Geothermal Power Generation Project (RRP INO 52282)

Financial Management Assessment Report Project Number: 52282-001 Loan Number: XXXX September 2019

INO: Geothermal Power Generation Project —PT GEODIPA ENERGI

Asian Development Bank

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CURRENCY EQUIVALENTS (As of March 2020)

Currency unit – Rupiah (IR)

IR1.00 = $0.000061 $1.00 = IR16,331.00

ABBREVIATIONS

ADB – Asian Development Bank

AFS – audited financial statements

APFS – audited project financial statements

BoC – Board of Commissioners

BoD – Board of Directors

CEO – Chief Executive Officer

CFO – Chief Financial Officer

CPS – country partnership strategy

CTF – Clean Technology Fund

EA – executing agency

EBIT – earnings before interest and tax

ERP – enterprise resource planning

FM – financial management

FMA – financial management assessment

FMAQ – financial management assessment questionnaire

FY – financial (or fiscal) year

GDE – PT Geo Dipa Energi

GOI – Government of Indonesia

IA – implementing agency

IACM – Internal Audit Capacity Model

IFRS – International Financial Reporting Standards

IRCA – International Register of Certificated Auditors

KPI – key performance indicator

LFIS – loan financial information system

LIBOR – London interbank offered rate

MW – megawatts

OPIC – Overseas Private Investment Corporation

PEFA – public expenditure and financial accountability

PFM – public financial management

PIU – project implementation unit

PLN – Perusahaan Listrik Negara

PPA – power purchase agreement

PPP – public-private partnership

PSAK – Pedoman Standar Akuntansi Keuangan

RKAP – Rencana Kerja Anggaran Perusahaan

SOE – statement of expenditure

SOP – standard operating procedure

VAT – value-added tax

CONTENTS

EXECUTIVE SUMMARY ............................................................................................................4

I. INTRODUCTION .................................................................................................................6

II. PROJECT DESCRIPTION ...................................................................................................7

III. COUNTRY FINANCIAL MANAGEMENT ISSUES ...............................................................8

IV. PROJECT FINANCIAL MANAGEMENT SYSTEM .............................................................11

V. RISK DESCRIPTION AND RATING – INCLUDING THE FINANCIAL MANAGEMENT AND

INTERNAL CONTROL RISK ASSESSMENT............................................................................19

VI. PROPOSED TIME-BOUND ACTION PLAN .......................................................................21

VII. CONCLUSIONS.................................................................................................................22

APPENDIX 1: CURRENT ORGANIZATIONAL STRUCTURE OF GEODIPA FINANCE

DEPARTMENT .........................................................................................................................23

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EXECUTIVE SUMMARY

1. A financial management assessment (FMA) was conducted over the period August 2018- May 2019 in accordance with ADB’s guidelines1. The FMA considered the capacity of PT Geodipa Energi (Geodipa), including ability to manage funds-flow arrangements, staffing, accounting and financial reporting systems, financial information systems, and internal and external auditing arrangements.

2. Geodipa’s financial management strengths identified during the FMA, include a clear legislative framework, an internal audit function performed by qualified and certified staff with direct reporting to the board of commissioners, policy and procedure manuals for all financial operations, and comprehensive company-wide adoption of enterprise resource planning software.

3. No significant financial management issues were identified, although the lack of experience in implementing a large-scale capital investment program, coupled with a lack of exposure to borrowing from international development partners, will be a challenge for finance staff.

4. The overall pre-mitigation financial management risk of Geodipa is assessed as substantial and the following financial management action plan is proposed.

Table 1: Financial Management Action Plan

Risk Description Mitigation Actions Responsibility Timeframe

Foreign Exchange and Interest Rate Risk Although GDE is currently naturally hedged against its foreign exchange exposure, its net exposure may change over time, particularly as it takes on more foreign currency loans. Similarly, the expected increase in floating interest rate borrowing will change the company’s exposure to interest rate risk. This may negatively impact the financial performance of the company.

GDE to prepare and implement a foreign exchange and interest rate risk management policy. Approved by the Board of Directors

GDE

By loan effectiveness date.

GDE Corporate Model GDE relies on its corporate model to produce financial projections for internal use and to inform external stakeholders. The model

GDE to commission an external audit of its corporate financial model.

GDE

To be completed by July 2020.

1 ADB. 2005. Financial Management and Analysis of Projects. Manila; ADB. 2015. Financial Management Technical Guidance Note – Financial Management Assessment. Manila

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Risk Description Mitigation Actions Responsibility Timeframe

should be independentally audited to ensure the accuracy of GDE’s projections.

ADB Processes and Procedures GDE is adequately staffed with appropriately qualified and skilled employees, however the company has no experience in the implementation of ADB-funded projects. This poses fiduciary and reputational risk.

GDE will ensure that key staff undertake training in ADB procurement, disbursement and financial management procedures.

GDE and ADB

Within 3 months of loan effectiveness.

GDE Finance and Accounting Function. The size and complexity of the project represents a significant increase in the workload of GDE’s finance and accounting staff. This presents a risk with staff who are unfamiliar with implementing large scale projects with development partners.

Engage a Project Management Consultant with appropriate finance and accounting experience.

GDE (from loan proceeds).

