Annex 6

The Government's Response to the Auditor General's Observations on the 1997 Financial Statements

The 1997 Public Accounts of Canada contains the Auditor General's opinion of the government's financial statements for 1996-97. As well, the Auditor General raises a number of accounting issues in his observations on the government's financial statements. These are:

▪	accounting for employee pensions;

▪	accounting for environmental liabilities and contingencies;

▪	full accrual accounting for capital assets;

▪	enterprise Crown corporations;

▪	accrual accounting for tax revenues; and

▪	Statement of Transactions of the Debt Servicing and Reduction Account (DSRA).

The government's response to the Auditor General's opinion and observations on the 1997 financial statements are discussed in this annex.

Audited opinion of the Government's Financial Statements

After five consecutive years of expressing a clean opinion on the government's financial statements, the Auditor General expressed a qualified opinion on the 1997 financial statements. According to the Auditor General, the 1996-97 deficit is overstated by $800 million, relating to the recording of a transaction to the Canada Foundation for Innovation. The Auditor General is of the view that this liability did not exist at March 31, 1997 and that the $800 million expenditure should be recorded in 1997-98 and not in 1996-97.

The government strongly disagrees with this assessment. The government made a commitment in the 1997 budget to provide funding of $800 million to the Canada Foundation for Innovation. Legislation establishing the Foundation and authorizing the payment was passed by Parliament before the financial statements for 1996-97 were closed. The government believes that these actions created a liability which should appropriately be recorded in 1996-97.

The government believes that transparency and accountability to Parliament and Canadians are best served by recording liabilities in the year in which they are incurred. This is good public policy. The government has been consistent in this practice and will continue to be so in the future. As such, non--recurring liabilities will be recognized in the year in which the decision to incur the expenditures is made, provided the enabling legislation or authorization for payment receives parliamentary approval before the financial statements for that year are closed.

Accounting for employee pensions

The Auditor General notes that, "although the Government accounts for employee pensions in accordance with its stated accounting policies and related legislation", he is concerned about the growing difference between actuarial obligation for employee pensions and the liability shown in the Statement of Assets and Liabilities. He is recommending that the government fully comply with generally accepted accounting practices enunciated by the Public Sector Accounting and Auditing Board (PSAAB). In his observations, he indicated that he intends "to consider the impact of this matter in formulating my opinion on the Government's financial statements in future years, should the accounting for employee pensions remain unchanged".

The PSAAB recommends that, for government accounting purposes, pension interest should be calculated on the actuarial obligation rather than on the pension account balances. Over time, this method of accounting would reduce the difference between the actuarial obligation and the liability reported in the Statement of Assets and Liabilities.

The government is responsible for the pension benefit plans covering almost all of its permanent employees (including the public service, Canadian Forces, Royal Canadian Mounted Police and certain Crown corporations), as well as federally appointed judges and Members of Parliament. Under current legislation, it must generally fully fund benefits as they accrue and is responsible for any unfunded liability. The various pension accounts in the government's financial statements fully reflect the financing requirements set out in the applicable legislation.

The government is concerned with the growing difference between the actuarial obligation and the liability reported in the Statement of Assets and Liabilities. As a result, it will accept the recommendation of the Auditor General and change its accounting for employee pensions. In addition, the President of the Treasury Board will be undertaking consultations with plan members regarding fundamental reform of the management and financing of public service pensions.

Accounting for environmental liabilities and contingencies

The Auditor General recommends that the government:

▪	develop policies to define clearly what constitutes environmental obligations and the liabilities (both potential and actual) that relate to these obligations;

▪	prepare a complete inventory of areas of federal responsibility where there are obligations to make significant future expenditures to clean up environmental damage;

▪	determine to what extent the government, the provinces, the private sector or some combination of the three, bear responsibility for the cost of environmental clean-up in these areas; and

▪	develop a methodology to determine when potential environmental liabilities become actual liabilities.

The Auditor General notes that progress is being made in these areas. The Treasury Board Secretariat is working on developing appropriate accounting policies and obtaining cost estimates from applicable departments. Environmental liabilities will be included in the financial statements once the implications of such an accounting change have been fully assessed.

Capitalization of physical assets and

accrual accounting for tax revenues

The government records most of the expenditures for operations and non-tax revenues on an accrual basis of accounting. In contrast, tax revenues, some international financial obligations and capital assets are recorded on a cash basis of accounting.

The government has indicated its intention to move to full accrual accounting in previous budgets. The Auditor General applauds this move but cautions that such changes represent significant challenges.

The government recognizes the challenges that full accrual accounting will present. To that end, the government will continue to work closely with the Office of the Auditor General to implement full accrual accounting in an appropriate manner.

Enterprise Crown corporations

The Auditor General encourages the government to adopt the PSAAB's recommendations to use the equity method to account for enterprise Crown corporations in its financial statements. This is in contrast with the practice that the government has been following since 1989-90 of recording such investments at cost and making appropriate adjustments for net profits and losses through allowances. These two methods give similar results and, therefore, the change in accounting will not materially affect the annual budgetary balance.

However, there would be a positive impact on the Statement of Assets and Liabilities reflecting the financial position of these Crown corporations prior to 1989-90. The government will change its accounting when other accounting changes are implemented.

Debt Servicing and Reduction Account

In his observations on the 1996-97 public accounts, the Auditor General recommends that the government re-examine the need and usefulness of the Debt Servicing and Reduction Account (DSRA).

The DSRA was established by statute in June 1991. Under that legislation, all goods and services tax (GST) revenues, net of applicable input tax credits, rebates and the low-income credit, along with the net proceeds from the sale of Crown corporations and gifts to the Crown explicitly identified for debt reduction, must be deposited into this Account. The funds in this Account are earmarked to pay interest on the public debt and, ultimately, to reduce the debt. In 1996-97, net revenues, primarily from the GST, amounted to $18.2 billion. In contrast, public debt expenditures chargeable to the Account were nearly twice this amount. It will be some time before these revenues match the public debt expenditures chargeable to the Account.

The Auditor General notes that, "given the fundamental concept of the Consolidated Revenue Fund (CRF) underlying the government's accounting system, the Account is an internal mechanism that may not be necessary". All revenues received by the government must be deposited in the CRF and any disbursements from the CRF must be authorized by Parliament. Therefore, the specific revenues of the DSRA must be deposited in the CRF and the public debt expenditures chargeable to the Account must be appropriated from the CRF by Parliament. As all of the information relating to the DSRA is already reported in other parts of the government's financial statements, there is no requirement for a separate financial statement.

The government will ask the House of Commons Standing Committee on Finance to review this recommendation.