FINANCE COMMITTEE

I. Background

1. The paper should be seen as a progress report on the work being undertaken on the overall question of support costs. It is provided largely for the information of the Finance Committee but as it sets the conceptual framework (i.e. definitions, etc.), the Committee may wish to express its views on the approach being taken.

2. While certain specific issues have been raised by the External Auditor, there are a number of reasons why a broadly based review is appropriate at this time. These can be summarized as follows:

a) Director-General's Strategy for reducing Support Cost

3. Following informal consultations with interested Members in 1994, the Director-General reported to the Programme and Finance Committees¹ that he intended to suspend consideration of new support cost reimbursement rates until administrative costs had been reduced. Two issues are therefore due for eventual consideration: the first, to review progress in reducing costs, will be covered in this paper and, the second, to determine whether rates should now be reconsidered, in a subsequent document.

b) Emphasis in Strategic Framework on the need to make FAO more competitive

4. This matter has been addressed in various versions of the Strategic Framework where the cross-organizational issue on Leveraging Resources includes as a strategy element "continuing efficiency savings with a view to reducing the cost of supporting field programmes and placing FAO in a better position to compete for resources"².

c) External Auditor's Call for Rationalization

5. The External Auditor, in his Long Form Report as appended to the Audited Accounts 1996-97³, identified twelve different categories of expenditure which had been grouped by him under the heading of support costs. He expressed concern that the accounting and reporting complexities which arose tended to "obscure the purpose and measurability of the policy" and recommended that the Secretariat "prepare a comprehensive but much simplified framework for support cost arrangements". This document is the first step in that process in that it addresses the conceptual framework for support costs - a prerequisite to removing unnecessary complexities.

d) Governing Body Concern over the Level of Support Costs

6. Some Members have, in various meetings of the Governing Bodies, expressed their concern at the extent of the contribution that the Regular Programme makes in supporting extra-budgetary activities⁴. This concern arises out of regular reporting to the Governing Bodies in the Programme Implementation Report (PIR)⁵, which implies that the Regular Programme contribution for 1996-97 was as much as US$ 94.1 million. The Secretariat's response mitigated the reaction to these figures, by drawing attention to the method of calcuation (i.e. full costing), the return flow to the Regular Programme through direct support for normative work and the benefit to FAO's capacity as a centre of excellence through feedback of practical field experience to normative work. However, it was agreed that there should be further reporting and clarification of the costs involved. This paper provides the response to these questions.

e) Council's call for Harmonization of SPFS and TCP TSS

7. The Council at its 113th Session reaffirmed that TCP and SPFS projects be charged support costs for a reasonable estimate of the cost of the operational services provided to such projects. It also agreed that technical support services should be charged on the basis of the direct cost of the services provided. Finally, the Council sought a degree of harmonization between the methodologies applied to the two different programmes.⁶ This is consistent with the subsequent recommendation of the External Auditor as outlined above and will be addressed in the next part of this study.

f) Inappropriate Distribution of AOS Support Cost Resources

8. The distribution of AOS support cost reimbursements has historically been based upon the authorization of separate posts for that purpose. Given that reimbursements are not sufficient to cover all costs, certain units have traditionally been excluded from such allocations and this is now leading to some structural inequalities in the system (e.g. technical divisions). Although a largely internal matter, the subject will be considered in the overall review.

II. Definition and Scope

9. The subject of this document is broad and complex. It is therefore necessary to define the scope of the work and the terms being used. This is to be approached by examining what aspects are considered inclusive to the term "support costs" and then by developing definitions of terms for use by the Organization.

Support Cost Expenditure and Support Cost Reimbursements

10. In discussing support costs there is a need to distinguish between expenditures incurred in supporting projects and the recovery of these costs from the project entities concerned. This latter aspect is sometimes referred to as support cost "income" but to avoid the accounting problems inherent with support cost recoveries from internal entities such as SPFS and TCP projects (which are not income to the Organization), all such recoveries will be referred to as support cost reimbursements. This is particularly apt as it also reflects the underlying principle of recovering up to the amount incurred and never more; that is, the Organization at no time attempts to generate a profit on such transactions.

Distinction between Project Inputs and Support Costs

11. To understand support costs, there is also a need to look at the total cost of a project. As a concept, one can argue that the total cost of a project needs to be a considered as if it were completely stand-alone. In such a case, one would have to incur, not only direct project inputs (e.g. one tonne of seed) but also the time of the Plant Production Officer who specified the seed, of the Purchasing Officer who put out the tender request and completed the purchase action and of the Accountant who managed the internal control aspects of the transaction and maintained the project's accounting records.