Within 3 months of loan effectiveness

Submission of periodic progress reports Periodic progress reports may not be submitted on a timely basis and in a useful format by GDE to ADB.

GDE will provide ADB with quarterly progress reports in a format consistent with ADB's project performance reporting system, no later than 45 days after end of each quarter. The quarterly progress reports should include financial and disbursement report, variance analysis of physical and financial progress, details of utilization of funds and reconciliation with ADB loan financial information system (LFIS).

GDE

Quarterly from loan effectiveness date till loan closing date

5. Based on the FM Action Plan outlined in Table 1 and the review of Geodipa’s historical and forecast financial performance, the proposed financial covenants are as follows:

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• Except as ADB shall otherwise agree, the Borrower shall ensure that it maintains the following ratios measured annually for each financial year: a) a debt service coverage ratio of at least 1.2x; b) a debt-to-equity ratio of no more than 75:25; c) a self-financing ratio of at least 15%; and d) a current ratio of at least 1.0.

For the purpose of this paragraph, (i) the term “maintenance capital expenditure” means all capital expenditures made

in the ordinary course of business to maintain existing business operations; (ii) the term “free cash flow” means cash flow from operations (after tax and working

capital changes, but before interest expense and lease payments on financial leases) less scheduled maintenance capital expenditure;

(iii) the term “debt service requirements” means scheduled interest expense and principal repayments on debt, and lease payments on financial leases required to be paid in the relevant period, excluding capitalized interest expense and fees during construction;

(iv) the term “debt service coverage ratio” means free cash flow divided by debt service requirements;

(v) the term “debt” means any indebtedness of the Borrower maturing more than one year after the date on which it was originally incurred;

(vi) the term “equity” means the sum of the total unimpaired paid-up capital, retained earnings and reserves of the Borrower not allocated to cover specific liabilities;

(vii) the term “capital expenditures” includes gross expenditures for property, plant and equipment, capitalized interest expense and fees on debt, and intangible assets;

(viii) the term “self-financing ratio” means cash flow from operations (after tax and working capital changes, but before interest expense, and lease payments on financial leases) divided by capital expenditure;

(ix) the term “current assets” means cash, and other assets that are expected to be converted into cash, consumed, or sold within twelve months, including but not limited to, accounts receivable, marketable securities, inventories and prepaid expenses.

(x) the term “current liabilities” means all liabilities, which are due to be paid to creditors within twelve months, including but not limited to, accounts payable, customer advances, debt service requirements, taxes and fees; and

(xi) the term “current ratio” means current assets divided by current liabilities.

I. INTRODUCTION

7. This Financial Management Assessment (FMA) has been prepared in accordance with ADB’s guidelines2 over the period August 2018- May 2019. It aims to assess whether PT Geodipa Energi (Geodipa) has adequate capacity to satisfactorily function as executing agency (EA) and implementing agency (IA) for the proposed loan, in the areas of planning and budgeting, management and financial accounting, reporting, auditing, and internal controls. Preparation activities included reviewing documents, interviewing the EA’s officials, and analyzing the EA’s response to the financial management assessment questionnaire (FMAQ). The FMA also includes a review of proposed disbursement and funds-flow arrangements and identifies

2 ADB. 2005. Financial Management and Analysis of Projects. Manila; ADB. 2015. Financial Management Technical Guidance Note – Financial Management Assessment. Manila

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measures for addressing identified deficiencies.

II. PROJECT DESCRIPTION

8. The project intends to add an additional 110 megawatts (MW) of geothermal electricity generating capacity, 55 MW each at the existing plants Patuha in Ciwidey, Bandung West Java and Dieng in Banjarnegara Central Java. The project will have the following outputs:

(i) Output 1: Geothermal power plants constructed and commissioned. The

project will support GDE in commissioning a 55 MW geothermal power plant at Dieng, Central Java Province (Dieng Unit 2) and a 55 MW geothermal power plant at Patuha, West Java province (Patuha Unit 2). Both Dieng Unit 2 and Patuha Unit 2 subprojects will include: (i) drilling of new wells for production and reinjection of reservoir fluids, and (ii) construction of a steam above ground gathering system and fluid reinjection lines connecting the wells and generating units. Patuha Unit 2 will be single-flash power plant, and Dieng Unit 2 will be a geothermal combined cycle plant.3 The project will also support the transmission interconnection systems between the plants and the grid. At Dieng, this will include commissioning of a new, 6-kilometer underground transmission line to the Dieng substation. Existing lines and towers will be used to connect Patuha Unit 2 to the Patuha Substation, but the project will include installation of a new transformer at the existing substation.

(ii) Output 2: Institutional capacity of GDE strengthened. The project will

strengthen GDE’s capacity to plan for, develop, and operate geothermal power plants, including management of complex technical conditions and multiple coordinated contracts. This will be accomplished through gender-responsive training programs organized by the pilot plant consultants and project management consultants (PMC) on reservoir management and procurement as well as on-the-job-training, supported by the PMC, through the fulfillment of the ADB requirements. GDE will additionally increase their ability to manage environmental and social risks through implementation of a revised Environmental Management System that will incorporate gender, climate, and community safety considerations.

