft UN Task Force report on review of UN System Accounting Standards [UNSAS] and the International Public Sector Accounting Standards [IPSAS] suggest that this is similar throughout the UN system and that a major objection to implementing the IPSAS is related to concern about the impact of IPSAS 17 Property Plant and Equipment requirements for depreciation.

14. It can be seen from the above experiences that, by and large, these accounts/funds have often been introduced on an ad hoc basis to meet a specific need rather than accommodating proactive medium-term capital expenditure planning. In the Director-General’s view the need to invest in modern technology and infrastructure as pre-requisite to maintaining the Organization’s comparative advantage requires a more systematic approach. However, for FAO to move into full fixed asset accounting with depreciation would certainly take it out of line with system-wide practice and may therefore be seen as a rather too radical proposal at this stage.

A Possible Approach to Capital Budgeting in FAO

15. The Secretariat is of the view that rather than make a sudden radical change, the Organization should consider an incremental approach which may evolve over several biennia as knowledge of capital expenditure patterns grows. This would involve the establishment of a Capital Expenditures Facility (hereinafter referred to as the Facility) which is further defined below.

PURPOSE

16. The purpose of the Facility would be to allow FAO to manage activities which involve capital expenditure. These are defined as being expenditures on tangible or intangible assets with a useful life in excess of FAO’s financial period of two years and which generally require a level of resources which cannot be funded within the appropriation for a single biennium. Such expenditures by definition require the management of funds over a period of more than two years.

MECHANISM

17. The Facility would consist of two separate but inter-related elements:

• Chapter 8 of the Budget which may also consist of several major programmes (e.g. ITC, Buildings, etc.);
• a reserve fund, entitled the Capital Expenditure Fund, established by the Conference under the provisions of Financial Regulation 6.8.

18. Chapter 8 of the Appropriation Resolution would provide the authorization to spend as envisaged under Financial Regulation 4.1 (a). The expenditures plans would eventually be based upon a medium-term capital expenditure programme which would be developed as part of the rolling MTP and hence updated every two years. Within any one biennium, the amount appropriated could consist of funds from within the Regular Programme appropriation as well as income in the form of part or all of the resources already held in the Capital Expenditure Fund.

19. It follows that the Appropriations Resolution would include a deduction from the net appropriation, equal to that portion of the funding which is proposed to be funded from the Capital Expenditure Fund, to arrive at the figure for assessed contributions – in the same way as Miscellaneous Income is treated today.

20. For the purposes of  Total Resource Availability, for example as shown in the table preceding paragraph CSX of the SPWB 2004-05, the funding assumed to be required for that biennium from the balance in the Capital Expenditure Fund would be disclosed:

21. During the biennium, transfers between budgetary chapters (i.e. to or from Chapter 8) could be proposed by the Director-General for the approval of the Finance Committee as foreseen under the provisions of Financial Regulation 4.5 (b).

22. At the end of each financial period (i.e. biennium), any balance on Chapter 8 between the amount expended and the amount appropriated (after approved transfers) would be transferred to the Capital Expenditure Fund.

EXPENDITURES AND GOVERNANCE

23. Proposed expenditures from the Facility will be developed in the MTP and further identified in the budgetary proposals under Chapter 8 of the PWB. Post facto reporting will be provided to the Membership in the Financial Statements, the Annual Report of Budgetary Performance and in the Programme Implementation Report.

SOURCES OF FUNDS

24. The following sources of funds are proposed to apply:

• Regular Programme budgetary provisions may be made to the Facility either through the Appropriations Resolution as described above or via approval by the Finance Committee as per the provisions under Financial Regulation 4.5 (b)
• Income from the net interest earning of Regular Programme balances after deducting bank charges and discounts payable on early receipt of contributions (i.e. this would be diverted from Miscellaneous Income to the Facility).
• Voluntary Contributions could also be made to the fund so long as the donor agreed to commingle the contribution with the other resources of the fund. Alternatively they could be handled through separate Trust Funds.

25. It is also proposed that the unspent balance of the arrears, paid by the major contributor, as at 31 December 2005 be transferred to the Facility. This would not change the intended use of such funds.

Conclusion and Recommendations

26. The proposal is intended to be the first step in the introduction of capital budgeting in FAO. It is a rather conservative approach, in part because the historical data on capital expenditure is very limited as the definition is not recognized or recorded in our information systems. We will therefore have to build up the data necessary to increase the sophistication of the approach over the coming years and introduce the capital expenditure plan into the Medium Term Plan as envisaged under paragraph 18 above.

27. Meanwhile, the Finance Committee is requested to review and endorse the proposal for consideration by the Council. Subject to approval in principle, the Secretariat will proceed to identify such changes as may be necessary to the Financial Regulations for eventual consideration by the Finance Committee, the Committee on Constitutional and Legal Matters, the Council and the Conference.

UN SPECIALIZED AGENCIES
TREATMENT OF SURPLUS

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¹ CL 123/15 paragraph 20

² CL 123/REP paragraph 58

³ Staffing Review of AFI, KPMG, June 2002, paragraph 6.2.2

⁴ CL (JIU/REP/2002/8), Recommendation 6