Audit focus

In determining the 2019–20 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 2016 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’s assessment of high levels of risk and observed changes in key cost assumptions since the publication of the 2016 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’s 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’s 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’s purposes relies on a large and dispersed workforce (comprising approximately 58,000 Defence personnel, 26,000 reservists and 16,000 public servants), and effective internal coordination. Audit work on Defence’s internal administration has indicated that ensuring compliance with requirements and providing management with assurance on compliance can be challenging. The audit of the Land 200 Program for modernising army Command and Control — the Land 200 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’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. Further information is available from the department’s 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 2013, Defence Force Discipline Act 1982 and Defence Act 1903, which are independent but reside administratively within the Defence portfolio. These include, among others, DHA and the ASD, which became a statutory agency on 1 July 2018 following a recommendation made to the government in the 2017 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 2019–20 Portfolio Budget Statements (PBS) for the Defence portfolio, the aggregated budgeted expenses for 2019–20 total $43.59 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 are the most material component, representing 80 per cent of the portfolio’s expenses.

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

Source: ANAO analysis of PBS 2019–20 Budget related papers pre–machinery-of-government changes announced on 29 May 2019.

Financial statements and other audit engagements

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

 

Type of entity

Risk of material misstatement

Number of higher risks

Number of moderate risks

Material entities 

Department of Defence

Non-corporate

High

2

4

Australian Signals Directorate

Non-corporate

Moderate

2

Defence Housing Australia

Corporate

Moderate

3

1

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 1997 section 20 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’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 government.

The department’s total budgeted expenses for 2019–20 are just under $42 billion, with supplier expenses and employee benefits representing 38 per cent and 30 per cent, respectively, of the total budgeted expenses, as shown in Figure 2.

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

Source: ANAO analysis of PBS 2019–20 Budget related papers pre–machinery-of-government changes announced on 29 May 2019.

The six key risks for Defence’s 2018–19 financial statements that the ANAO has highlighted for specific audit coverage in 2019–20, 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’s 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’s cyber resilience. ASD became a prescribed agency on 1 July 2018. Prior to this date, ASD existed within the Department of Defence.

ASD’s total budgeted expenses for 2019–20 are just over $833 million, with 57 per cent of these expenses attributable to supplier expenses, as shown in Figure 3.

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

Source: ANAO analysis of PBS 2019–20 Budget related papers pre–machinery-of-government changes announced on 29 May 2019.

ASD’s 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’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 expenses for 2019–20 are just over $1.1 billion, with 95 per cent attributable to employee benefits and supplier expenses, as shown in Figure 4.

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

Source: ANAO analysis of PBS 2019–20 Budget related papers pre–machinery-of-government changes announced on 29 May 2019.

DHA’s four key risks for its financial statements are the:

  • valuation and significant judgements applied in the evaluation of the net realisable value of DHA’s housing portfolio;
  • assessment of impairment of DHA’s investment properties, given the volume, complexity and judgement applied in calculating the required inputs;
  • 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, volume and complexity of transactions, and the impact of the initial application of AASB 15 Revenue from Contracts with Customers on revenue recognition, measurement and disclosure; and
  • assessment of the implications of AASB 16 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’s annual Major Projects Report complements other audit coverage of Defence.

The ANAO has prepared the Major Projects Report annually since 2007–08. 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 30 June each year. In addition, the report provides longitudinal analysis across these key elements of project performance over time.

The objective of the 2018–19 Major Projects Report is to provide the Auditor-General’s 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 12 months after they have received Gate 2 (or second pass) approval, and generally after contract signature for delivery of the materiel.

The 2018–19 Major Projects Report will review 26 projects, with a combined budget of approximately $63 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’s risk management reform program.

In progress performance audits