(iii) Output 3: Community development program enhanced. The project will support enhancement of GDE’s Community Development Program. 4 This will begin with implementation of a Gender-Responsive Stakeholder Communication Strategy,5 which will involve (i) increased outreach and education on the project and associated impacts, and (ii) information gathering on the communities’ challenges, including consideration to the differential needs and experiences of men and women. Improved communication will help address misperceptions

3 The wells will produce reservoir fluids that are a mixture of steam and water. In a single-flash steam power plant, the

steam is separated from the water and then used as the working fluid in the power plant while the water is unused and reinjected in the reservoir along with the condensate from the steam cycle. In the combined cycle plant, the steam and water are still separated, but the heat energy from the steam is used twice, and the heat energy from the water is used once before reinjection. The steam will first go through a steam turbine after which it will go through a heat exchanger where the residual heat in the steam will be transferred to an organic fluid that will power another turbine. The water will also go through a heat exchanger where the heat is transferred to an organic fluid that will power another turbine.

4 GDE’s Community Development Program is their corporate social accountability program through which they undertake activities to benefit the communities in the areas surrounding their operations. GDE has annual budget allocations and dedicated staff to design and implement these programs.

5 Stakeholder Communication Strategy (will be accessible from the list of linked documents in Appendix 2 of the RRP).

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around the existing power plant and planned future development; this is particularly important at Dieng where communities live and cultivate between and around various project sites. Based on insights from the communities on key challenges and needs, the Community Development Program will then realign activities to focus on those actions that will most meaningfully contribute to improved well-being of the men and women in the project communities, perhaps with a stronger emphasis on challenges such as access to education, water strain, declining agricultural production, and alternative livelihood opportunities. The improved communication and more strategic focus of programs to benefit neighboring communities will strengthen the relationship with GDE and support for the project among nearby communities. The PMC will also develop a feasibility study for a geothermal direct-use project, such as for agricultural drying or heating for homestays, that could provide enhanced livelihood opportunities for community members. This direct use investment could then be implemented in parallel with development of Dieng Unit 3 as part of the Community Development Program.

III. COUNTRY FINANCIAL MANAGEMENT ISSUES

9. The Indonesian Public Financial Management (PFM) system is very large and complex, and has multiple layers. A substantive public expenditure and financial accountability (PEFA) assessment was undertaken by the World Bank in 2017. 6 Previous assessments were undertaken in 2007 and 2012. The PEFA assessment provides ratings from “A” to “D” for aspects of Indonesia’s PFM. The ratings for the PFM performance indicators are based on the criteria set out in Table 2. The PEFA assessment scores are set out in Table 3.

Table 2: Summary of PEFA Performance Rating Criteria

Rating Criteria

A High level of performance that meets good international practices

B Sound performance above the basic level

C Basic level of performance broadly consistent with good

international practices

D Either less than the basic level of performance or insufficient

information to score

A. Strengths identified

10. Strengths identified were related to the budget preparation process and parliamentary scrutiny of the budget. Indicators related to these functions were scored “A”.

B. Weaknesses Identified

11. Budget reliability. The main weakness identified with respect to budget reliability was the accuracy of revenue forecasts. Accurate revenue forecasts are a key input to the preparation of a credible budget. The indicator used to assess the quality of revenue forecasting by comparing revenue estimates in the original approved budget with actual domestic revenue collection was

6 The World Bank. 2018. Indonesia - Public Expenditure and Financial Accountability (PEFA) – Assessment Report

2017. Jakarta.

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rated “D”.

12. Several factors were identified as contributing to inaccurate revenue forecasts. Most significantly, Indonesia’s state revenue has historically been dominated by commodity earnings, which are difficult to predict. The commodity price collapse that began from mid-2014 onwards, particularly for oil, has resulted in significantly reduced natural resources related revenues. An additional factor is the number of fiscal reforms launched simultaneously, which makes it difficult to estimate revenue. For example, between 2013 and 2016, Indonesia altered the threshold for collecting value-added tax (VAT), added new exemptions to VAT and income tax, and changed the minimum retail price of tobacco from year to year.

13. Fiscal risk reporting. Two weaknesses were identified. Firstly, reporting from subnational governments has not occurred in a timely manner for all subnational governments (resulting in a PEFA rating of D). The PEFA assessment commented that the inter-governmental fiscal transfer system lacks predictability and is not fully transparent, undermining the quality of local spending. Secondly, while contingent liabilities are reported in the national budget, the reporting was qualitative. In applying a rating of C, the PEFA assessment commented that limited quantitative information on the risks was included and that the budget does not provide a consolidated view of the overall fiscal risk. The types of risks to which the budget is exposed in the case of PPP-related guarantees are not adequately covered. There is a lack of information regarding explicit contingent liabilities outside the infrastructure sector, for example those relating to health and social security schemes. In addition, data on the quantification of, and provision for, implicit contingent liabilities, is unavailable (e.g. example the potential need to bail out state-owned enterprises with non-guaranteed debts).

14. Public Investment Management. Major and strategic capital investment projects are subject to ministry-level review and approval during the budget process, before they are implemented by line ministries. However, detailed technical, financial, economic, environmental and sensitivity analyses are not always available or completed at the time of investment project selection. The PEFA assessment considered that presidential priority projects (40% of the major capital investment projects) are appropriately supported with technical capacity and resources at the design and implementation stages. However, the remainder items in the capital investment projects are delivered by line ministries with limited management capacity and control. The costing of major projects is not included in the budget documents. The monitoring of cost and physical progress is reported across various ministries and not consolidated. This indicator was rated “D+”.

