Specified Procedures on the Departmental Financial Statements for FY2014-15

Final Report

November 2015

Executive Summary

Each year, the Office of the Chief Audit Executive of the Department of Foreign Affairs, Trade and Development (DFATD, the Department) undertakes detailed audit work on specified areas of the Departmental Financial Statements. In the past four years, specified audit procedures were carried out in the following areas: Canada Based Staff Payroll, Transfer Payments, Tangible Capital Assets, Locally Engaged Staff Salary, Pension and Severance Payments as well as Severance Liabilities, and Revenue on Sales of Goods and Services. This year, specified audit procedures were carried out on the disposals and write-offs of tangible capital assets reported in the draft Departmental Financial Statements.

Departmental Financial Statements are a principal tool for accountability to Parliament, ensuring the reliability of the information contained within the statements supports sound stewardship. In order to fulfill its mandate and achieving the established strategic outcomes, the Department purchases and/or constructs a number of tangible capital assets. As of March 31, 2015, the Department had over $2.5 billion in acquisition value for tangible capital assets. In fiscal year (FY) 2014-2015, a total of 224 capital assets items, with an acquisition cost of $41.9 million and a net book value of $23.9 million, were disposed and written off. The asset items are broken down as follows:

The auditors developed and executed audit procedures to:

• Gain a high level understanding of the roles and responsibilities, policies, procedures, and controls in place;
• Perform analytical procedures to assess the reasonableness of disposals and write-offs reported;
• Conduct tests of details on disposals and write-offs recorded in the Department’s financial information systems, as well as tests of details on recorded tangible capital assets for existence; and,
• Assess the reporting (e.g. disclosures) in the departmental financial statements.

The audit procedures did not include an assessment of the completeness of the control documentation, nor the design, implementation or operating effectiveness of these controls.

The auditors observed the following issues related to disposals and write-offs of tangible capital assets:

• 1. Disposals of 13 real properties (6 land and 7 building assets) were not properly recorded in the year when they were sold. These land and building assets were related to one disposal transaction;
• 2. Issues with regard to the presentation of disposals and write-offs of the tangible capital assets in Note 3 a)--Reconciliation of net cost of operations to current year authorities used.

Conclusion

Based on the specified audit procedures performed, the auditors found no reason to believe that the reported amount of disposals and write-offs in the FY2014-2015 Departmental Financial Statements were materially misstated.

Two recommendations were developed to address control weaknesses identified in the audit.

Statement of Assurance

In my professional judgment as Chief Audit Executive, the audit was conducted in conformity to the Institute of Internal Auditors’ International Standards for the Professional Practice of Internal Auditing and the Internal Auditing Standards for the Government of Canada, as supported by the results of the quality assurance and improvement program.  Sufficient and appropriate audit procedures were conducted and evidence gathered to support the accuracy of the findings and conclusion contained in this report, and to provide an audit level of assurance. The findings and conclusion are based on a comparison of the conditions, as they existed at the time of the audit, against pre-established audit criteria that were agreed upon with management.  The findings and conclusion are applicable only to the entity examined, for the scope and period covered by the audit.

Chief Audit Executive

1.0 Observations

1.1 High-Level Understanding of Processes and Controls

In the course of the audit, the audit team obtained a high level understanding of business processes, systems and internal controls in the areas of approving, recording and reporting disposals and write-offs of tangible capital assets. This understanding helped auditors develop an audit program and sample strategy to enable the conduct of detailed testing.

During the audit testing of disposals and write-offs of tangible capital assets, it was noted that the Department has documented its key tangible capital assets related business processes and internal controls, including disposals and write-offs. Specifically, the Department has:

• Linked its key processes and internal controls to the relevant financial statement assertions;
• Identified, for each business risk, the risk of material misstatement; and,
• Determined the frequency and type (manual / automated) of each control.

The key internal controls related to the disposal and write-offs of tangible capital assets include:

Controls related to real property tangible capital assets

• The Department’s Program Review Committee approves a disposal plan of land and building assets annually; whereby no disposal of these assets can be made without the Committee’s approval;
• The Asset Disposal Report Form must be approved in accordance with the Department’s delegation of authority;
• Missions annually reconcile real property assets recorded in SAP^{Footnote 1} with the Department’s Real Estate System (Prime)^{Footnote 2} to confirm the existence of tangible capital assets.

Controls related to all tangible capital assets

• Missions (and asset custodians for Headquarters assets) are required to submit an annual certification of their tangible capital assets, stating to the completeness and that such assets are actively in use;
• Once a tangible capital asset is identified as being disposed or written-off within SAP, SAP automatically calculates the related gains and losses (the difference between the net book value of the tangible capital asset and the proceeds on disposal); and,
• Journal entries related to disposals and write-offs of tangible capital assets are approved by an individual other than the preparer prior to being entered into SAP by Corporate Accounting.

In addition, management has also implemented a control environment which enables segregation of duties for key financial roles responsibilities of tangible capital asset disposals and write-offs. Specifically:

• Disposals and write-offs must be approved in accordance with the Department’s approved delegation of authority;
• Missions physically dispose of tangible capital assets; and
• Corporate Accounting is responsible for recording all disposals and write-offs.

1.2 Analytical Procedures

The total disposals and write-offs of tangible capital assets reported by the management in the draft FY2014-2015 Financial Statements were $41.9 million. Management provided the auditors with the listing of all transactions in General Ledgers.

The auditors conducted analysis on the sub-categories of disposals/write-offs and performed the following three types of analytical procedures to assess the reasonableness of the total disposals/write-offs reported:

• 1. A comparison of the capital asset disposals/write- offs with those of previous year by asset class;
• 2. A comparison of capital assets disposals/write-offs reported with other external and internal reports, such as, Tangible Capital Assets reported for public accounts and Financial Management Support Unit manual tracking sheet for the disposals of real property;
• 3. A comparison of the cross-components – an analysis through reconciliations between proceeds from sales of capital assets, gain/loss from disposal/write-offs, and the retirement records of capital assets to assess the reasonableness of the reported amounts.

