Defence

Feature

Making good progress with financial reform

In his opening remarks to the Joint Committee on Public Accounts and Audit (JCPAA), the Secretary highlighted good progress with the work to rebuild Defence's credibility as a respected financial manager.

The Auditor-General, Mr Ian McPhee, PSM, speaks with Secretary of Defence, Mr Ric Smith.
Photo provided by Public Affairs

We have talked in the past about why it is that Defence has qualified audit reports, and the background to my decisions in 2004 and 2005 to reach 'no opinion' findings, with which the Auditor-General concurred.

The resolution of the financial management issues we face is not one for me, or for the Chief Finance Officer Phillip Prior, or for our civilian staff alone. It affects many parts of our organisation, civilian and military. Our uniformed colleagues have much to contribute as managers in many of these areas. Our efforts have the full support of the Chief of the Defence Force and the Service Chiefs.

Approach

Our efforts in improving financial controls and reporting are driven by 16 remediation plans. Many of these plans were initiated as a direct result of adverse findings by the Australian National Audit Office (ANAO). It's worth noting that some, like the recently endorsed plan on Defence's lease register and commitments, are a direct result of our own people reviewing the way in which Defence does its business.

We have engaged a range of professional accountants and advisers, and taken external advice from a number of sources. In the light of all this advice, I believe that we are doing everything possible to improve the management of our accounts and statements. We are committed to being benchmarked against similarly governed organisations and to being seen internationally as a 'best practice' organisation. To achieve this we have actively engaged with the Defence organisations of the United Kingdom, Canada, New Zealand, and the United States.

The remediation activities are not without a cost in terms of both money and people. In 2005–06, Defence has committed $80 million. In 2006–07, we will commit a further $59 million. These figures represent an estimated 422 staff years in 2005–06 and 366 staff years in 2006–07 that have been committed to remediation efforts.

We have reviewed our workforce and skilling needs in the light of the pressures with Defence's remediation plans and of the adoption of international business accounting standards. We have embarked on a major program of specialised training for our people. We have committed an amount of $35 million over 10 years (to 2015–16) to deliver an effective skilling system for financial management—a system that meets the needs of Defence and our people working in finance areas. In terms of training conducted to date, we have trained more than 16 500 of our people in financial management and IT systems in the past two financial years.

Our financial reporting and equipment procurement are starting to see some benefits from all of this effort. We made progress last year, and will make more this year. I remain hopeful that a real breakthrough will be made in remediating our financial statements, if not this year, then the next.

Remediation successes

The good progress with remediation efforts to date includes:

• Removal of a significant proportion of uncertainty in the valuation of Land and Buildings, Infrastructure, Plant and Equipment during 2004–05.
  We expect to remove the remaining $103 million by 30 June 2006.
• Reduction in the pricing uncertainty with regard to Explosive Ordnance.
  We reduced the pricing uncertainty on this asset from $845 million in 2003–04 to $309 million in 2004–05, and expect to eliminate it altogether this year.
• Reduction of $732 million in the pricing uncertainty over General Stores Inventory during the last financial year.
  We have also been implementing new IT controls within the Standard Defence Supply System (SDSS), and are in a good position to complete the remediation efforts in the next two years.
• For Employee Leave Provisions, full remediation of the qualification on military long service leave in 2004–05.
  Work is ongoing on the remainder, and we are fully committed to the removal of all uncertainty on all leave balances, both military and civilian.

As to resolving Category A, B and C audit findings, we have sent 71 closure packages to ANAO, and are on track to complete another 35 by 30 June 2006.

Standards

We face challenges with the application of the Australian-Equivalent International Financial Reporting Standards (AEIFRS). We are not alone in this, and some highly technical issues are involved.

Our inability to comply with the new standard governing the valuation of specialist military equipment could have precluded us from accessing much-needed transitional provisions in the standards. We raised the matter with the Australian Accounting Standards Board (AASB) and in February 2006 the Board issued an amendment that allows all not-for-profit public-sector utilities, including Defence, to be first-time adopters this financial year. We have also raised with the AASB some technical but important questions about the applicability of some of the new standards, not only for Defence but for government bodies more broadly.

Secretary of Defence, Mr Ric Smith.
Photo provided by Public Affairs

One example is the requirement for Defence to value its inventory at cost or replacement cost, whichever is the lower. The story of our audit qualifications is that we are not able to prove the prices of our entire inventory. We are not Coles or Woolworths, with their rapid turnover of stock. As a result, cost information potentially needs to be held for long periods for regular assessment against changing replacement costs. The application of this test in the new standard appears to be of questionable benefit given the nature of Defence's inventory holdings, the reasons why we hold the inventory and the limitations in our existing logistics management systems.

With the introduction of AEIFRS, and to maximise the ability to form an opinion for the 2005–06 financial statements, Defence has worked to develop a conceptual view of appropriate accounting practices and to implement these changes before the end of the financial year.

As we have progressed this task, it has become increasingly evident that some issues cannot be resolved quickly. We have developed more than 20 detailed 'position papers' that articulate the accounting policies and treatments for major elements in our balance sheet. These papers highlight why the difficulties exist and explain what Defence is doing to achieve compliance. They have helped us in meeting disclosure requirements and have paved the way for clearer discussions with the Auditor-General and his people on the validity of Defence's proposed accounting treatments, and we welcome that.

Cash management and operations

While attending to the financial remediation and procurement reforms Defence maintains sound cash management practices and continues to deliver on its operational commitments. Our commitment to our allies and to our Pacific neighbours has not been affected by the extra activity at home. As these remediation programs are worked through, Defence will continue to maintain our responsiveness to government requirements, manage specialised military equipment well, and carefully maintain and diligently monitor our funds and budgeting processes.

In conclusion, I do not underestimate the scale of our problems. But by doing everything we can to ensure that the remediation efforts are enduring, we are now repositioning ourselves to be able to take pride in our financial management. We have made good progress both in scoping the problems and in remediation, but there is much work still to be done.

It will require perseverance, but we are determined to be recognised by government as highly competent, professional and business-like financial managers within the next five years.

This is an extract from the Secretary's opening statement to the JCPAA on 11 May.

[ top of page ]