15. Monitoring of public procurement performance. Out of the total public procurement value, 30% of purchases cannot be tracked or monitored in the e-procurement system. For the 70% of purchases that are awarded competitively and can be monitored, limited information is available. In addition, no public information is available on awarded contracts or the resolution of complaints, and there is no independent body to review appeals in the complaints-handling process. This indicator was rated “C”.

16. Parliamentary scrutiny of audit reports. In 2014, the Public Account Committee was abolished. The role of scrutiny of audit reports was distributed to several commissions in parliament. The PEFA assessment was the effectiveness of parliamentary scrutiny on audit reports (other than matters covered by the National Public Procurement Agency, LKPP) is limited. This indicator was rated “D+”.

C. Public Financial Management Reform

17. Public financial management reform has been given high priority by the government since

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2001. The 2017 PEFA assessment reported the following ongoing areas of reform:

(i) Tax collection. Collecting more tax is a top priority for the government. The PEFA identified challenges related to: complex tax regulations, a narrow tax base with a limited number of taxpayers filing returns, a relatively low compliance rate, and low capacity of both IT systems and human resources. The government proposes to improve tax collecting by both strengthening tax administration within government and reforming the tax system (to broaden the tax base, ease administrative complexity, reduce economic distortions and provide incentives for targeted changes in consumer behavior).

(ii) Strengthened public investment management and procurement. The PEFA review identified challenges in public investment management from the absence of guidelines and criteria, leading to a lack of quality control on project selection and preparation, as well as on the monitoring of infrastructure projects. The government is continuing to strengthen the control environment and the regulatory framework for public procurement to improve the efficiency of spending. The LKPP was established by a presidential regulation to govern the implementation of e-procurement to increase transparency and efficiency in the procurement process. Regulations require all government units, as well as national and subnational levels of government, to adopt e-procurement. The PEFA noted Indonesia has a plethora of decrees, regulations and instructions related to procurement, issued by ministers, provincial governors, district heads and municipal mayors. These instruments contain conflicts and inconsistencies. LKPP is now focused on the preparation of a standardized procurement law and has carried out a public consultation process on a draft law that included government agencies and international development partners.

(iii) More effective oversight related to the internal and external audit functions. The government intends to increase the capacity of the government’s internal auditors to Level 3 on the Internal Audit Capacity Model (IACM) scale. Currently, only about 5 percent of internal auditors are qualified to Level 3. The State Audit Agency, or Badan Pemeriksa Keuangan (BPK), has adopted several measures to strengthen auditors’ professionalism and integrity by improving the quantity and quality of BPK’s audit resources. But BPK requires more auditors with diverse educational backgrounds, in addition to accounting and finance backgrounds, to enhance the quality of public administration and accountability. ADB has been supporting BPK through the State Audit Reform Sector Development Program.

Table 3: Summary of PEFA Performance Measurement Framework

PFM Performance Indicator Overall Rating

Pillar One: Budget Reliability PI-1 Aggregate expenditure outturn C

PI-2 Expenditure composition outturn C+

PI-3 Revenue outturn D Pillar Two: Transparency of Public Finances PI-4 Budget classification A

PI-5 Budget documentation B

PI-6 Central government operations outside financial reports A

PI-7 Transfers to subnational governments B

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PI-8 Performance information for service delivery C+

PI-9 Public access to fiscal information A

Pillar Three: Management of Assets and Liabilities

PI-10 Fiscal risk reporting C

PI-11 Public investment management D+

PI-12 Public asset management B

PI-13 Debt management B+

Pillar Four: Policy-based Fiscal Strategy and Budgeting

PI-14 Macroeconomic and fiscal forecasting B+

PI-15 Fiscal strategy B+

PI-16 Medium-term perspective in expenditure budgeting C+

PI-17 Budget preparation process A

PI-18 Parliamentary scrutiny of budgets A

Pillar Five: Predictability and control in budget execution

PI-19 Revenue administration C+

PI-20 Accounting for revenue A

PI-21 Predictability of in-year resource allocation A

PI-22 Expenditure arrears B+

PI-23 Payroll controls C+

PI-24 Procurement management C

PI-25 Internal controls on non-salary expenditure A

PI-26 Internal audit C+

Pillar Six: Accounting and reporting

PI-27 Financial data integrity A

PI-28 In-year budget reports B+

PI-29 Annual financial reports C+

Pillar Seven: External Scrutiny and Audit

PI-30 External audit C+

PI-31 Parliamentary scrutiny of audit reports D+

Source: World Bank 2018, Jakarta.

IV. PROJECT FINANCIAL MANAGEMENT SYSTEM

A. Overview of Geodipa’s Financial Management System and Institutional Context

18. Geodipa was formed in 2002 and is based in Jakarta Selatan, Indonesia with additional offices in Wonosobo and Bandung, Indonesia. It is a state-owned enterprise under the Ministry of Finance and is 93.33% owned by the Government with the balance held by Perusahaan Listrik Negara (PLN), and prior to 2011 operated as a subsidiary of PT Pertamina (Persero). The company was established to engage in geothermal activities, including in the upstream and downstream sectors and other related and supporting business activities in the field of geothermal energy. Currently, the Company generates its revenue from selling electricity generated by Dieng and Patuha geothermal power plants. The company owns a total of 110 megawatts (MW) of

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geothermal generating capacity across two power plants - Dieng and Patuha. Dieng and Patuha commenced commercial operations in 2002 and 2014 respectively. The company plans to increase installed generating capacity to 270 MW by 2023 through further development of the Dieng and Patuha fields, and thereafter to around 1,000 MW by 2034.

