Defence portfolio

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 portfolio are the Department of Defence, the Department of Veterans’ Affairs, the Australian Signals Directorate and Defence Housing Australia. The Department of Veterans’ Affairs is discussed separately.

The purpose and mission of the Department of Defence and the Australian Defence Force (ADF) (together the department and the ADF are known as ‘Defence’) are to defend Australia and its national interests in order to advance Australia’s security and prosperity. In 2021–22, support for the community and civilian authorities included a range of activities to support state and territory authorities during Operation COVID-19 Assist and Operation Flood Assist, as well as related support provided by the department to other parts of the Australian Public Service. The department is also responsible for granting security clearances, and is one of the pilot entities under the ‘cyber hub’ model developed as part of the ‘Hardening Australian Government IT Initiative’. Further information is available from the department’s website.

The portfolio’s entities include statutory offices, trusts and companies that are subject to the Public Governance, Performance and Accountability Act 2013, and that are independent but reside administratively within the Defence portfolio.

In the 2022–23 Portfolio Budget Statements (PBS) for the Defence portfolio, the aggregated budgeted expenses for 2022–23 total $50.7 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 1. The Department of Defence represents the largest proportion of the portfolio’s expenses, and departmental expenses of the portfolio are the most material component, representing 83 per cent of the entire portfolio’s expenses.

Figure 1: Defence portfolio – total expenses and average staffing level by entity

Note: The Department of Defence’s average staffing level excludes Australian Defence Force personnel.

Note: Australian Signals Directorate staffing levels are classified as ‘not for publication’ and are therefore excluded from the figure.

Source: ANAO analysis of 29 March 2022–23 PBS.

In determining the 2022–23 audit work program, the ANAO considers prior-year audit and other review findings and what these indicate about portfolio risks and areas for improvement. The ANAO also considers emerging risks from new investments, reforms or changes to the operating environment.

The primary risks identified for the portfolio relate to Defence’s ability to: anticipate, prepare for and respond to threats to Australia’s interests; acquire and sustain capability while avoiding the emergence of capability gaps and meeting sovereign capability requirements (and managing optimism bias in reporting); recruit and mobilise a large, distributed and traditionally siloed workforce to effectively work as ‘One Defence’; and meet expectations of its ability to respond to environmental and other disasters.

In the Defence portfolio, specific risks relate to governance of a large organisation, the substantial procurement activity currently underway, the management of existing assets and capabilities, and financial management.

Governance

In November 2020, the Department of Defence released Lead the Way: Defence Transformation Strategy, which builds on the One Defence enterprise concept set out in the 2015 First Principles Review. The successful achievement of this strategy depends on the establishment of effective internal management and coordination across Defence’s large and dispersed workforce (comprising approximately 61,500 Defence personnel, 29,700 reservists, 16,600 public servants and 34,900 consultants, contractors and outsourced service providers) and the ability of senior leaders to bring together Defence’s long-standing separate groups and services effectively.

The department’s senior leadership depends on effective governance, review and reporting arrangements to inform them on the progress of key activities. Reporting provided to the senior leadership also needs to avoid the risk of optimism bias.

• Recent audit work identified that the department had enterprise-level arrangements to provide the accountable authority with advice and assurance on the implementation of agreed ANAO recommendations, with similar arrangements for agreed parliamentary committee recommendations introduced in August 2020. 
• Recent audit work also identified that Defence is unable to provide assurance of the effectiveness of its implementation to date of its Pathway to Change – Evolving Defence Culture 2017–2022 cultural reform strategy. 
• Further audit work found that the benefits obtained through independent assurance reviews, a key Defence assurance mechanism for complex procurements, were not fully realised in a number of cases but have had significant impacts when the review findings were applied. 

Audit work on Defence’s internal administration has indicated that there are weaknesses around compliance with requirements and the provision of assurance to management. 

• The audit of Defence’s modernisation of Army command and control through the Land 200 program observed that unreformed governance and coordination arrangements had affected project delivery.
• Audit activity has also identified optimism bias in internal advice to senior Defence leaders and ministers. 
• Recent audit activity identified program-level probity risks and weaknesses in decision-making arrangements which came about when Defence relied heavily upon its contracted workforce to deliver outcomes without making necessary adjustments to governance to address the changes in the workforce model in use. 

Defence has a significant number of systems that it uses to gather information required to conduct business. A specific risk for Defence is whether its information and communications technology infrastructure is fit for purpose to support its business, including its responsibility to deliver effective security vetting services on behalf of the Australian Government and meet record keeping obligations. 

• Audit work identified that recommendations made to the Australian Government Security Vetting Agency had not yet been fully implemented due to delays in establishing new ICT systems. 