12. In practice, these support services are carried out by the relevant functional units and cannot therefore be easily charged as a direct cost to the project - hence the need for a methodology for charging projects with a reasonable share of such costs.

General Categories of Cost

13. Accounting terminology contains a confusing range of terms covering aspects of the concept of "cost". Most of this terminology was developed by the cost accounting profession which has its origins in manufacturing. The following table defines the terms used in this paper.

Table 1 Definition of Cost Accounting Terms

Categories of support cost

i) Administrative and Operational Support (AOS)

14. These have been defined in MS 250 where it states that project servicing costs are levied to counterbalance the costs of administrative and operational services which are a necessary and inherent part of any project which the Organization agrees to execute, but which, because of their nature, cannot be readily or directly singled out for charging to the project itself.

• Administrative services may include such items as:
• recruitment, briefing and servicing of project personnel;
• servicing of fellowships;
• procuring supplies and equipment, formalizing contracts;
• preparation of budgets and control of project expenditures;
• receipt, custody and disbursement of funds, maintenance of project accounts, financial reporting, external and internal audits, etc.;
• security monitoring.
• Operational services may include such items as:
• assembling and submitting proposals to donors;
• negotiating agreements and plans of operation with project-sponsoring bodies and recipient governments;
• location and recommendation of qualified personnel;
• guidance and supervision of the implementation of projects;
• preparing, monitoring and revising workplans and budgets;
• reporting periodically on projects;
• fellowships placement and formulation of study plans;
• technical selection of equipment and technical preparation of contracts.

15. It is noted that all of these costs fall under the definition of indirect project support costs.

ii) Technical Support Services (TSS)

16. Technical support services include:

• project identification;
• project design and formulation;
• project appraisal services;
• project technical backstopping both at Headquarters, at the Regional Offices or in the field, including attendance at project meetings and tri-partite reviews; and
• project evaluation services.

17. It is noted that most of these costs fall under the definition of direct project costs although certain aspects may have to be treated as "indirect" because of difficulty in tracking staff time on a project by project basis for activities such as technical backstopping.

III. Factual Overview of the Cost of Supporting the Field Programme

18. In summary, the situation shown in the PIR 1996-97 is as follows:

Table 2 Support Costs and Extent of Reimbursement Received

N.B. In the tables which follow there are some minor amendments made to the totals as a result of the work on this study.

19. The first point to be made is that the figures for support costs in Table 2 are determined using a full costing methodology and are inclusive of direct project costs falling under the heading of TSS. The full costing methodology implies that all variable costs (i.e. direct project costs and indirect project support costs) are subject to the apportionment of a reasonable share of fixed overhead costs. The analysis below disaggregates this data into it various components using the definitions given above.

20. The analysis also needs to separately examine the two key types of support cost: Administrative and Operational Support Services (AOS) and Technical Support Services (TSS).

Administrative and Operational Support Services (AOS)

i) Measurement of Cost

Methodology

21. The extent of AOS is measured by means of an annual work measurement survey conducted in November of each year in which all staff graded D-1 to G-5 (G-4 in the FAORs and Regional Offices) of the technical departments, operating units, PBEE and FAORs complete a detailed questionnaire in which they estimate how their time was spent using a percentage split between:

• RP activities down to programme element;
• project TSS;
• project AOS; and
• services to WFP.

22. The number of staff filling in the questionnaire in these surveys has always far exceeded the requirements for statistical reliability and therefore it provides a reasonably accurate measure of time spent on AOS by grade.

23. The time allocated to each AOS activity is converted to a full cost figure, by means of two steps:

• the time is multiplied by the standard cost by grade to arrive at the staff cost;
• to this amount an allocation is made for the cost of the administrative departments (AF, PBEP and the MSUs in non-technical units) using the most appropriate statistical keys for measuring the workload attributable to those units (e.g. space utilization, staff numbers, accounting transactions, etc.).

Results - including fixed overhead costs

24. The following table summarizes the results in terms of the full cost in absolute dollars and percentages of field programme delivery for the last three years. It is emphasized that this data is not limited to those costs which are purely incremental; that is they include a proportional allocation of fixed overhead costs according to the methodology described above.