19. In general, this assessment finds Geodipa to have strong financial management discipline, clear and robust processes and procedures, appropriate checks and balances, and well-trained professional staff.

B. Strengths

20. Geodipa’s relative strengths in financial management are as follows:

• Financial management of Geodipa, like other public sector companies in Indonesia, is governed by a clear legislative framework.

• Comprehensive internal audit function, integrated with the company’s activities and follows international and domestic best practice.

• The company appears to be thorough in documenting financial management procedures and processes.

• The company uses ERP for most financial management activities.

C. Weaknesses

21. The identified weaknesses in Geodipa’s financial management processes and procedures are as follows:

• Financial management procedures in relation to major capital investment programs are largely untested and to date ERP has not been used by staff for project accounting.

• Finance staff are unfamiliar with international lending agency requirements, practices and procedures.

D. Personnel, accounting policies and procedures, internal control, internal and external

22. Personnel. In accordance with relevant law, Geodipa is governed by a three-person Board of Commissioners (BoC) and a separate Board of Directors (BoD). The BoC is charged with supervising management policies whereas the BOD is responsible for company management and strategy execution, in accordance with Indonesian company law.

23. Geodipa’s Finance Division is headed by a Finance Director, supported by a Vice President Commercial. The division is organized into separate departments for budgeting and reporting, and finance and accounting. Organization charts for the overall company and for the finance and accounting function are provided in Appendix 1.

24. The number of staff in the finance and accounting division is stable at 15. Turnover is very low; only one staff member has left and been replaced in the past three years. A mandatory training policy is in place for all finance and accounting staff and has covered financial accounting standards, tax regulation and cash flow management.

25. Accounting Policies and Procedures. Geodipa prepares its financial statements under the historical cost convention on an accrual basis. The financial year in Indonesia runs from 1 January to 31 December. The company follows Indonesia’s national accounting standards (Pedoman Standar Akuntansi Keuangan or PSAK) which are mostly aligned with GAAP and

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which are reviewed regularly in light of changes to GAAP and to local laws and regulations.

26. The company prepares consolidated financial statements including an income statement, a balance sheet and a cash flow statement. The Chart of Accounts can be modified if necessary to suit the requirements of the project.

27. Full financial statements are prepared on a monthly, quarterly and annual basis. Reports are automatically generated from the ERP system and are disseminated to the company’s senior management and other staff as required. Annual financial statements are submitted to Ministry of Finance and to Ministry of Energy.

28. Geodipa has adopted the 2013 guidance on internal controls from the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to ensure adequacy and consistency in preparing and approving transactions.7

29. Accounting records are retained for 5 years in ERP and in a separate document management system.

30. Geodipa’s regional offices (one at each of the two power stations) are authorized to make relevant journal entries and payments up to Rp 100 million (approximately $6,100).

31. Safeguard over assets. The company appears to have robust asset financial management policies in place and uses the ERP Asset Management module, A detailed fixed asset register is maintained in ERP and is updated monthly in accordance with the policy and procedure provided in the company’s account manual. The register is duplicated in Microsoft Excel.

32. According to the company, physical verification of fixed assets occurs annually and twice yearly for stores. Any discrepancies are immediately resolved. All fixed assets are comprehensively labelled.

33. The company’s asset impairment policy allows write down on assets at the director level, however full asset write-off requires shareholder approval.

34. Comprehensive insurance is in place for fixed assets at a cost of approximately $1.6 million per annum.

35. Asset Capitalization. The company has a written procedure for capitalization of commissioned assets and according to the company no issues have arisen with respect to this policy and that the capitalization procedure is always completed in a timely manner. A review of the capital expenditure versus capitalization in the past 4 years supports the company’s view that the process of asset capitalization is acceptably managed.

36. Payments. Geodipa’s payment process is summarized in Figure 1. All invoices are processed through the ERP system. The written procedure requires all invoices to be entered into the ERP system and allocated to cost centers accordingly. Invoice processing procedures include appropriate comparison and verification against purchase orders and receiving reports. The authenticity of invoices and supporting documents are thoroughly verified, according to the company.

Figure 1: Geodipa’s Payment Process

7 COSO. Internal Control — Integrated Framework. 2012. USA.

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Source: Geodipa

Invoice to

FinanceIssuance of BKB

& Number

Invoice

Verification

Parking

Document

Posting

Document

Invoice

ReverificationApproval and

Posting Payment

Writing Letter

of Payment

Approval of Letter of Payment

Processed by

Bank Transfer ReceiptDocument

Archive

FINANCE ACCOUNTING

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37. Revenue. All of Geodipa’s revenue is earned from sales of electricity to PLN. Sales are governed by long-term power purchase agreements (PPAs). To initiate revenue receipt for electricity sales, Geodipa’s operating units first prepare an Official Report of Energy Transfer Transaction. These reports are then verified at Geodipa’s head office, and a draft invoice is generated for approval by Director Finance. Invoices are transmitted to PLN electronically and are accepted after a verification of meter readings. Once an invoice has been accepted by PLN, payment is received by Geodipa within 1.5 months.

