Budget 2001 - Budget Plan
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Annex 6
The Government's Response to the Auditor General's Observations on the 2001 Financial Statements

In the 2001 Public Accounts of Canada, the Auditor General expressed a clean opinion on the Government’s financial statements for 2000-01.

The Auditor General raised a number of matters for Parliament’s attention. These are:

• compliance with the Employment Insurance Act;
• transfers to foundations;
• the Canada Foundation for Sustainable Development Technology;
• the Financial Information Strategy – the move to full accrual accounting;
• departmental financial statements;
• offsetting Canada Child Tax Benefit disbursements against revenues ("netting");
• the Debt Servicing and Reduction Account;
• simplified and useful financial statements – the Annual Financial Report of the Government of Canada; and
• dictating accounting treatment in legislation.

The Government’s responses to the Auditor General’s observations on the 2001 financial statements are discussed in detail in this annex.

Compliance With the Employment Insurance Act

According to the Auditor General, the Canada Employment Insurance Commission (the Commission), which is responsible for setting employment insurance premium rates, did not provide an adequate justification for the size and rate of growth of the balance in the Employment Insurance Account in setting premium rates for 2001.

The Employment Insurance Act requires that the Commission set premium rates at levels that will cover program costs while keeping rates relatively stable over the business cycle – at the cyclical break-even rate. However, the stability requirement is inconsistent with a growing cumulative balance in the Account. Furthermore, as the Chief Actuary of Human Resources Development Canada notes, given the difficulties of making accurate forecasts at any time, as a practical matter, adjustments to the premium rates May be needed.

The December 1999 Report of the Standing Committee on Finance noted that the current rate-setting process "involves not only a ‘look forward’ process in assessing the level of revenues sufficient to cover program costs over a business cycle, but also a ‘look back’ process by taking into consideration the level of any past excesses or shortfalls of revenues relative to program costs." As employment insurance premium revenues and program costs are consolidated in the Government’s budgetary balance, the "look back" provision, the Report concluded, will cause serious disruptions to the overall management of the federal government’s budget. The Report recommended, therefore, that employment insurance rates be set on the basis of levels of revenues needed to cover program costs over the business cycle looking forward, and not take into account the level of the cumulative surplus or deficit.

Recognizing these difficulties, the Government announced that it would undertake a review of the premium rate setting process. In the interim Bill C-2 gave power to the Governor in Council to set the rates for 2002 and 2003.

Transfers to Foundations

The Auditor General is concerned with the way the Government accounts for transfers to foundations because most of the funding provided has yet to be spent on the ultimate purposes intended. She urges the Government to change its accounting, recognizing expenditures only when the foundation transfers the funds to the ultimate recipient. In addition, she is critical of the overall accountability and governance arrangements of foundations.

The Government recognizes that the booking of liabilities to these foundations is an area where existing accounting standards do not offer explicit guidance, and that professional judgment must be brought to bear. Recognizing this, the Government consulted two major accounting firms, both of which endorsed the Government’s approach. Furthermore, the previous Auditor General reported that he undertook research on the accounting treatment of such "special purpose entities" to determine if they should be consolidated in the Government’s financial statements as part of the Government’s overall reporting entity. From his research, he concludes that the application of current PSAB (Canadian Institute of Chartered Accountants’ Public Sector Accounting Board) accounting recommendations requires considerable judgment to determine the appropriate accounting treatment. A PSAB task force is currently reviewing this issue to determine if additional guidance is required.

The Government has consistently argued that its decisions to provide funding to arm’s-length organizations, such as the Canada Foundation for Innovation and the Canada Millennium Scholarship Foundation, established liabilities that should be recorded in the year that the decisions to provide funding were made. Decisions on the projects selected are made by the directors of the foundations under broad agreements signed with the Government. The Government continues to believe that, in applying PSAB recommendations, these entities should not be considered part of government and, therefore, not consolidated within its financial statements.

This current accounting treatment enhances transparency and accountability to Parliament and Canadians. As such, in accordance with its stated accounting policy, non-recurring liabilities will be recognized in the year the decision to incur them is made, provided the enabling legislation or authorization for payment receives parliamentary approval before the financial statements for that year are finalized.

The Canada Foundation for Sustainable Development Technology

The Auditor General expressed concerns over the process that the Government used to create and fund the Canada Foundation for Sustainable Development Technology as well as the use of the Government’s contingencies vote to provide temporary funding to the foundation.

The sustainable technology initiative was first announced in the February 2000 budget. To this end the Government, upon the approval of the Treasury Board, entered into a funding agreement with a not-for-profit private sector corporation. While this agreement was signed before the passage of Bill C-4, which enabled Parliament to directly determine the mandate, governance and accountability arrangements, the legislated authority to enter into this agreement already existed under the Energy Efficiency Act and the Department of the Environment Act.

As there were no alternative funding authorities immediately available, access to Treasury Board vote 5 enabled the Government to honour its liability to the corporation. The use of this vote for new grants and increases to existing grants has been an accepted practice for decades and is fully reported to Parliament in the Supplementary Estimates.

