Defence Audit focus In determining the audit work program the ANAO considers prior year audit and other review findings and what these indicate about portfolio risks and areas for improvement as well as emerging risks from new investments reforms or operating environment changes In the Defence portfolio considerations predominantly relate to the substantial procurement activity currently underway the management of existing assets and capabilities governance of a large complex organisation and financial management where there are significant complexities involved in valuation of assets and liabilities Procurement Following the release of the Defence White Paper and the associated Integrated Investment Program Defence is undertaking substantial procurement activity to refresh its capability in the land air and maritime domains The investment program includes complex developmental acquisition projects which are historically prone to slippage and many of which are dependent on successful mobilisation activity relating to local workforce infrastructure knowledge transfer and enterprise level management and coordination Recent audits have highlighted emerging risks to the affordability and achievement of the investment program The audit of Naval Construction Programs — Mobilisation noted Defence assessment of high levels of risk and observed changes in key cost assumptions since the publication of the Defence White Paper The audit of ANZAC Class Frigates — Sustainment observed limited planning to support the transition to new platforms and identified benefit in reviewing sustainment cost assumptions Asset management and sustainment The Department of Defence maintains assets to support achievement of its purposes Accurate valuations of assets are an important element in determining ongoing maintenance and sustainment investment required the cost of future asset replacement and reporting of the asset fair value in the annual financial statements Valuation of the capability held at a point in time is challenging for specialist military equipment inventory infrastructure and land due to the significant judgement and estimation involved The department expenditure on sustainment activities is substantial and Defence has planned to extend the life of certain platforms pending the introduction into service of replacement platforms Recent audit work has identified misalignment between the operational use and sustainment plans and budget for Anzac class frigates which must operate longer than anticipated pending the delivery of new Hunter Class frigates The audit of Joint Strike Fighter — Introduction into Service and Sustainment Planning identified both financial and non financial risks arising from a maturing global sustainment solution for the new fighter fleet Governance Defence has a significant number of systems that it uses to gather information required to conduct its business A specific risk for Defence is whether its information and communications technology infrastructure is fit for purpose to support its business Delivery of Defence purposes relies on a large and dispersed workforce comprising approximately Defence personnel reservists and public servants and effective internal coordination Audit work on Defence internal administration has indicated that ensuring compliance with requirements and providing management with assurance on compliance can be challenging The audit of the Land Program for modernising army Command and Control — the Land Program observed that unreformed governance and coordination arrangements had affected project delivery Financial management Along with the issues discussed above the military superannuation liabilities associated with Defence personnel are subject to complex assumptions and calculations underpinning the actuarial assessment of these liabilities Portfolio overview The Defence portfolio includes a number of entities that together are responsible for the defence of Australia and its national interests The principal entities within the Defence portfolio are the Department of Defence Defence the Australian Signals Directorate ASD and Defence Housing Australia DHA Defence including the Australian Defence Force is responsible for protecting and advancing Australia strategic interests through the promotion of security and stability the provision of military capabilities to defend Australia and its national interests and the provision of support for the Australian community and civilian authorities as directed by the Australian Government Further information is available from the department website at www defence gov au The portfolio contains a number of entities including a number of statutory offices trusts and companies subject to the Public Governance Performance and Accountability Act Defence Force Discipline Act and Defence Act which are independent but reside administratively within the Defence portfolio These include among others DHA and the ASD which became a statutory agency on July following a recommendation made to the government in the Independent Intelligence Review The portfolio also contains the Department of Veterans Affairs and associated bodies including the Australian War Memorial The Department of Veterans Affairs is administered separately to Defence and is discussed separately In the Portfolio Budget Statements PBS for the Defence portfolio the aggregated budgeted expenses for total billion The PBS contain budgets for those entities in the general government sector GGS that receive appropriations directly or indirectly through the annual appropriation acts The level of budgeted departmental? and administered? expenses and the average staffing level for entities in the GGS within this portfolio are shown in Figure The Department of Defence represents the largest proportion of the portfolio expenses and departmental expenses are the most material component representing per cent of the portfolio expenses Figure Defence portfolio — total expenses and average staffing level by entity Source ANAO analysis of PBS Budget related papers pre machinery of government changes announced on May Financial statements and other audit engagements Overview Entities within the Defence portfolio and the risk profile of each entity are shown in Table Table Defence portfolio entities and risk profile Type of entity Risk of material misstatement Number of higher risks Number of moderate risks Material entities Department of Defence Non corporate High Australian Signals Directorate Non corporate Moderate Defence Housing Australia Corporate Moderate Non material entities AAF Company Company Low Army and Air Force Canteen Service Frontline Defence Services Corporate Low Australian Military Forces Relief Trust Fund Corporate Low Australian Strategic Policy Institute Limited Company Low Royal Australian Air Force Welfare Recreational Company Company Low Royal Australian Air Force Veterans Residences Trust Fund Corporate Low Royal Australian Air Force Welfare Trust Fund Corporate Low Royal Australian Navy Central Canteens Board Corporate Low Royal Australian Navy Relief Trust Fund Corporate Low Other audit engagements including Auditor General Act section engagements Australian Defence Force Superannuation Scheme ADF Super ADF Super Australian Prudential Regulation Authority reporting and prudential standards Military Superannuation and Benefits Scheme MSBS MSBS Australian Prudential Regulation Authority reporting and prudential standards Major Projects Report assurance engagement Material entities Department of Defence The Department of Defence is responsible for protecting and advancing Australia strategic interests through the promotion of security and stability the provision of military capabilities to defend Australia and its national interests