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Public Accounts of Canada 2016 Volume I—Top of the page Navigation

Observations of the Auditor General of Canada on the consolidated financial statements of the Government of Canada For the Year Ended 31 March 2016

Our opinion provides assurance that the Government of Canada is properly reporting its overall financial performance to Parliament and to Canadians. Reporting the Government's financial results requires significant effort by public servants. Staff in individual departments and central agencies work together to prepare the Government's consolidated financial statements. For the 18th consecutive year, we have expressed an unmodified audit opinion on the consolidated financial statements, and we thank those involved for their assistance and for the cooperation extended to my Office during the audit.

The purpose of these observations is to comment on matters that we would like to bring to Parliament's attention.

Transformation of Pay Administration

The Government is transforming the administration of the pay of Public Service employees. As part of this multi-year initiative, it has consolidated some of its pay services in one location and replaced its 40-year old pay system. In 2012, the Government began the four year process of consolidating the work of compensation advisors from various departments to a new pay centre in Miramichi. By the end of April 2016, the administration of payroll had been transferred for about 200,000 of the Government's employees, with almost half of these transfers occurring during the fiscal year that ended on 31 March 2016. In addition, in February 2016, the Government implemented a new pay system, Phoenix, across 34 departments (120,000 employees), and in April 2016 for the remaining 67 departments (170,000 employees).

As part of our annual audit of the consolidated financial statements, we test pay and benefits, which together represent one of the Government's largest expenses. This year, we found payment errors, however, because the transformation initiative was only partially implemented before the end of the fiscal year, the impact of these errors was not material to the consolidated financial statements. We have concluded that the payroll expense and related accruals are presented fairly in the Government's 2015–2016 consolidated financial statements. The errors we noted were overpayments and underpayments of portions of employee pay attributable to input errors and to delays in processing changes in employees' work arrangements, such as eligibility for a bilingualism bonus and changes in shift-work hours. We also noted instances in which several entries were required to adjust employee pay.

A project of this size and complexity usually comes with challenges and during our audit we found several areas of concern related to the transformation of pay administration. We found that between March 2015 and March 2016, the number of outstanding pay action requests increased proportionally more than the increase in the number of employees' pay accounts processed at the pay centre. Moreover, we noted that this backlog grew significantly between March and July 2016, after the transition to Phoenix. The Government is projecting that the current backlog will not be fully resolved until more than half way through the 2016–2017 fiscal year. In our view, the extent of errors and delays in processing corrections to employee pay and other pay actions that we identified in our audit is not acceptable given the direct effect on employees. We have not yet assessed the implications on next year's financial statement audit. However, we encourage the Government to continue its efforts and quickly address the identified weaknesses in pay administration, in order to pay employees the right amount, on time.

In addition to our annual audit of the Government's 2016–2017 consolidated financial statements, and the follow up on these Observations, we have also decided to undertake a performance audit of the Transformation of Pay Administration Initiative. We are currently planning the scope of that audit.

Management estimates—selecting discount rates

The establishment of reasonable estimates has a direct effect on the quality of the financial information used for decision making. The consolidated financial statements are a source of this information for Parliament and Canadians. Financial statements are useful to assess the ability of the Government to meet financial obligations and its capacity to maintain current services and to finance new programs. Note 1—Summary of significant accounting policies in the consolidated financial statements provides more information about the sources of measurement uncertainty.

For 2016, we determined that the Government's significant estimates and underlying assumptions are within the reasonable range permitted by the Public Sector Accounting Standards. The discount rate selected by management is an important assumption for many estimates. Discount rates are used in establishing the values of several liabilities, especially long-term ones and can have a significant impact on the valuation of these liabilities. In our view, certain rates determined by the Government to value significant long-term liabilities are at the higher end of the acceptable range, when compared with market trends. Using a higher discount rate yields a lower estimate for long-term liabilities.

Example—Sensitivity to the discount rate of accrued benefit obligations of unfunded pensions

The estimated amount of accrued benefit obligations is very sensitive to changes in the discount rate. For example, in 2016, as indicated in Note 8—Public sector pensions and other employee and veteran future benefits in the consolidated financial statements, the discount rate used in measuring the accrued benefit obligations of the unfunded pension benefits sponsored by the Government was set at 3.9 per cent. A decrease of 1 per cent in the discount rate would have increased the obligations by $9,600 million.

