Observations of the Auditor General of Canada

Public Accounts of Canada 2017 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 2017

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 19th 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.

Pay Administration

Together, pay and benefits represent one of the Government of Canada's largest expenses. To transform the way it administers pay, the Government consolidated many of its pay services in Miramichi, New Brunswick, and implemented Phoenix, a new pay system, for approximately 290,000 Public Service employees. The new system was fully implemented by the end of April 2016 and processed approximately $22 billion in pay expenses in 2016–2017.

The pay transformation initiative changed many of the Government's pay processes. Consequently, we reviewed the design of the internal controls in the new system to determine if we would be able to rely on the system to process and record pay accurately to support our audit opinion. Due to the deficiencies we identified, we could not rely on the internal controls. In some areas, we found weaknesses, and in other areas, we could not get sufficient information to understand and test how the controls worked. For example, an information technology system must have strong controls over who is granted access, who can change data and what changes they can make. These controls are particularly important in situations where there is a large number of people accessing the system, as is the case for Phoenix. Also, key tasks need to be done by different people; otherwise, improper pay transactions could be created, or people could have unauthorized access to the private information of other employees. The Government was not able to adequately explain to us what tasks certain users were able to do in Phoenix.

Because we determined we could not rely on the controls in the new system, we needed to change the way we conducted our audit of pay expenses. As a result, we examined a much larger sample of transactions than in prior years. For 2016–2017, we tested all payments made to a sample of employees for the entire fiscal year. We looked at about 18,000 pay transactions across 48 of the 101 departments that used Phoenix, and we found overpayments and underpayments to employees. We found that 62 per cent of the employees in our sample were paid incorrectly at least once during the year. On average, the employees who were paid incorrectly experienced errors in 3 different elements of their pay, such as, overtime and temporary assignments at a higher pay level. Some of these errors repeated over multiple pay periods. As at 31 March 2017, 56 per cent of the employees in our sample required corrections to their pay.

Mistakes in entering pay information, delays in processing changes, and multiple adjusting entries that, in some cases, created additional errors, all contributed to the overpayments and underpayments in employee pay. We found these errors occurred throughout the year and in every step of the pay process.

The change in our audit approach resulted in a significant increase in audit effort. We spent approximately 10,000 hours more to audit pay expenses than in past years. The audit approach we used was labour intensive and costly, and will be required in future audits until the pay control deficiencies are fixed and we can rely on controls.

We were able to conclude that pay expenses were presented fairly in the consolidated financial statements even though we noted a significant number of errors in the pay of individual employees. We came to this conclusion because the overpayments and underpayments made to employees partially offset each other and because the Government recorded year-end accounting adjustments to improve the accuracy of its pay expenses. These adjustments changed only the reported pay expenses in the consolidated financial statements; they did not correct the underlying problems nor did they correct the pay errors that continue to affect individual employees.

The extent of the errors we found and the time it takes to make corrections are unacceptable, given the direct impact on employees. Resolving pay issues is a shared responsibility across the Government. While Public Services and Procurement Canada (PSPC) is responsible for processing payroll transactions, departments also play an important role in providing timely and accurate information to PSPC about changes to employee pay.

In addition to our annual audit of the Government of Canada's consolidated financial statements, we have two performance audits of the Government's initiative to transform pay administration under way. We plan to present the first of these audits for tabling in the House of Commons in November 2017.

Management estimates—selecting discount rates

As we reported last year, the Government of Canada has an ongoing project to update the way it determines the discount rates used in its estimates of long-term liabilities. The reasonableness of these estimates has a direct impact on the financial information included in the consolidated financial statements and used by Parliament and Canadians for decision making. While the Government has analysed options, it has not yet concluded on how it will change its method to determine discount rates.

Discount rates are used in estimating the value, in today's dollars, of several large long-term liabilities and can have a significant impact on these estimates. For example, a decrease of 1 per cent in the discount rate used in measuring the accrued benefit obligation for unfunded pension benefits would increase this liability by $7.7 billion. It is important that the Government's process for determining discount rates be sound and supported by observable and relevant data. While we have concluded that the assumptions underlying the Government's significant estimates are within a reasonable range, historically, certain discount rates have been at the high end of the acceptable range when compared with market trends. Using a higher discount rate yields a lower estimate for long-term liabilities.