It is important for entities to have effective risk management practices for cyber security. This includes conducting assessments of the effectiveness of security controls, security awareness training, and adopting a risk-based approach to prioritise improvements to cyber security. Weaknesses in the implementation and operation of governance and monitoring processes relating to cyber security increase the risk of unauthorised access to systems and data held by entities.

Australia’s Cyber Security Strategy 2020 outlines a range of initiatives to uplift Australia’s cyber security, including to harden government IT systems. Defence is one of the pilot entities under the ‘cyber hub’ model developed as part of the ‘Hardening Australian Government IT Initiative’. While this initiative aims to strengthen Government’s cyber security posture across Commonwealth entities, it is still under development and there are risks related to the delivery and implementation of services to entities.

The large, distributed and mixed nature of the Defence workforce creates risk that policies and processes approved by senior management may not be implemented effectively unless robust assurance arrangements are established to identify non-compliance.

• Recent audit activity identified that Defence’s administration of contractual obligations relating to the Defence Industry Security Program was partially effective, as arrangements for administering, monitoring compliance and managing non-compliance with contracted requirements were not always fit-for-purpose. 

Defence relies on portfolio entities to help achieve its purposes. Recent audit activity found that no work has been done to assess the effect of Defence Housing Australia’s (DHA’s) services on ADF member retention, which was a major reason for creating DHA. 

Procurement

Defence is undertaking substantial procurement activity to refresh its capability in the land, air and maritime domains, in the context of the 2020 Defence Strategic Update, 2020 Force Structure Plan and sovereign capability initiatives. Many key projects are dependent on successful mobilisation activity in Australia, including in relation to local industry and workforce participation, physical infrastructure development, knowledge transfer and enterprise-level management and coordination. 

• Recent audits have observed that where partnership arrangements have been established with industry, their active management is of particular importance for the delivery of expected procurement outcomes.  In addition, recent audit work identified room to improve clarity and transparency regarding the handling of unsolicited procurement proposals. 

There has been a move in recent procurement activities towards more developmental acquisition projects and a focus on the expansion of Australian industry involvement in Defence procurement. Acquisition projects that are more developmental in nature have historically been more prone to slippage , and there are a number of audited projects facing system integration and delivery challenges. Recent investment has sought to address Defence’s industry policy by supporting more involvement of Australian industry in the delivery of sovereign industrial capability. Recent audit work has identified that Australian Industry Capability Program verification activities had not yet been established for a number of major procurements.  Industry policy objectives are also being pursued through a Defence export strategy that did not clearly map how strategy initiatives would contribute to the achievement of strategy objectives. 

Defence has established a range of non-material contracts of significant value for the delivery of essential services, such as base management and health care. Active contract management and the implementation of effective assurance arrangements across these contracts contributes to the achievement of value for money, and the mitigation of risks to the successful delivery of contracted outcomes.

Asset management and sustainment

The department 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 assets’ 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.

Audit and review activity of the procurement and introduction into service of the Joint Strike Fighter and associated sustainment planning identified both financial and non-financial risks arising from a maturing global support solution for the new fighter fleet. 

Recent audit work on the procurement of the evolved Cape class patrol boat observed the impacts of schedule delay and the need to actively manage the risk of a capability gap.  Effective planning is also required to manage the risk of a capability gap which may result from delays to the delivery of future submarines and Hunter class frigates.

Pending the introduction into service of replacement platforms, Defence has planned to maintain certain platforms beyond their normal lifetime. Not planning appropriately for the effective sustainment of capability creates risk including additional costs, reduced availability, and reduced effect through obsolescence.

• Audit work on the ANZAC class frigates  observed limited planning to support the timely transition to the Hunter class frigates. In the case of the future submarine fleet, the risk of a capability gap emerging has been recognised and a Collins class life-of-type extension was identified as a key risk mitigation strategy.  For the Armidale class patrol boats, a planned life-of-type extension was set aside in favour of procuring additional Cape class patrol boats.  Delays in the delivery of the new patrol boats has required Defence to plan for the life-of-type extension of some Armidale class patrol boats, at additional cost. 

Financial management

The military superannuation liabilities associated with Defence personnel are subject to assumptions and calculations underpinning the actuarial assessment of these liabilities.

Overview

Entities within the Defence portfolio , and the risk profile of each entity, are shown in Table 1.

Table 1: Defence portfolio entities and risk profile

Department of Defence

The Department of Defence is responsible for protecting and advancing Australia’s 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.

The department’s total budgeted assets for 2022–23 are just under $138.2 billion, with specialist military equipment, land and buildings and inventory representing 62 per cent, 18 per cent and 6 per cent, respectively, as shown in Figure 2. Employee provisions, encompassing the defined benefit superannuation provisions, are attributable to 86 per cent of total budgeted liabilities.

Figure 2: Department of Defence’s total budgeted financial statements by category ($’000)

Source: ANAO analysis of 29 March 2022–23 PBS.

Financial statements audit

There are four key risks for Defence’s 2021–22 financial statements that the ANAO has highlighted for specific audit coverage and are considered potential key audit matters (KAMs).

• Valuation and accuracy of specialist military equipment, which includes defence weapons platforms, assets under construction, and associated spare parts. The measurement of specialist military equipment at fair value involves a high degree of management judgement, due to the specialised nature of the assets and the subjectivity of the valuation. The subjectivity in the valuation assessment is due to the difficulty in obtaining the replacement costs of assets with a similar capability in the absence of an active market, the selection and application of appropriate indices, the determination and assessment of appropriate useful lives, and the identification of indicators of impairment. There is also complexity, and a high degree of judgement is exercised in the cost attribution model that allocates accumulated capitalised costs on large scale acquisition projects between individual platform assets, associated spares and inventory. The balance of specialist military equipment as at 30 June 2021 was $74.5 billion. (KAM – Valuation and accuracy of specialist military equipment)
• Valuation and disclosure of administered employee provisions, due to the complexity of the calculations and high degree of judgement in selecting key long-term assumptions (including such matters as salary growth and discount rates, pension indexation rate, pension take-up rate and invalidity retirements). The provision balance as at 30 June 2021 was $180.2 billion. (KAM – Valuation and disclosure of administered employee provisions)
• Valuation of general assets, which includes land and buildings, infrastructure, plant and equipment, heritage and cultural assets, and intangibles. The valuation involves a high degree of management judgement in applying assumptions in respect of classifying project costs as capital or expense and the selection of valuation methods to measure fair value. Significant judgements applied in the valuation process relate to the selection capitalisation rates, current replacement costs, discount rates, and conditions of the assets. Where observable market data is not available, the valuation is subject to a higher level of judgement. There is also subjectivity in determining appropriate useful lives and the assessment of the financial impact of indicators of impairment. The balance of general assets as at 30 June 2021 was $31.5 billion. (KAM – Valuation of general assets)
• Existence and completeness of inventories, due to the variety and quantity of inventory, which is managed across a large number of geographically dispersed locations. A large volume of transactions are processed daily, inventory is managed through multiple systems and is subject to complex system interfaces. The balance of inventory as at 30 June 2021 was $7.8 billion. (KAM – Completeness and existence of inventories)

Australian Signals Directorate

The purpose of the Australian Signals Directorate (ASD) is to defend Australia from global threats and advance Australia’s national interest through the provision of foreign signals intelligence, cybersecurity and offensive cyber operations, as directed by government. The Australian Cyber Security Centre, which is a part of ASD, provides support to government and the Australian community to improve Australia’s cyber resilience.

ASD’s total budgeted assets for 2022–23 are just under $1.3 billion, with land and buildings and property, plant and equipment accounting for 75 per cent, as shown in Figure 3.

Figure 3: Australian Signals Directorate’s total budgeted financial statements by category ($’000)

Source: ANAO analysis of 29 March 2022–23 PBS.

There are two key risks for ASD’s 2021–22 financial statements.

• The valuation, allocation and accuracy of non-financial assets, particularly assets under construction. ASD is undertaking a number of complex projects which are progressively capitalised in assets under construction. The nature of these projects requires the application of judgement about whether costs are capitalised or expensed. Additionally, at each balance date ASD must determine whether these non-financial assets are appropriately recorded at fair value or exhibit indicators of impairment which also requires the application of judgement and estimation.
• The reliance on the Department of Defence for corporate shared services, including financial processing and payroll. The risk arises due to the significance of ASD’s reliance on internal controls established by Defence in support of these processes which influence financial management and reporting by ASD.

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’s 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’s primary source of capital funding to acquire new properties.

DHA’s total budgeted assets for 2022–23 are just under $4.8 billion, with around 83 per cent attributable to land and buildings, and 10 per cent attributable to inventories as shown in Figure 4. Budgeted revenue is just under $1.0 billion, with sales of goods and rendering of services accounting for the majority of the balance. DHA’s leases account for around 84 per cent of total budgeted liabilities.

Figure 4: Defence Housing Australia’s total budgeted financial statements by category ($’000)

Source: ANAO analysis of 29 March 2022–23 PBS.

There are four key risks for DHA’s 2021–22 financial statements.

• The valuation and significant judgements applied in management’s assessment of the net realisable value of DHA’s inventory.
• The assessment of impairment of DHA’s investment properties, given the volume, complexity and judgement applied in calculating the required inputs.
• The accounting for, and reporting of, DHA’s 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, the volume and complexity of transactions, and the impact of the application of Australian accounting standard AASB 15 Revenue from Contracts with Customers on revenue recognition, measurement and disclosure.
• The accounting for DHA’s leases, due to the complexity involved in calculating the value of leased assets and liabilities in accordance with Australian accounting standard AASB 16 Leases.