As a result, the Government believes that the creation and funding of this foundation respected all parliamentary authorities and practices.

The Financial Information Strategy – The Move to Full Accrual Accounting

Currently the Government records most of its expenditures and non-tax revenues on an accrual basis of accounting. In contrast, tax revenues and capital assets are recorded on a cash basis of accounting. In previous budgets the Government has indicated its intention to move to full accrual accounting, and the Auditor General has supported this move.

The Auditor General notes that while the Government has made progress toward its objective, all departments and agencies have a lot of work to do to implement full accrual accounting.

The specific areas where the Auditor General comments on the progress being made include tangible capital assets, environmental liabilities, accrual of tax revenues, and Aboriginal claims.

The Government recognizes the implementation of the Financial Information Strategy (FIS) and full accrual accounting as a priority and recently provided additional support to departments in this area. It will continue to work closely with the Office of the Auditor General to ensure the successful implementation of FIS and full accrual accounting.

However, it is government convention that the audited financial statements report on the same basis of accounting as that used in the budget. Given the timing of the 2001 budget and the fact that important components of the information required to implement full accrual accounting have not yet been verified and audited, it is not possible to move to a full accrual basis of accounting at this time. Therefore, the Government has decided to delay the implementation of full accrual accounting for at least one year.

Departmental Financial Statements

As part of FIS, departments will be required to produce annual financial statements. The Auditor General notes that there are several issues that still need to be resolved before departments will be fully in a position to produce appropriate detailed financial statements.

The Treasury Board Secretariat will continue to work closely with the Office of the Auditor General and departments to ensure that meaningful departmental financial statements are produced.

Offsetting Canada Child Tax Benefit Disbursements Against Revenues ("Netting")

The Auditor General points out that the Government currently reports revenues and expenditures on a net basis. For budgetary purposes, there are a number of tax expenditures that are netted against revenues and a number of revenue items that are netted against spending. Netted against revenues are the Canada Child Tax Benefit (CCTB), the quarterly goods and services tax credit (GSTC) and repayments of Old Age Security benefits. Netted against spending are revenues of consolidated Crown corporations and revenues from levies charged by departments for specific services, such as the costs of policing services in provinces. This netting has no impact on the overall budgetary balance.

The Auditor General has recommended that the financial statements and the budget be prepared only on a gross basis. Of particular concern to the Auditor General is the CCTB, which is currently netted against personal income tax revenues. The Auditor General argues that this represents incomplete financial disclosure.

However, it is important to note that the Government already publishes this information in both the Annual Financial Report of the Government of Canada and the Public Accounts.

The "net" presentation is the appropriate approach for the budget because it is consistent with the way Parliament appropriates funds. Furthermore, programs like the CCTB and the quarterly GSTCare integral parts of the tax system – these programs are administered through the tax system. They are thus netted from tax revenues for budgetary purposes.

The Debt Servicing and Reduction Account

The Debt Servicing and Reduction Account (DSRA) was established by statute in June 1992. Under that legislation all 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.

The Auditor General questions the need for this Account, given the fundamental concept of the Consolidated Revenue Fund (CRF). All revenues received by the Government must be deposited in the CRF and any disbursements from it 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 it by Parliament. Since all of the information relating to the DSRA is already reported in other parts of the Government’s financial statements, there appears to be limited usefulness in having a separate financial statement.

The House of Commons Standing Committee on Finance’s recommendations for the 2000 budget included elimination of the DSRA.

Although all of the information relating to the DSRA is already reported in other parts of the Government’s financial statements, as noted by the Auditor General, the Government believes that, at this time, the DSRA provides useful information to Canadians on the flow of GST revenues, gifts to the Crown and the net gains associated with the disposals of investments in Crown corporations. This information is enhanced through the presentation of a separate audited statement. As a result, the Government does not propose that any changes be made at this time.

Simplified and Useful Financial Statements – the Annual Financial Report of the Government of Canada

The Auditor General notes that the Annual Financial Report of the Government of Canada (AFR) should be revised so that it is more useful and understandable to a wider variety of users.

Upon the recommendations of the previous Auditor General and working closely with the Auditor General’s staff, substantial improvements have been made to the AFR. In addition, a user survey was conducted following the release of the 1998-99 AFR.

Results of that survey, which were published in the 2000 budget, were generally very positive. The majority of respondents were "very satisfied" or "somewhat satisfied" with organization and content and felt that the AFR contained a sufficient amount of information.

As with all of its other publications, the Government will continue to ensure that the AFR is useful and understandable to a broad range of users.

Dictating Accounting Treatment in Legislation

The Auditor General has expressed concern that the legislative wording for the Canada Health and Social Transfer supplements appeared to be dictating the accounting treatment to be followed in the financial statements. As such, the Auditor General recommends that the applicable legislation should not stipulate the fiscal year to which such one-time payments apply.

The Government follows accounting policies based upon generally accepted accounting principles in the preparation of its financial statements. It therefore recognizes liabilities when they are incurred. Legislation does not dictate accounting treatment in the Government’s financial statements.

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