Table 3 Indirect Support Costs including Allocated Fixed Overhead Costs

25. The trend in total support costs as a percentage of delivery shows a notable improvement, reflecting the impact of the many cost savings measures introduced in recent times. Declines have occurred under every input type except for support to training where a cost reduction exercise is currently under way. In absolute terms, total indirect support cost including the appropriate allocation of fixed overhead costs has declined by US$ 8.9 million or 18% to US$ 41.3 million.

Results - excluding fixed overhead costs

26. While the above methodology is an appropriate way to measure the full cost of the services provided to projects, it is apparent for several reasons that it is not an appropriate target for cost recovery. The first reason concerns the implications for the Organization's financial structure if it were to adopt a policy of full cost recovery. Such a policy assumes that part of the funding for fixed costs (e.g. the senior management structure) should come from support cost recoveries. However, this could place the Organization's financial viability in jeopardy if the extra-budgetary programmes (on which such recoveries rely) were to decline significantly. Income would decline whereas the fixed costs could not - leaving a deficit to be covered by other sources of funds. For this reason, the consultants who have worked on this issue with us and many other UN organizations never recommend the recovery of fixed costs unless it is unavoidable because an Organization relies entirely on support cost recoveries for its income.

27. Secondly, donors have made it clear that they are not prepared to pay for core staff who should be funded from the Regular Programme and, in fact, such an approach results in an element of double budgeting. For example, if the post of an ADG is to be included in the regular budget and then also charged as an indirect support cost, it is clear that the amount would be appropriated twice.

28. The methodology for excluding fixed overhead costs eliminates the following elements of the costs to arrive at the AOS indirect project support costs. This methodology is the same as that applied in the UNDP Cost Studies.

29. The fixed costs excluded are as follows:

• all costs related to the ADG Offices [AFD, AGD, ESD, FID, FOD, GID, SDD, TCD] excluding the Management Support Units (MSUs) which are allocated to indirect project support costs using the work measurement questionnaire;
• all fixed overhead costs related to the operation and maintenance of the information technology infrastructure by AFI except for those costs charged directly to departmental budgets which are treated as direct project costs or as indirect project support costs as applicable;
• all costs of the operation of the financial system except the AFF units directly responsible for UNDP and Trust Fund accounting which are treated as indirect project support costs;
• all costs of administering the central personnel function by AFP;
• costs of space, security, communications, messenger service, central records and procurement for Regular Programme activities administered by AFS except as directly charged to projects (AFSP costs related to project procurement are treated as indirect project support costs);
• costs of regular budget preparation, control and evaluation by PBE, although costs of project budgetary control and evaluation are treated as indirect project support costs or, in the case of evaluation missions, as direct project costs;
• costs of legal services provided by LEG, excluding technical services to projects which are treated as direct project costs (see TSS below); and
• costs of Internal Audit and External Audit excluding direct services provided to projects.

30. If such fixed overheads are excluded, the above results would change as follows:

Table 4 Indirect Project Support Costs excluding Allocation of Fixed Overhead Costs

31. The recent results are good and the final rate of 10.5% compares very favourably to the theoretical rate of 13% PSC charged on many projects. On the other hand, it should be noted that the delivery figure for 1998 includes an exceptionally high amount of US$ 78 million against emergency projects and that this has somewhat artificially expanded the base on which the above percentage is calculated. A normal level of emergency delivery would be in the region of US$ 25 million to US$ 35 million p.a. which, if it had occurred in 1998, would have resulted in a much higher percentage (i.e. 12.4% to 12.9% instead of the 10.5% reported above). Thus, a rather critical assumption needs to be made about emergencies when addressing policies for cost recovery and the related charge-out rates.

ii) Reimbursement

Methodology

32. Reimbursement of AOS is generally made through a percentage charge on delivery - known as "project servicing cost" (PSC). These include:

• standard rates on Trust Funds of 13% with reductions to 7% for large contracts or projects with high proportions of supplies and equipment;
• a rate of 12% on Associate Professional Officer funds;
• standards rates of 10% on UNDP projects and most UN and UNDP administered Trust Funds; and
• a reduced rate for projects which provide direct support to Regular Programme normative activities (usually 6%).

33. Policies on rates are a matter for the Governing Bodies through their adoption of rates over the years⁸. In 1993, the Conference failed to reach a consensus on a new regime which attempted to move away from percentage based rates to a structure involving unit costs per service provided. This new approach would have allowed the full recovery of incremental costs but not of fixed overhead costs.