Given the significance of these estimates to the consolidated financial statements, we would expect the Government to complete its project and change the way it determines discount rates in fiscal year 2017–2018. As the Government finalizes this project, we recommend that, within the requirements of the Canadian Public Sector Accounting Standards, it consider industry practices in both the public and private sectors, emerging changes in standards, and trends in the Canadian financial market. Going forward, the Government should periodically validate its estimates by comparing with actual experience and adjust the methods as needed.

National Defence—Inventory and asset pooled items

Inventory

National Defence inventory is an important item in the consolidated financial statements of the Government of Canada. Valued at approximately $5.8 billion as at 31 March 2017, it represents 85 per cent of the Government's total inventory.

The Department has two groups of inventory: ammunition and non-ammunition (also referred to as consumables). Its ammunition is valued at over $3.3 billion, and its consumables, which are generally high-volume, low-value items such as clothing, fuel, and medical supplies, are worth almost $2.5 billion.

The Government reports inventory as an asset. An expense is recorded only when an item is removed from inventory, either because the item will be used or is no longer usable.

Asset-pooled items

In addition to inventory, National Defence has items such as major spare parts to repair or maintain fleets, equipment, and machinery, which it reports as asset-pooled items (APIs). In contrast to inventory, APIs support capital assets and are treated similarly. Amortization expense is recorded over the same period as the capital assets they support.

As at 31 March 2017, the net book value of the Department's API assets was approximately $3.6 billion.

It can be difficult to differentiate between inventory and API. Proper identification matters because of the different accounting treatments.

Action plan to improve inventory management

We first reported on National Defence's challenges to properly record and value inventory 14 years ago, and the problems have persisted. However, in the last few years, we have seen improvement.

In the 2016–2017 fiscal year, the Department tabled a long-term action plan to improve its inventory management practices as requested by the House of Commons Standing Committee on Public Accounts. National Defence's inventory has characteristics, such as the number of items and locations involved in the Department's inventory, which make it harder to improve these practices. As a result, this is a multi-year plan that extends until 2026.

The Department made accounting adjustments in the 2016–2017 fiscal year to improve the accuracy of the values in its inventory in the consolidated financial statements. These year-end adjustments correct the values reported in the consolidated financial statements, but they do not address the underlying inventory management issues. In fact, they are an indication that to address the remaining issues, National Defence must maintain the new practices implemented and it must continue to improve other inventory management processes detailed in its action plan.

Audit results

We select a sample of National Defence's inventory items each year and examine them to determine whether the Department:

A summary of our results for each of these tests follows:

Quantity. Over the years, National Defence has increased the number of inventory counts. These counts are on a cyclical basis and emphasize items that are high-risk because of their nature, value, or desirability. This year we expanded the locations for our test counts and we found that the Department has a robust approach to counting its inventory stored in locations we typically visit. However, we found a significant number of quantity errors in locations not regularly selected for testing. The number of errors we identified indicate that National Defence does not yet have a sound approach to count items in all locations.

Pricing and obsolescence—Ammunition. In the action plan that National Defence presented to the Standing Committee on Public Accounts, one of the short-term projects was to review and adjust the way the Department prices ammunition. We found that the Department did a comprehensive analysis of its ammunition inventory codes and corrected errors it found. Because of this extensive cleanup, we did not identify any ammunition pricing errors in our testing.

However, we did identify that National Defence still had obsolete ammunition items. We estimated that more than $260 million worth of ammunition in inventory should have been written down. The Department needs to continue to improve how it identifies obsolete ammunition items in its inventory.

Pricing and obsolescence—Consumables. We found pricing errors for consumables, which we estimated to be an overstatement of inventory worth approximately $140 million. The Department recorded an allowance of $154 million which includes an amount that partially offsets these errors and an amount to address obsolescence concerns in consumables.

Classification. In the current year, National Defence analyzed its inventory and expense items, which resulted in some reclassification of inventory items to API. However, we still estimated that the Department recorded almost $145 million worth of items as inventory when it should have recorded them as API.

Overall

We found that National Defence appears to be on track to complete the action plan it presented to the Standing Committee on Public Accounts. The Department has made significant progress on better knowing the quantity of its inventory in its major depots, but it needs to improve the way it counts inventory at other locations. Considerable effort is still required as the Department also has to improve its pricing of inventory, its recognition of obsolete inventory, and its classification of items as either inventory or API.

Public Accounts of Canada 2017 Volume I—Bottom of the page Navigation

Date modified: