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ANNEX H

Illustrative Management Letter


The term management letter describes the written communication to an MFIs management identifying significant internal control deficiencies, offering constructive recommendations, and noting other matters arising during the audit that the external auditor wants to bring to the attention of the MFIs management and audit committee. A number of potential control weaknesses may be identified in a management letter; some are listed in box H.1. Following the box is an illustrative management letter. The auditor should normally solicit and consider management comments on a draft of the management letter before preparing the letter in final form for presentation to the audit committee.

Audit committee Aspire MFI Address In planning and performing our audit of the financial statements of the Aspire Microfinance Institution for the year ended 31 ecem!er 1""# $on %hich %e have issued our report dated March 1&' 1""()' %e considered its internal control structure in order to determine our auditing procedures for the purpose of e*pressing an opinion on the financial statements' not to provide assurance on the internal control structure+ ,uch consideration %ould not necessarily disclose all matters in the internal control structure that might !e material %ea-nesses under standards esta!lished !y .the country/s professional !ody0+ A material %ea-ness is a condition in %hich the design or operation of the specific internal control structure elements does not reduce to a relatively lo% level the ris- that errors or irregularities in amounts that %ould !e material relative to the financial statements !eing audited may occur and not !e detected %ithin a timely period !y employees in the normal course of performing their assigned functions+ 1e noted no matters involving the internal control structure and its operations that %e consider to !e material %ea-nesses as defined a!ove+ 1e did note other matters related to the internal control structure' and certain other issues+ 2ur comments are presented in the attached report+ 3his report is intended solely for the information and use of the audit committee' management' and others %ithin the organi4ation+ 1e %ill !e pleased to discuss these comments %ith you and' if desired' to assist you in implementing any of these suggestions+ $signature) 5artner X67 Audit 8o+

Attachment

Aspire Microfinance Institution Report to management for the year ended 31 December 1997
8ontents Internal audit function Loans Loan loss provisions Cash Capital Various policies

Internal audit function


LA89 2F F:N83I2N, As Aspire continues to gro% !oth in terms of ne% !ranches and dis!ursed loans' it may prove difficult for personnel in the head office to effectively supervise operations as %ell as perform their o%n duties+ It %as noted that there is no internal monitoring of Aspire/s adherence to policies and procedures+ Recommendation; Management should consider esta!lishing an internal audit function+ 3his ne%ly created function %ould not only provide management and the audit committee %ith a degree of assurance' it could also help %ith the annual e*ternal audit' there!y saving money+

Loans
L2AN ,3A3:, <E52<3, In some cases loan status reports %ere not ade=uately chec-ed and revie%ed against loan officers/ records and !orro%ers/ pass!oo-s+ 3hus errors could remain in accounting records for a long time %ithout !eing detected+ <ecommendation; e!tor listings should !e produced and chec-ed periodically+ 3hey should !e regularly chec-ed !y loan officers against !orro%ers/ pass!oo-s' and any difference should !e investigated promptly+ Internal auditors $if an internal audit function is esta!lished> see a!ove) should also perform such procedures during the normal course of their %or-+

:N<E82N8ILE IFFE<EN8E, All the !ranches had unreconciled differences !et%een loan trac-ing system !alances and the general ledger+ 3hese differences %ere attri!uta!le to the method of apportioning repayments !et%een principal and interest+ Recommendation; 3he loan trac-ing system and the general ledger must !e reconciled at least monthly+ 8<E I3 MAN:AL Aspire does not have a comprehensive credit manual covering the policies and procedures relating to its credit methodology+ Recommendation ; Aspire should consolidate all of its policies and procedures into one manual+ 3his manual should !e provided to all !ranches and all loan officers+

Loan loss rovisions


E<<2<, IN 8AL8:LA3I2N 3here %ere minor errors in the calculation of loan loss provisions+ 3his appears to occur !ecause there is little coordination !et%een loan officers and !ranch accountants %hen determining the amounts to provision+ Recommendation; 3he accounting department should !e fully involved in the e*ercise of provisioning for dou!tful accounts+ A thorough revie% of accounts and valuations should !e performed to ensure that provisions and %rite?offs of loans cannot !e manipulated+

!ash
8:<<EN3 A882:N3, 8urrent accounts !et%een the head office and !ranches are not !eing reconciled regularly+ 3his shortcoming' %hich necessitates recording activity into suspense accounts to facilitate consolidation' is attri!uted to insufficient communication !et%een offices+ Recommendation; 8urrent accounts should !e reconciled monthly+ @AN9 <E82N8ILIA3I2N, Included in the loan account reconciliation %ere t%o chec-s' amounting to X' that %ere returned for insufficient funds in August 1""# and had not !een reversed in the records as of 31 ecem!er 1""#+ Recommendation; @an- reconciling items should !e identified and promptly resolved+ Any recurring reconciling items should !e investigated !y management+ ,EA<EAA3I2N 2F :3IE, In some !ranches there is inade=uate segregation of duties+ For e*ample' the same person handles the functions of loan officer and cashier+ Recommendation; Aspire should properly segregate duties !et%een those accounting for activities and those handling assets+ 5roper monitoring of adherence to policies and procedures is re=uired+

