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Annex 5
The Government's Response to the Auditor General's Observations on the 2004 Financial Statements

The Auditor General of Canada expressed a "clean" opinion on the Government’s financial statements for 2003–04. This means that the financial statements present fairly, in all material aspects, the financial position of the Government of Canada. This marks the 6th consecutive year—and the 11th time in the last 13 years—that the Auditor General has given a clean opinion on the Government’s financial statements.

The Auditor General also raised two issues for Parliament’s attention as well as a number of ongoing accounting challenges, and commented on the status of items reported in previous years in her "Observations" to the financial statements. This annex reviews these Observations.

Foundations

Since 1997 the federal government has provided over $9 billion to a number of foundations, such as the Canada Foundation for Innovation, the Canada Millennium Scholarship Foundation, Canada Health Infoway Inc., Genome Canada and the Canada Foundation for Sustainable Development Technology. These foundations are not-for-profit organizations governed by independent arm’s-length boards of directors made up of experienced and knowledgeable individuals with expertise in specific areas of research, development and learning. Their arm’s-length nature, financial stability and focused expertise allow them to address specific challenges in a highly effective, non-partisan manner. The Government views these organizations as alternative means to better serve the long-term interests of Canadians and address specific challenges and strategic national needs.

The Auditor General questions the way that the Government accounts for its transfers to these foundations. She believes that the Government should record the expenses only when the foundation distributes funds to the ultimate intended recipient rather than recording the liability as an upfront expense to the foundation. However, the Auditor General notes that she "cannot state unequivocally that the Government has not complied with objective accounting standards established by the Canadian Institute of Chartered Accountants’ Public Sector Accounting Board (PSAB)."^[1] PSAB has recently issued a new standard on the reporting entity for government, which is to be implemented by the 2005–06 fiscal year, and which primarily relates to the control the Government has over an organization. If it is determined that the Government exercises control over the organization, that organization should be included in the financial results of the Government. The Government is in the process of examining its relationship to each foundation vis-à-vis the new standard and discussing the implications with the Office of the Auditor General. However, for these organizations to provide independent, non-partisan decision making, it is important that the Government not control, or be perceived to control, these organizations. If it was determined that the Government actually controlled these organizations from an accounting perspective, it would have to seriously review this vehicle as an alternative to delivering public policy.

The Auditor General also notes that:

"the accountability and governance structures for the foundations may be influenced by the desire to ensure that transfers to foundations can be treated as expenses immediately, rather than when these funds are used by the foundations for their ultimate purposes. In my view, decisions on funding and accountability should be based on the need for sound management of public funds; they should not be based on the goal of achieving a desired accounting result."^[2]

Since 1994 the Government has followed a prudent approach to budget planning. Economic and fiscal forecasting, however, is more of an art than a science. Recognizing this, the Government announces new spending initiatives and tax relief measures to address many competing priorities only when it is certain it has the funds to sustain these initiatives on an ongoing basis, without going back into deficit. It will not finance such initiatives through new borrowings. As a result, some initiatives are announced during the course of the fiscal year, when there is more certainty regarding the outcome. In fact, since 1997, when it recorded its first budgetary surplus in 27 years, the Government has transferred nearly $15 billion to the provinces and territories, in most cases using a mechanism comparable to foundations. The Auditor General has not expressed any concerns over these transfers.

For more information, see the backgrounder Accountability of Foundations, which is available on the Department of Finance Web site at www.fin.gc.ca.

Employment Insurance Account Surplus

The Auditor General states that, in her opinion, the Government has not been observing the intent of the Employment Insurance Act when setting the employment insurance contribution rate. She urged the Government to resolve this long-standing issue.

The Government recognizes that there are inconsistencies in the rate-setting mechanism set out in the Employment Insurance Act. As a result, it announced in the 2003 budget that it would undertake a review of the premium rate-setting process, based on the following principles:

• Premium rates should be set transparently.

• Premium rates should be set on the basis of independent expert advice.

• Expected premium revenues should correspond to expected program costs.

• Premium rate setting should mitigate the impact on the business cycle.

• Premium rates should be relatively stable over time.

The Government proposes to resolve this outstanding issue. The proposal is provided in detail in Chapter 4. A summary of these proposals is provided below.

• Annual calculations of the employment insurance (EI) break-even rate would be undertaken by the EI Chief Actuary in September, based on the average of the private sector economic forecasts and the benefit structure in place at that time. The break-even rate would be on a forward-looking basis, without reference to previous experience.

• The calculations would be presented to the EI Commissioners so that they can consult with their respective constituents.

• The EI legislation will be amended to give the EI Commission the authority to set the premium rate. The premium rate set by the Commission could not change by more than 15 cents from the previous year. The Government of Canada would reserve the right to override the rate set by the Commission, if it were in the public interest to do so, through an Ordering Council no later than November 30th.

• In order to provide premium rate stability through the transition to the new rate-setting mechanism, the Government commits to ensuing that the employee rate for the next two years will not exceed $1.95. As a measure of prudence in case the legislation is not passed in time, the Government proposes to give the Governor-in-Council the authority to set the rate for 2006 in the fall of 2005.