38. Budgeting. A Rencana Kerja Anggaran Perusahaan (RKAP) or company workplan and budget is prepared annually in accordance with Geodipa’s standard operating procedure (SOP). The annual budgeting process is driven and monitored by a budget committee appointed by management in June (or thereabouts). This committee, which provides oversight to the budgeting process, firstly evaluates budget realization for the current year and then formulates assumptions and policies for the workplan. Management validates these assumptions and policies, which are then subject to a risk assessment by the Business Development Department. Each cost center then prepares its own detailed workplan and expenditure budget based on the assumptions promulgated by the budget committee. Cost centers are also responsible for preparing feasibility studies for any non-routine and/or investment expenditure. The company’s Budget and Report Department compiles workplans and budgets, undertaken an overall analysis, and submits a draft RKAP to the budget committee. After revisions to the RKAP, the Board of Directors and Board of Commissioners is engaged and a final draft of the budget is submitted to shareholders by 31 October. The Budget is finally approved at a Special General Meeting.

39. Geodipa’s budgets include financial and physical targets. Some of these targets are characterized as key performances indicators (KPIs) against which performance is monitored. Variations to capital expenditure budgets of greater than 20% require shareholder approval.

40. In general and based on each cost center’s instructions, there is a quarterly release of funds into ERP. A budget verification is required when requesting procurement. Further, the Budget and Report Manager verifies and approves release of procurement orders for cost centers.

41. Process for counterpart funds. The Government has approved a budget appropriation of new equity to be transferred to GDE (termed a “PMN”) in 2020, equivalent to $50 million. These funds will be transferred to GDE in the forth quarter of 2020. GDE already has the equivalent of $50 million in cash (or equivalent) available. Additional counterpart proceeds will be secured by way of debt facilities from local banks, drawn as necessary to meet project disbursement requirements. This means that, subject to timely payment of the Government’s committed additional equity investment, GDE will have available counterpart funds and will follow its own disbursements processes and procedures to make payments to contractors and suppliers.

42. Internal Audit. The company has separate internal audit functions for management/operations and financial auditing. In addition to holding at least a bachelor’s degree, the management/operations auditor is required to be International Register of Certificated Auditors (IRCA) certified and licensed. The financial auditor is required to hold a minimum of a bachelor’s degree in accounting and be either a qualified or certified internal auditor. The Internal Audit Department reports to the President-Director and to the BoC, thus ensuring true independence. The internal audit program, which covers finance, ERP, management and operations, is risk-based and meets the requirements of the Indonesian Corporate Governance Manual (GCG), ISO 19011 (Guidelines for Auditing Management Systems), IFRS and local regulations. The audit program has not covered IT in the past, however an IT audit is planned for 2019 as it is mandatory under GCG.

43. Internal auditors meet with the audit committee quarterly to discuss findings. Findings and follow-ups are monitored using a customized form. Both pre- and post-audits are performed. The

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company has a total of three internal audit staff, which this assessment considers to be adequate for now but will need be increased as work begins on new projects. The project will be included in the annual work program however the company acknowledges that the internal auditors currently lack a full understanding of ADB policies and procedures as they relate to project implementation.

44. External audit. Geodipa is subjected to external audit by the statutory auditor (the Indonesian Supreme Audit Institute), a public accounting firm, the country’s Development and Finance Supervisory Agency plus ISO 14001, environmental management and occupational safety and health audits from relevant bodies.

45. External auditors are replaced every 5 years (by way of competitive tender) although the audit associate is replaced every 3 years.

46. Audit reports are generally issued without delay. Auditors meet regularly with the audit committee – at least once a month according to the company. No issues with respect to information availability have been indicated.

47. The project will be audited by a commercial financial services firm that is familiar with ADB’s transactional reporting and auditing requirements. An additional level of audit is applied when government equity is included in the project’s financing, as will be the case for the project. This is undertaken by the Development and Finance Supervisory Agency.

48. The supreme auditor’s major comments in the most recent audit report for 2017 are as follows.

a) Asset takeover from Overseas Private Investment Corporation (OPIC) and debt payment to CS First Boston is not well documented. This issue relates to the price paid for and value of the Geodipa’s geothermal assets relative to the valuation of the relevant SOE. This is a historical issue for which very little documentation is reported to exist and according to the company the issue is unlikely to be resolved anytime soon.

b) State investment funds are not clearly utilized. This relates to the way in which government funds are identified in financial reports and, according to the company, is a consequence of the protracted legal case with the company’s former partner Bumigas. There is an expectation that this audit issue can be resolved now that the legal case is closed.

c) Internal audit function is not optimal. The supreme auditor noted the absence of an annual audit plan and the generation of an audit action list. The company has now acted on this audit observation and believes that internal audit will now fully meet the external auditor’s requirements.

d) Financial reporting information systems do not produce accurate information. This observation relates to staff not following standard operating procedures for transactions (for example, drawing inventory without following proper requisition procedures). The company attempted to resolve this issue through training and failing that resorted to formal warnings issues to some staff for repeated non-compliance.

e) Three work packages were not executed in accordance with contractual requirements. According to Geodipa this relates to lack of documentation from contractors. The company resolved this issue by issuing warning letters to the transgressing contractors.

f) Handling of compensation claims at Dieng is not optimal. Geodipa explained

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that the third-party validator of claims against damage from the 2016 Dieng well explosion did not provide adequate validation of some claims. A special audit was instigated to ensure that claims were paid in accordance with documented processes. Geodipa notes that this audit did not detect any fraud in relation to payments made.

g) Year 2016 performance measurement is not accurate. The external audit noted a mismatch between audited financial statements and ERP. Geodipa stated that this mismatch relates to material management and accounting and in particular inventory valuations. This is a recurrent audit observation that the company believes relates to staff not following proper processes; in this context, formal warnings have been issued to some staff.