Results and Contribution of the Regular Programme to the Cost of AOS Services

34. The level of support cost reimbursements, expressed in US dollars and as a percentage of delivery, has been as follows over the last three years:

Table 5 Support Cost Reimbursements versus Indirect Project Support Costs

35. It will be noted that this table compares indirect project support costs (i.e. excluding the allocation of fixed overheads) to the reimbursements. As already suggested above, this is considered to be the appropriate comparison given that it would be unreasonable to expect a donor to pay for costs which are incurred regardless of whether the project exists or not and which are fully budgeted under the Regular Programme.

36. While there was a decline in the amount of under-recovery in 1997, the net situation deteriorated slightly in 1998. The cause of the deterioration was the decline in recoveries which fell from the usual 10% to 7.2% of delivery in 1998. As already mentioned, this arose from the exceptional delivery of emergency projects in 1998 - if the US$ 78 million emergency were to be removed from the base, the percentage reimbursement would also rise to the usual 10.0% of delivery.

iii) Contribution by the Regular Programme

37. From Table 5 above, it is apparent that a contribution from Regular Programme resources covering part of the indirect project support costs incurred by the Organization remains. This is currently about US$ 9 million per annum.

38. From a policy standpoint, such a contribution may be valid given the benefits to the Regular Programme of the field programme activities. On the other hand, the Director-General's policy has been to reduce costs so that the recoveries are sufficient to cover them and, if possible, to reduce rates thus increasing our competitiveness in leveraging resources for FAO and its Members.

Technical Support Services (TSS)

i) Measurement of Cost

Methodology

39. As with AOS described above, the extent of TSS is measured by means of the annual work measurement survey which includes estimates of how much time was spent on project TSS.

40. Again, it should be noted that the number of staff filling in the questionnaire in these surveys has always far exceeded the requirements for statistical reliability and therefore it provides a reasonably accurate measure of time spent on TSS by grade.

41. The same methodology as described under AOS above is applied to arrive at the full cost of TSS.

Results - including fixed overhead costs

42. Using the methodology described above the results on a full cost basis are as follows:

Table 6 Technical Support Services including Allocated Fixed Overhead Costs

43. Costs here have shown a tendency to rise both in absolute terms and as a percentage of field programme delivery. It should be emphasized that there has been no attempt to reduce the extent of such services - on the contrary, field project evaluation reports point to the need for more, not less, TSS. In particular, they have reported the need for more attention to the design of projects and it is pleasing to note that this particular aspect of TSS has shown a consistent growth in terms of resources applied.

Table 7 Technical Support Services excluding Allocation of Fixed Overhead Costs

44. This table shows the same underlying trend and changes only in that the absolute amounts of TSS are about 19% less when fixed overhead costs are excluded.

ii) TSS Reimbursement

Methodology

45. Reimbursement of technical support services provided by staff was generally not envisaged until quite recently although donors always paid for such services where they were provided by an external consultant. This was probably considered to be consistent with FAO's mandate which includes technical assistance to Members.

46. However, efforts to recover a greater proportion of such costs increased with the recent pressure on Regular Programme resources. During the 1996-97 budget reduction exercise involving a cut of US$ 56.9 million or 8.3%, it was planned to improve reimbursements to the extent of US$ 3 million p.a. from external sources. In addition, it was expected that internally funded technical assistance activities such as TCP or SPFS would also be treated consistently and reimburse technical divisions for their services.

47. Donors have been varied in their response to a call for greater recovery of the cost such services when they are supplied by staff although there has been a gradual increase in amount reimbursed. Certainly some services are much more easily reimbursed than others - for example, evaluation missions are often covered without question whereas general project monitoring costs (other than specific missions) are rarely recovered.

48. While the precise methodology varies by source of funds, in all cases the approach is based upon charging the direct cost of the professional staff time involved either at a standard or at actual cost. The various sources of funding for projects (including the UNDP through its Governing Council) have made it clear that they would not accept charges for fixed overhead or even indirect project support cost charges levied on the value of TSS.

Results

49. There are some problems in extracting accurate data on TSS reimbursements. Until very recently these were accounted for as direct reimbursements of staff time which meant that in the accounting records individual transactions were netted off against salary expenditures making them very difficult to track in FINSYS. During 1998 some effort was made to improve the situation but the results should still be considered tentative until Oracle has been implemented.