Ongoing Accounting Challenges

This section deals with accounting challenges raised by the Auditor General related to the Government’s financial statements. These challenges relate to the Department of National Defence’s recording and tracking of the cost of its inventory, and the former Canada Customs and Revenue Agency’s recording of tax revenue and receivables. The Auditor General notes that neither issue is significant enough to undermine the fair presentation of the financial statements.

With the adoption of full accrual accounting, inventories are now recognized as part of the Government’s non-financial assets. Most of these inventories are at National Defence. The Auditor General noted improvements made by National Defence but also outlined a number of concerns relating to early identification of errors in the estimates and the limited progress in determining obsolete inventory. The Department has initiated an action plan to address the issues raised by the Auditor General.

The Auditor General also noted limitations to the former Canada Customs and Revenue Agency’s financial reporting system for tax revenues and receivables. The Department is working closely with officials from the Treasury Board Secretariat, Department of Finance and Office of the Auditor General to address these concerns.

Status of Items Reported in Previous Reports

The Auditor General also commented on the status of a number of issues that she reported in her Observations on previous years’ financial statements. These are discussed below.

i) Timely Reporting

The Auditor General has indicated that the usefulness of the Government’s summary financial statements is diminished when they cannot be made public until six months after year-end. She notes the challenges the Government faces in the preparation of more timely statements.

The Government agrees with the Auditor General that it should consider how to complete and table its summary financial statements more expeditiously. Fiscal year 2002–03 was the first year under full accrual accounting and, as the Auditor General notes, the accrual of tax revenue does take a significant amount of time after the year-end to calculate. The accuracy of reported tax revenue is—and must be—a goal of the Government’s financial reporting. But as the Government gains experience in the next few years with full accrual accounting, more accurate estimates of accrued tax revenues should be feasible on a more timely basis. The Government will work closely with the Auditor General to accelerate the release of its financial results.

ii) Clarity in Terminology

The Auditor General feels that the use of the term "federal debt" in government publications in place of "accumulated deficit" could be misinterpreted by Canadians.

When full accrual accounting was first announced in the 2003 budget, the Government took great pains to explain the two terms. In almost every instance that the term "federal debt" was used, it was explained as being equivalent to the "accumulated deficit." In surveys of Canadians’ understanding of the Government’s finances, many still feel the federal government is in deficit, although it has reported seven consecutive annual surpluses. Terms like "accumulated deficit" may present the impression that the federal government is still in deficit. Therefore, the Government used the term "federal debt" to describe its accumulated financial position to avoid that incorrect interpretation.

iii) Departmental Financial Statements

The Government committed to having departmental financial statements audited within five years. While much has been accomplished, the Auditor General is still concerned about the amount of work that still needs to be done.

Plans are being developed, in consultation with the Office of the Auditor General, so that progressively over the next five years, departmental financial statements can be audited. All departments and agencies currently prepare accrual-based financial statements and a number of these are already being audited and tabled in Parliament.

iv) Netting

With the audited financial statements for 2002–03, the Government resolved a long-standing dispute with the Auditor General by presenting these statements on a gross basis of accounting only. In previous years the results were presented on both a gross and net basis. The Auditor General felt that this dual presentation was confusing to users.

However, the budget and the monthly Fiscal Monitor are presented on a net basis. This is the basis on which Parliament approves funding to departments. As a result, the Canada Child Tax Benefit is netted against personal income tax revenues, departmental revenues levied for specific services are netted against expenses and expenses of consolidated Crown corporations in excess of their appropriations are netted against their total revenues. This classification has the effect of reducing both revenues and expenses by an equal amount, thereby having no impact on the budgetary balance. The Annual Financial Report of the Government of Canada provides the reconciliation between these two bases of presentation.

The Auditor General feels the use of the different classification systems is confusing to users and urges the Government to present its budget, The Fiscal Monitor and the Annual Financial Report on a gross basis only.

In Budget 2004 the Government indicated that it would explore ways in which the budget, Annual Financial Report and Public Accounts could be prepared on a comparable basis. As noted in Chapter 7 and in the section below, the Government has launched a review of its reporting to Parliament as part of its efforts to enhance accountability and transparency. In addition, the forecasting review exercise, currently underway, is expected to make recommendations with respect to increased transparency in the presentation of the fiscal projections. The Government will await the results of these exercises before making any changes to the presentation of the fiscal results in the budget and The Fiscal Monitor.

v) Reporting to Parliament

The Auditor General recommends that the Government consider enhancements to the way it reports its financial results to parliamentarians and other interested Canadians.

The Treasury Board Secretariat has established a special working group to consult with interested parties and make recommendations to enhance its reporting of financial and non-financial results. The group will work closely with officials from the Office of the Auditor General.

¹ Public Accounts of Canada, 2001, p. 1.33. [Return]

² Public Accounts of Canada, 2004, p. 2.28. [Return]

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