49. The Development and Finance Supervisory Agency undertakes an annual audit of entities using public funds. This good corporate governance audit, which follows relevant ISO standards, assesses performance against 568 conformity test factors including business processes, management systems and codes of conduct. Geodipa scored 59.5% in this audit in 2016 and 75.99% in 2017.

50. The 2017 public accounting firm audit noted many of the same issues raised by the supreme auditors – in particular, inconsistencies with inventory, expenditure and asset management. According to Geodipa, these issues all arise as consequences of staff not following procedures. An additional audit concern noted by the public accounting firm related to procurement at Dieng was also attributed to flawed implementation of written procedures. The only audit observation was a discrepancy in relation to tax reported and filed. Geodipa indicated that this is a process timing issue that it is in the process of rectifying.

51. Foreign exchange risk management. Geodipa does not have any policy regarding foreign exchange risk management. The company is already exposed to foreign exchange risk through a dollar-denominated loan from PT Bank Negara Indonesia Persero. This exposure will increase with the proposed project, for which the project debt will also be dollar-denominated. Geodipa indicated that it achieves natural hedging of this exposure through its PPAs which are denominated in dollars. Notwithstanding this natural hedge, a written policy concerning management of this (and interest rate) risk is required.

52. Cash and bank. An up-to-date cash book is maintained by Geodipa. The company does not collect cash from its sole customer (PLN) and cash holdings are minimal (less than $1,000). Bank accounts are reconciled at least once a month, with all reconciling approved and recorded. No persistent non-reconciling items are noted.

53. The company’s CEO, CFO, and Director of Human Capital and General Affairs are authorized bank account signatories. Online payments are permitted only for tax transactions and only two people are authorized to make these payments. Cash/bank management and petty cash procedures are covering under documented standard operating procedures.

54. Delegated authority. A standard operating procedure (SOP) is in place for delegated authority to transact and approve.

55. Computerization. Geodipa is comprehensively computerized. It has an enterprise-wide off-the-shelf (SAP) ERP, including modules for plant maintenance (PM), material management (MM), financial accounting (FI), and project systems (PS). All users of SAP have their own terminals. SAP is used directly for generating periodic financial statements although sime minor intervention is required in relation to cost accruals.

56. GDE has indicated it will adopt SAP for all project financial and asset reporting

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requirements.

57. Project Payments. The flowchart in Figure 2 summarizes Geodipa’s documented payment process for incoming goods as it will apply to the project.

Figure 2: Geodipa’s Project Payment Process

E. Disbursement Arrangements and Funds Flow

58. The ADB and CTF loan proceeds will be disbursed in accordance with ADB’s Loan Disbursement Handbook (2017, as amended from time to time)8, and detailed arrangements agreed upon between the government and ADB. The funds will be provided to GDE as an Ordinary Capital Resources (OCR) Loan with a sovereign guarantee.

59. Payment for goods, works, and consulting services will be disbursed by ADB through direct payment procedure.

60. Counterpart funds will part or fully finance various contracts, plus the costs for environment and social mitigation, land acquisition and resettlement, and taxes and duties. Disbursement and liquidation of counterpart funds will follow GDE procedures. GDE will recevice a customs and sales tax exemption from the government in relation to imported goods and services. Disbursement for counterpart funds will be carried out in accordance with the government’s guidelines and practices.

8 The handbook is available electronically from the ADB website (http://www.adb.org/documents/ loan-disbursement-

handbook

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Incoming Goods

Verification(Performing Invoice and supporting documents

of goods receive)

Delivery of goods Goods verification

Delivery Intimation(notice of incoming goods)

Delivery Advice(Documents of incoming

goods has matched)

Interim Payment Certificate

Project

Which consists of:

- Date of upcoming delivery

- Type of goods

- Amount will be charged

Receiving Report(signed by contractor,

supervisor, & GDE)Contractor

Bank(performs payments)

GDE Head Office(Verifies documents, and

issues payment order)

Bank(Verifies documents, & confirms to GDE Head

Office)

Contractor(complete payment

documents)

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61. The proposed fund flow mechanism is as follows:

V. RISK DESCRIPTION AND RATING – INCLUDING THE FINANCIAL MANAGEMENT AND INTERNAL CONTROL RISK ASSESSMENT

62. A Financial Management Internal Control and Risk Management Assessment was conducted (Table 4). The overall pre-mitigation risk is assessed as “substantial”.