We support the Government's ongoing project to update the methodology used to determine discount rates. Within the requirements of the Public Sector Accounting Standards, we recommend that the Government consider industry practices in both the public and private sectors, emerging changes in standards and trends in the Canadian financial market. There should also be consistency, when relevant, in the methods and data used to develop other assumptions that the Government makes in the preparation of the consolidated financial statements. As the Government finalizes this project, it should validate its estimates by comparing with actual experience, and adjust as needed.

National Defence—Inventory

National Defence's inventory is important to the consolidated financial statements because it is valued at $6.2 billion and represents 86 per cent of the Government's total inventory.

We have been reporting on National Defence's challenges in properly recording and valuing inventory for 13 years, since the Government of Canada first recorded inventory in its consolidated financial statements. Last year, we noted the Department's progress with inventory quantity issues and recommended that the Department place more attention on pricing and obsolescence issues. Again this year, we found that National Defence's inventories were overstated by hundreds of millions of dollars.

National Defence's inventory has characteristics that make it harder to resolve its accounting problems. There are hundreds of thousands of types of inventory items. National Defence has undertaken various manual exercises to try to improve its accounting, but the sheer volume means that the progress of these manual activities is slow in relation to the volume of inventory that the Department must review.

Issues identified during our audits over the years are caused by a combination of quantity errors, failure to write-off obsolete items, pricing errors, and misclassification between inventory and asset-pooled items.

Quantity. The Department has expanded its counts of inventory over recent years. Inventory is counted through a cyclical, risk-based approach. We continue to find some quantity errors, but the magnitude, in recent years, is not as significant as previously found.

Obsolescence. One of the causes of obsolescence errors is situations in which the Department has removed a fleet or type of equipment from service but has not removed the related inventory from its records. A best practice would be to review all inventory items annually and remove those that are no longer needed or used. However inventory volumes make such reviews lengthy. We found obsolescence errors again this year.

Pricing. Inventory includes parts for the Department's various fleets and equipment that can be decades old. Given the age of many of these items, records are not always available to support values. Moreover, given the volume of purchases each year, input errors can occur. We continue to find pricing errors in inventory.

Classification. Asset-Pooled Items are major spare parts used to repair or maintain fleets and equipment. It can be difficult to differentiate between Asset-Pooled Items and inventory. Proper identification matters because Asset-Pooled Items and inventory have different accounting treatments. Again this year, we found classification errors in this area which contributed to the overstatement of the Department's inventory.

This year, National Defence developed and implemented a new and automated methodology to analyze inventory pricing and obsolescence. As a result, the Department recorded an allowance, which reduced the recorded value of inventory by $131 million. This approach is innovative but, in our view, the issues are still not fully resolved. National Defence should continue to refine its analysis and methodology to further improve the allowance calculation.

National Defence is making some progress. Still, the Department must continue its efforts to ensure that inventory is properly recorded in the consolidated financial statements. In June 2016, the House of Commons' Standing Committee on Public Accounts recommended that by 30 September 2016 National Defence report back to the Committee with an action plan to record and value its inventory properly.

Liability for contaminated sites

As at 31 March 2016, the Government has a total financial liability of about $6.3 billion for the estimated costs to remediate contaminated sites. Unless appropriately mitigated, contaminated sites can pose a hazard to human health and the environment, and their remediation could entail significant financial costs for the federal government.

Last year, we recommended that the Government develop better processes to refine the accounting estimates and record the liabilities associated with contaminated sites at earlier stages of investigation. To address our recommendation, the Government developed a model to estimate liabilities for sites that are at an earlier stage of investigation. Using historical data for similar sites, the model is designed to predict how many sites that have no liability within a particular class will progress to remediation and what the projected remediation and monitoring costs could be for that class. We found that the model used the data appropriately and performed its calculations accurately. We are satisfied that the Government has addressed last year's recommendation.

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