50. Of the total amount of US$ 24.9 million incurred, it is estimated that US$ 3.5 million was recovered from external sources and a that further amount of US$ 1.5 million was reimbursed from internal transfers for services to TCP and SPFS in 1998. This implies a net direct cost of US$ 19.9 million funded from the Regular Programme technical programmes in 1998.

iii) Rationale for Funding TSS from the Regular Programme

51. Those arguing in favour of FAO's field programme, point both to its mandate to provide technical assistance and also to the benefits that it brings to the normative work of the Organization. These arguments are particularly valid for TSS which is a form of technical assistance that involves staff and therefore establishes the ideal conditions for feedback from field to normative work.

Conceptual and Legal Framework for the Provision of TSS Foundation

52. TSS takes the form of direct technical services provided to Members via projects developed at the request of Members but funded from a variety of sources. The provision of technical assistance to Members is mandated in the Constitution Article I 3.(a) which states that "It shall also be the function of the Organization to furnish such technical assistance as governments request". This implies, in turn, that the funding for such technical assistance may legitimately come from the Regular Programme Budget and, in fact, the Organization discloses information on the extent of services proposed under each technical programme of the budget as approved by the Conference.

Direct Support to Normative Work

53. There is a tendency to see the TSS expenditures of US$ 19.9 million (see paragraph 50 above) as the net outgoings. However, this is not a correct interpretation as much of the extra-budgetary resources are in direct support of Regular Programme activities. An examination of all projects with a normative content and therefore operated by technical units (c.f. operating units) was carried out with a view to identifying the added value to the Regular Programme. It was estimated that the net contribution in direct support to the Regular Programme was US$ 20 million in 1998.

Synergies between the Regular and Field Programmes

54. The above calculation does not include the inestimable value of the experience which flows back from field work into the normative work of the Organization. In considering the Review of FAO's Field Operations in 1989¹¹:

The Conference recognised the catalytic importance of FAO's field operations to Member Nations, recipients and donors alike. In partnership with member countries, the Field Programme had given concrete expression to FAO's aims and objectives and had made its presence and impact felt in developing member countries.

The Conference endorsed the conclusion of the report that the Regular and Field Programmes were intertwined both in structure and functions. Through its analytical support, the Regular Programme was making its technical and analytical work available to field projects and in turn was receiving data and feedback from the field to strengthen the technical contents of its own activities and to update its information bases.

55. More recently, in reviewing the relationship between the regular and field programmes, including TCP, the Programme Committee¹²:

... underlined the importance of the synergy between the Regular and Field Programmes and of the value added by the field activities to the normative Regular Programme. Experience gained and the close interaction with the Regular Programme was a fundamental source of FAO's strength in meeting the requirements of countries for technical cooperation. It noted that the Regular Programme provided field operations with a technical basis, including normative standards and facilitated their transferability as well as the global synthesis of development experience. Conversely the Field Programme represented an invaluable source of empirical information and data on, as well as direct link with, the needs and problems in various countries and regions, supplying feedback on the relevance and adequacy of the Regular Programme's technical and normative work.

56. Thus, while it is not possible to measure the benefits to the Regular Programme of FAO's work in the field, there is a broad consensus among Members on its critical importance.

IV. Conclusions

57. This document endeavours to do the following:

• defines support cost expenditure and support cost reimbursement and classifies expenditures into direct project costs, indirect project support costs and fixed overhead costs;
• defines administrative and operational support costs (AOS) and technical support services (TSS);
• describes the methodology used to determine costs, noting that it is consistent with that used in the UNDP Cost Studies;
• reviews recent trends in AOS expenditures making the distinction between indirect support costs and fixed overhead costs and demonstrating the very considerable progress made in recent years to reduce such costs;
• reviews the trends in reimbursements of indirect project support costs and determines that the Regular Programme contribution to AOS has fallen to US$ 9.2 million or 3.3% of delivery;
• reviews recent trends in TSS expenditures making the distinction between direct project inputs and fixed overhead costs, demonstrates the increased attention to project design as recommended in successive evaluation reports and determines that the net Regular Programme contribution was US$ 19.9 million in 1998;
• notes that TSS is within the Organization's mandate which includes the function of furnishing technical assistance to Members and that TSS services are identified in the budget approved by the Conference.

58. This document has been provided for information and as a progress report on the work undertaken on this complex issue to date. While it largely summarizies pre-existing and accepted concepts, the Committee may wish to note the definitions, and comment on the approach or the results so far. However, no specific decision is sought at this stage.

59. The next document, which should be available for the Committee's session in May 2000, will deal with the remaining issues which would include proposals for the harmonization and rationalization of support cost reimbursement policies within this conceptual framework.