Table 4: Financial Management Internal Control and Risk Assessment (FMICRA)

Risk Type/area Risk Rating

Risk Description Mitigation Measures

A. Inherent Risks

1. Country specific risks

Low Poor scrutiny of public sector investments.

In addition to detailed analysis undertaken by ADB, the project is subject to several levels of analysis and scrutiny at GDE before being presented to MoF and the Indonesia Infrastructure Guarantee Fund (IIGF). The project’s reporting structures will ensure that adequate information is made available to the

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Risk Type/area Risk Rating

Risk Description Mitigation Measures

Government to allow thorough project scrutiny.

Low Weak monitoring of public procurement performance.

This risk relates specifically to the Government’s e-procurement system, which the project will not use.

2. Entity specific risks

Moderate Financial risk: the project involves an investment that will increase the value of GDE’s net fixed assets by a factor of four. This will stretch the company’s resources, financial and otherwise, putting the company’s financial performance at risk if commissioning is delayed, if operational problems reduce plant output, or if project costs overrun.

Project cost estimates have been reviewed by external experts, then further improved to incorporate information obtained from a market sounding exercise, and have been the subject of intense discussion and debate. Financial sensitivities tested have included significant capital cost overruns and declines in production. An experienced Project Management Consultant will be engaged to closely manage implementation of the project, including cost control. Ultimately GDE does have the right to renegotiate the Power Purchase Agreement (PPA) in place with PLN.

Overall Inherent Risk

Low

B. Control Risk

1. Executing agency

Substantial Compliance risk: GDE follows structured planning and technical assessment processes, however it has no experience in implementing externally assisted projects and is not familiar with ADB’s financial management and disbursement requirements.

GDE will use ADB loan proceeds to engage a Project Management Consultant with appropriate finance and accounting experience.

2. Staffing Moderate Staffing levels are adequate, skills are appropriate, and turnover is low. Inexperience with ADB disbursement and financial management processes and procedures does present some risk.

GDE will ensure that key staff undertake training in ADB procurement, disbursement and financial management procedures

3. Financial Management Information System

Moderate GDE has relatively high levels of computerization and automation including the widespread adoption of ERP. However, the company has not used ERP for project

GDE will communicate to ADB a decision regarding its choice of project accounting software by no later than the date of loan effectiveness.

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Risk Type/area Risk Rating

Risk Description Mitigation Measures

accounting and financial control previously, and there is some debate internally as to the preferred approach to project accounting (that is, using the ERP or standalone software).

Moderate GDE uses a sophisticated customized Excel-based corporate model to produce its financial forecasts. This model has not been externally audited.

GDE will engage an experienced financial modeler to provide a detailed audit of the model.

4. Risk management

Moderate Although GDE is currently naturally hedged against its foreign exchange exposure, its net exposure may change over time, particularly as it increases the portion of foreign currency loans on its balance sheet. Similarly, the expected increase in floating interest rate borrowing will change the company’s exposure to interest rate risk. This may expose the company to significant financial performance risk.

GDE to prepare and implement a foreign exchange and interest rate risk management policy. Approved by the Board of Directors

5. Reporting and Monitoring

Moderate Comprehensive monthly and quarterly financial management reporting systems are not yet in place.

Project financial reports will be generated on a quarterly basis and project budget figures will be compared with actual in each quarterly report. Annual unaudited project accounts will be provided within 45 days of the close of each financial year; and audited project accounts will be submitted within 6 months after the close of each financial year.

Overall Control Risk

Substantial

Overall Combined Risk

Substantial

VI. PROPOSED TIME-BOUND ACTION PLAN

63. Based on the risk assessment and proposed risk mitigation measures, the proposed risk action plan is provided as shown in Table 1 in the executive summary.

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VII. CONCLUSIONS

64. This assessment concludes that GDE follows sound financial management practices, is well staffed and uses technology appropriately. However, the company’s inexperience in executing investment projects funded by a multilateral development bank and some concerns around its capacity to absorb the significant increase in workload that will accompany the investment (from a resource and a risk perspective) lift the assessed pre-mitigation financial management risk to substantial.

65. The most pressing issues to be addressed to ensure adequacy of financial management arrangements for the proposed ADB loan are as follows:

a. Preparation of a foreign exchange and interest rate risk policy.

b. External audit of the company’s corporate financial model.

c. Training of staff in ADB procurement, disbursement and financial management procedures.

d. Ensuring appropriate finance and accounting experience in the Project Management Consultant.

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APPENDIX 1: CURRENT ORGANIZATIONAL STRUCTURE OF GEODIPA FINANCE DEPARTMENT

Finance Director

M. Ikbal Nur

Budget & Report Manager

Mursid Margono

Finance Manager

Genny M

Operation Budget Asst. Manager

-

Investment Budget

Staff

Andhiko

Accounting Manager

Tri Setiadji

Investment Budget Asst. Manager

-

Tax & Verification Asst. Manager

Meti

Treasury Asst. Manager

-

Asset AccountAsst. Manager

-

General Ledger Asst. Manager

Trie Yunita Vira

Financing Adm.

Staff

Endah

Tax Adm. Staff

Merry

Verification Staff

Shinta

Cash & Bank

Transaction Staff

Nadya

Asset Acc. Staff

Arief

Asset Management

Staff

-

General Ledger

Acc Staff

Financial Reporting

Staff

Andre

Operating Budget

Staff

Agista