!a ital
8A3EA2<I7A3I2N 2F <E,3<I83E AN :N<E,3<I83E F:N , Aspire/s funds are not categori4ed into restricted and unrestricted funds as re=uired !y the accounting standards promulgated !y .authoritative !ody0+ 3his point has !een discussed %ith the senior management of Aspire' %ho have agreed to comply %ith recommended practice+ ue to time constraints' the financial statement could not !e reclassified according to this recommendation+ Recommendation; Aspire should present its ne*t financial statements in accordance %ith the a!ove re=uirements+

"arious olicies
82,3 ALL28A3I2N As indicated in the notes to the financial statements' Aspire allocates indirect costs !et%een financial and nonfinancial services in the same proportion as total compensation of staff %hose time is dedicated to one service or the other+ 1hile this method of allocation is not especially precise' it is reasona!le under the circumstances' since it does not materially distort the costs of the respective services' and a more sophisticated system %ould !e too costly for an institution of Aspire/s si4e+ 52<3F2LI2?<ELA3E 52LI8IE, 3he terms of reference for the audit re=uire specific comment on Aspire/s policies for loan loss provisioning' loan %rite?off' and reversal of accrued interest on nonperforming loans+ 3hese policies are descri!ed in notes B and C of the financial statements+ 1e found them to !e reasona!le for Aspire/s circumstances' and consistently applied in practice+ Recommendation; None+

@2X H+1

5otential control %ea-nesses that may !e addressed in a management letter


!ash

No segregation of duties elays in preparing and revie%ing !an- reconciliations Lac- of physical security over cash on hand Inade=uate processes surrounding teller cash counts Fla%s in reconciling inter!an- and clearing accounts No segregation of duties Lac- of appropriate authori4ation of purchases and sales Noncompliance %ith !oard decisions on investments or investment policy Improper calculation of gains or losses on sales Lac- of physical security over investments No segregation of duties Inade=uate chec-s and !alances in loan approval process Lac- of adherence to MFI policies and procedures A!sence of' or noncompliance %ith' policies for immediate follo%?up on delin=uent loans Improper loan file documentation Loan trac-ing system fails to flag loans that are refinanced' rescheduled' or paid off %ith something other than cash E*cessive refinancing or rescheduling of loans Inaccuracy or untimely availa!ility of loan trac-ing system information Material discrepancies !et%een accounting and loan trac-ing systems E*istence of related party DinsiderE loans $@o* continues on ne*t page+)

Investments

Loans

Potential control wea nesses that may be addressed in a management letter

@2X H+1 $continued)

A!sence of internal audit function' including an operational audit unit $see sections 3+B and &+B+( of volume 1) A!sence of unannounced visits to !ranches and clients !y managers or internal auditors

Loan loss rovisions None*istent or inaccurate aging schedules :nreasona!le aging standards Aro%th is mas-ing delin=uency pro!lems Lac- of adherence to la%s and regulations :nverifia!le capital ade=uacy No segregation of duties No proper cutoff Incorrect management assumptions used in the determination of accruals No prenum!ering of chec-s No matching of !ills of lading %ith invoices and purchase orders No segregation of duties No monitoring of covenants Improper calculation of premiums or discounts on de!t No recording of donor loans and improper recording to capital No !oard approval Improper calculation of interest e*penses No segregation of duties 5ass!oo- entries not verified !y internal audit No monitoring of compulsory savings No segregation of restricted and unrestricted funds No !oard authori4ation of capital transactions Noncompliance %ith donor agreements Noncompliance %ith capital ade=uacy re=uirements and other la%s and regulations

#ayables and accruals

$ebt

%avings and de osits

!a ital

Revenues and ex enses Activity recorded in the %rong period Interest income recorded incorrectly Interest charged to !ranches not eliminated in consolidation onor grant revenue incorrectly recogni4ed %hen received over time Improper accounting of fi*ed assets 5urchases recorded to e*penses ,alary rates incorrect 5ossi!le e*istence of DphantomE employees Multiple family mem!ers on payroll ,ystem incapa!le of handling volume of transactions Faulty programming' resulting in distorted financial reporting 1ea-ness in access control or other security features No disaster recovery plan No offsite storage of !ac-up dis-s or tapes

Management information systems

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