and the provision of support for the Australian community and civilian authorities as directed by the government The department total budgeted expenses for are just under billion with supplier expenses and employee benefits representing per cent and per cent respectively of the total budgeted expenses as shown in Figure Figure Department of Defence total budgeted expenses by category Source ANAO analysis of PBS Budget related papers pre machinery of government changes announced on May The six key risks for Defence financial statements that the ANAO has highlighted for specific audit coverage in including those that the ANAO considers potential Key Audit Matters KAMs are the accuracy and valuation of specialist military equipment which includes defence weapons platforms assets under construction and associated military support items The measurement of specialist military equipment at fair value involves a high degree of judgement due to the specialised nature of the assets and the subjectivity of the valuation KAM Accuracy and valuation of specialist military equipment accuracy valuation and disclosure of military superannuation balances due to the complexity of the calculations and high degree of judgement The calculations require assumptions to be made in respect of matters such as expected benefit claiming patterns indexation of salaries and retirement payments future economic conditions and the amount of lump sum versus recurring payments to be made KAM Accuracy and valuation of employee provisions administered military superannuation accuracy and valuation of general assets which includes land and buildings infrastructure plant and equipment heritage and cultural assets and intangibles These assets include long term projects and complex cost allocation processes with multiple rollouts that are managed and accounted for by various service groups The valuation is subjective and based on assumptions and judgements made by the valuers and management Capitalisation of intangible assets is subject to the judgement involved in classifying project costs as capital or expense in nature KAM Accuracy and valuation of general assets completeness and existence of inventories due to the decentralisation of holdings and their management by multiple parties as well as the identification of and accounting for obsolete stock and valuation using a complex weighted average cost methodology KAM Completeness and existence of inventories accuracy completeness and valuation of capital commitments which include land and buildings specialist military equipment infrastructure plant and equipment and intangibles due to the number of contracts recorded as outstanding purchase orders that need to be converted from foreign currencies and recognition and measurement of litigation given the uncertainties in relation to class actions launched against Defence seeking compensation for contaminated groundwater stemming from the chemicals used in fighting liquid fuel fires and claims received following reviews into the Australian Defence Force and Defence culture Australian Signals Directorate The purpose of the Australian Signals Directorate ASD is to defend Australia from global threats and advance Australia national interest through the provision of foreign signals intelligence cyber security and offensive cyber operations as directed by government The Australian Cyber Security Centre a division within ASD provides support to government and the Australian community to improve Australia cyber resilience ASD became a prescribed agency on July Prior to this date ASD existed within the Department of Defence ASD total budgeted expenses for are just over million with per cent of these expenses attributable to supplier expenses as shown in Figure Figure Australian Signals Directorate total budgeted expenses by category Source ANAO analysis of PBS Budget related papers pre machinery of government changes announced on May ASD two key risks for its financial statements are the valuation of assets under construction as the complex technological nature of the projects makes the judgement about whether costs are capitalised or expensed more difficult and significant reliance on the Department of Defence for financial services including payroll due to the infancy of these arrangements Defence Housing Australia Defence Housing Australia DHA is responsible for providing housing and related services to members of the Australian Defence Force and their families consistent with Defence operational requirements To meet these requirements DHA is responsible for constructing purchasing and leasing houses for Australian Defence Force personnel Each year DHA sells a portion of its properties through a sale and leaseback program and those revenues are DHA primary source of capital funding to acquire new properties DHA total budgeted expenses for are just over billion with per cent attributable to employee benefits and supplier expenses as shown in Figure Figure Defence Housing Australia total budgeted expenses by category Source ANAO analysis of PBS Budget related papers pre machinery of government changes announced on May DHA four key risks for its financial statements are the valuation and significant judgements applied in the evaluation of the net realisable value of DHA housing portfolio assessment of impairment of DHA investment properties given the volume complexity and judgement applied in calculating the required inputs accounting for and reporting of DHA revenue from housing services provided to Defence the sale of inventories and the proceeds from the sale of investment properties due to the number of revenue streams volume and complexity of transactions and the impact of the initial application of AASB Revenue from Contracts with Customers on revenue recognition measurement and disclosure and assessment of the implications of AASB Leases including relevant disclosure of the impact assessment on the future operations and the relevant disclosures in the financial statements as this new standard will have significant impacts on how DHA accounts for its transactions and arrangements in the future Major Projects Report assurance engagement The ANAO annual Major Projects Report complements other audit coverage of Defence The ANAO has prepared the Major Projects Report annually since The report is intended to increase the transparency and accountability over the progress of Defence major projects These projects remain the subject of parliamentary and public interest and the Major Projects Report contains information relating to the cost schedule and progress towards delivery of required capability of individual projects as at June each year In addition the report provides longitudinal analysis across these key elements of project performance over time The objective of the Major Projects Report is to provide the Auditor General independent assurance over the status of the selected major projects as reflected in the statement by the Secretary of the Department of Defence and the project data summary sheets These summary sheets are prepared by Defence in accordance with established guidelines endorsed yearly by the Joint Committee of Public Accounts and Audit The guidelines stipulate that projects are considered for inclusion months after they have received Gate or second pass approval and generally after contract signature for delivery of the materiel The Major Projects Report will review projects with a combined budget of approximately billion and will continue to examine developments in governance arrangements within the Department of Defence particularly in relation to the continued implementation by Defence of the new Capability Life Cycle and the Capability Acquisition and Sustainment Group risk management reform program