Accounting Model
In accordance with the Financial Management and Accountability Act 1997, the DMO is required to present financial statements prepared in accordance with Australian Accounting Standards and the requirements of the Finance Minister's Orders.
Income Statement
The DMO receives an agreed level of funding for its service fee and its Output 1.3 policy work—about $640m in total value for the 2005–06 financial year. Consistent with Government policy, the DMO prepares its budget on the basis that it expects to achieve neither a profit nor a loss against its budget. Any variation between the budget and actual expenses across the year will result in an unplanned operating loss or profit. The contracted component of the payment to the DMO is funded on a no-win, no-loss basis, with revenue recognised as expenses occur, so that revenue and expenses will always be equal for the contracted part of the business. In light of this, the DMO operating result will be determined solely by performance against the service fee and Output 1.3.
While the contracted part of the DMO's business—representing approximately 90 per cent of total expenditure—will not provide any operating profit or loss, a comparison between budget and actual expenditure for those categories will give a guide to the DMO's performance. If expenditure is below budget expectations, it is indicative of slower than planned deliverables, with any unspent cash funding being held at the end of the year on the DMO balance sheet as cash plus appropriation receivable, offset by 'unearned revenue'. A comparison of the DMO budget and actual result for 2005–06 indicates that the DMO has achieved overall slightly ahead of the budget plan (for which Defence provided additional funds late in the year, some of which remained as cash at bank, appropriation receivable and unearned revenue in the final position).
It is to be expected that some level of cash and 'unearned revenue' will reside at year end, and indeed is necessary in the DMO. It is not uncommon for companies to hold up to a month of payments as 'cash at bank', and for the DMO this would represent well over $600m. The DMO accounts included in this annual report have just under $200m in cash and appropriation receivable—equating to about a week and a half of DMO expenses.
It should be noted that the business model for the DMO, established by the Government, does not involve the DMO receiving any profit margin on activity or paying dividends. The measure of success for the DMO is not, therefore, obtaining a large profit, but rather management of agreed activity delivery commensurate with funding provided and the unearned revenue liability balance. This will translate ideally to a zero operating result. For 2005–06, the DMO operating result represented 0.1 per cent of total revenue. Both cash and expenses exceeded the revised estimate by about 2 per cent—which reflected a Government direction to seek to progress early the purchase of C17 Globemaster III aircraft. This is indicative of the DMO more than meeting in net terms the overall milestones and deliverables targeted in the budget (being slightly behind on sustainment, due to operations not requiring all available sustainment funding, but well ahead on acquisition).
The DMO receives many services from Defence free-of-charge. This includes things like communications and information systems, accommodation, and human resources services. Under the Australian Accounting Standards the DMO is required to report the value of these services in its financial statements. This reporting does not appear in the cash flow statement or balance sheet, but is shown as both an expense and revenue item on the income statement—and as these are equal it has no impact on the net operating result.
Balance Sheet
As Defence provides the cash for the DMO to construct or purchase the equipment and other assets under the agency agreements, Defence will subsequently own the assets as progressively delivered. These assets in use or under construction will appear on the Defence balance sheet. At the time the 2005–06 budget was prepared, it was assumed that the existing stocks of spare parts and other inventory would be owned by the DMO, and this is evident in the large value of assets on the DMO balance sheet predicted in the Portfolio Budget Statements 2005–06. It was subsequently agreed that ownership of inventory should reside with Defence, and this was reflected in the balance sheets for Defence and the DMO in the Portfolio Additional Estimates Statements 2005–06. At this time 'Assets Under Construction' (elements of a materiel construction product delivered to date but not yet forming the final complete product) were expected to be held on the DMO balance sheet. It was subsequently agreed that these assets should reside on the Defence balance sheet, consistent with the notion of 'control' under the accounting standards. The balance sheet for the DMO included in this report reflects the fact that virtually all physical assets, including 'Assets Under Construction', reside with Defence. Those assets held by the DMO include some business systems and minor plant and equipment specific to the DMO's management.
The changes in balance sheet assumptions through the year are reflected in the comparisons in the tables throughout this chapter. Some apparently large variations (visible in the tables) simply reflect a refinement of the accounting treatment through the first year of operation of the DMO as a prescribed agency.
Cash Flows
The DMO's business is predominantly cash based, as the agency has few physical assets. In view of this, the cash flow and expenses in any year will be similar, but differences will result from:
- The DMO is fully refunded (a month in arrears) for GST payments made to industry. These payments and receipts—over a half a billion dollars annually—are recorded in the cash flow statement but are neither revenue nor expense for the DMO, so they do not appear on the income statement. The end of year DMO balance sheet holds a receivable asset for the GST payment associated with the June period, which will be refunded in July.
- The DMO will make cash prepayments, as outlined above, and these appear in the cash flow statement but not in the income statement (until work associated with the prepayment is completed) at which point the DMO will recognise the expense and earn revenue. Cash and expenses will vary depending on how prepayments made in-year compare with expenses reported in-year for acquittal of prior period prepayments. Amounts will net out over the long term, but will produce variations from year to year.
- The DMO will record some depreciation expenses associated with its small holding of business systems assets, and will also have some variations to accrued employee expenses. These accrual adjustments will be reflected in the income statement but not the cash flow.
In summary, the DMO is predominantly a cash based organisation. It has a small balance sheet—with equity of around $100m (compared with Defence holdings of many tens of billions of dollars). The DMO has a very large income statement, with annual revenue and expenses that represent over 40 per cent of Defence expenditure, and a much larger proportion of expenditure when employees costs are removed.