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Annex 2:
The Government’s Response to the Auditor General’s Observations on the 2004–05 Financial Statements

The Auditor General of Canada expressed a "clean" opinion on the Government’s financial statements for 2004–05. This means that the financial statements present fairly, in all material respects, the financial position of the Government of Canada.

The Auditor General raised one issue for Parliament’s attention in her "Observations" on the financial statements for 2004–05. This annex reviews this Observation and reports on the status of an issue raised by the Auditor General in previous reports.

Government Reporting Entity

The Public Sector Accounting Board of the Canadian Institute of Chartered Accountants has issued a revised accounting standard that provides guidance as to the organizations that should be included within a government’s reporting entity, for purposes of financial reporting. The revised standard comes into effect in 2005–06. The overriding criterion for inclusion is whether the government controls an entity. Control is defined as "the power to govern the financial and operating policies of another organization." The Auditor General notes that this is a particularly challenging standard to apply because government must consider the preponderance of evidence to judge whether it controls an organization—there is no single rule or criterion to establish control.

The Government has determined that, starting in 2005–06, a number of organizations will be consolidated within the government reporting entity, including, from a budgetary perspective, the following key entities:

• Canada Foundation for Innovation.

• Canada Millennium Scholarship Foundation.

• Sustainable Development Technology Canada.

• Aboriginal Healing Foundation.

The financial statements of the Government of Canada will now reflect the assets, liabilities, expenses and revenues of these organizations. Transfers to these organizations will not be treated as expenses until the organizations make payments to the ultimate recipients of the funds. As this represents a change in accounting policy, the Government’s financial statements of prior periods will be restated to give retroactive effect to this change in accounting treatment, resulting in an estimated cumulative $5.5-billion decrease in the size of the federal debt as at March 31, 2005. This decrease largely represents government transfers provided to these organizations that had not yet been paid out to third parties as at March 31, 2005. This change will also result in an estimated $0.7-billion decrease in the budgetary balance in 2005–06 and 2006–07 and an estimated $0.8-billion decrease in 2007–08.

A complete description of the impact of this accounting policy change and a restatement of financial data for the period 1996–97 to 2004–05 will be presented in the 2006 Public Accounts of Canada to be tabled in Parliament in the fall.

Netting

In numerous Observations on the Public Accounts of Canada, the Auditor General expressed concerns regarding the Government’s practice of presenting financial information in the budget and the monthly Fiscal Monitor on a net basis, whereby certain disbursements are netted against budgetary revenues and certain revenues are netted against expenses. This practice has the effect of reducing both revenues and expenses by an equal amount, thereby having no impact on the budgetary balance. In contrast, the Government’s summary financial statements, as well as the financial statement discussion and analysis contained in the Public Accounts of Canada, are presented on a gross basis. The Auditor General has argued that presenting the financial statements on a gross basis more properly reflects the nature and size of the Government’s revenues and expenses.

The Government has taken action to address this issue and improve the comparability and transparency of its financial information by presenting its Budget 2006 forecast on a gross basis. The Annual Financial Report of the Government of Canada and The Fiscal Monitor results will also be presented on a gross basis.

As shown in Table A2.1, there are three major components that are affected by the move to the gross basis of presentation:

• The Canada Child Tax Benefit, which was previously netted against personal income tax revenues.

• Departmental revenues that are levied for specific services, such as the contract costs of policing services in provinces, which were netted against expenses.

• Revenues of consolidated Crown corporations, which were netted against their total expenses.

Table A2.1
Differences Between Net and Gross Reporting

Presenting results on a gross basis pushes up revenues and program expenses in 2005–06 by an estimated $13.8 billion each. Thus, there is no impact on the budgetary balance. As a share of gross domestic product (GDP), moving to a gross basis increases revenues and program expenses by approximately 1 percentage point each.