In FY2014-2015, there were a total of 224 capital assets recorded as disposed and written-off items, from which a total of $36.7 million net proceeds were received. Additionally, $23.2 million gains and $10.4 million losses were recognized on disposals of the capital assets.

The comparison of the disposal transactions reported in the draft Departmental Financial Statements with the internal manual tracking sheet for the disposal of real property revealed that there were 13 land and building assets located in London, with a total acquisition value of $3.37 million, which were not in the FY2014-2015 tracking records of the Physical Resources Unit of the International Platform Branch.

Further analysis indicated that these land and building assets were related to one disposal transaction and all sold in FY2013-2014; however, the disposals were not properly recorded in FY2013-2014. To correct this accounting error, they were recorded as write-offs in the FY2014-2015, which resulted in misstatements of the financial statements for both fiscal years. For fiscal year 2013-2014, it caused an overstatement of capital assets by $3.37 million in cost and a net book value $0.7 million; and an overstatement of $0.7 million gain on disposal of capital assets, and for the fiscal year 2014-2015, it caused an overstatement of $0.7 million for the Loss on disposal of capital assets.

Nonetheless, based on the analytical procedures, the auditors found no reason to believe that the reported amount of disposals and write-offs of tangible capital assets were materially misstated.

1.3 Tests of Details

The auditors performed tests of details related to tangible capital asset disposals and write-offs. The purpose of these tests was to assess whether the reported amount of tangible capital asset disposals and write-offs were complete, valid, properly authorized, recorded at the proper amount and in the proper period.

Given that the testing was aimed at tangible capital assets as reported in the departmental financial statements, the recorded acquisition value of tangible capital assets and a materiality factor of 1% were used as the basis for calculating materiality.  As a result, a planning materiality of $25 million was calculated, and a working materiality of $10 million was retained for testing purposes. A total of 41 transactions were selected for the tests of details based upon a robust sampling strategy. This included: (1) the recorded disposal and write-offs of tangible capital assets, and (2) the existence testing of recorded tangible capital assets.

Recorded disposals and write-offs of tangible capital assets

Using a targeted sampling approach for recorded disposals and write-offs, a total of 14 transactions were selected for testing. For each sample, the auditors examined the supporting documents to the reported disposals and write-offs, which included the following:

• Disposal Report (Form EXT-369);
• Approval of the Program Review Committee (applicable for real property only);
• Delegation of Authority for approval of disposal /write-off;
• Sales documents or equivalent (including supporting documentation for costs incurred related to disposals, where applicable); and
• Cashed cheque / equivalent, where applicable.

The auditors noted that with one exception, management used the standard approval form to document the authority required as per the Departmental policy for all tested real property disposals.

The audit team requested management to provide proof of receipt of proceeds to substantiate the recorded amounts. However, prior to the conclusion of the testing, the proof of receipt of proceeds to substantiate the proceeds recorded in SAP was unavailable for five (5) transactions. The audit team noted a compensating control exists (e.g. bank reconciliations) and that the proceeds in sales and purchase agreement agree to the vouched journal entry.

Existence testing of recorded tangible capital assets

Due to the nature of the disposals and write-offs of tangible capital assets, there is an inherent risk that tangible capital assets may not be recorded as ‘disposed’ or ‘written off’ in the financial information system, even if they have been (or should have been) disposed by the Department. To address this risk, the audit team performed ‘existence’ tests of details on recorded tangible capital assets. Using a risk-based approach, the audit focused on tangible capital assets that were fully depreciated for at least 12 months, i.e. a net book value of $0 since at least March 31, 2014.

As of March 31, 2015, the Department had $200.4 million of tangible capital assets that met this criterion. Based on a working materiality of $10 million, a sample of 27 transactions was selected and tested. The auditors obtained a certification from the asset custodians stating that the assets were still owned by the Department and in use as at March 31, 2015.

1.4 Review of Tangible Capital Asset Disposal and Write-Off Reporting

The financial statements for the Government of Canada are expected to be prepared in accordance with the Government's accounting policies, which are based on Canadian Public Sector Accounting Standards. Treasury Board Accounting Standard 1.2 applies to financial statements prepared by government departments for the 2011-2012 fiscal year and subsequent years. This standard ensures that Departmental Financial Statements present relevant financial information in a transparent and understandable manner to Parliamentarians and Canadians.

The draft Financial Statements of the Department for FY2014-2015 were obtained and assessed for the disclosures related to disposal and write-offs of tangible capital assets. The purpose of this examination was to assess whether the disclosure of the tangible capital assets disposal/write-offs were properly presented in accordance with the requirements of Treasury Board Accounting Standard 1.2.

The auditors reviewed the financial statements and the following disclosures areas to assess the accuracy of amount reported and the compliance with the form and content specified in Treasury Board Accounting Standard 1.2:

• Accounting policies related to Tangible Capital Assets;
• Note 3 - Parliamentary authorities;
• Note 10 - Tangible capital assets;
• Note 15 - Segmented information on gain/loss on disposals of tangible capital assets.

As a result of review, the auditors noted the following two issues:

• 1. In the review of Note 10 Tangible capital assets, the auditors noted variances between the amount reported in the Disposals/write-offs column of Note 10 and the disposals /write-offs general ledger data.  The auditors conducted variance analysis and discussed with Corporate Accounting who agreed that variances were due to assets reclassification (transfers within asset class) and post capitalization of assets. Subsequent to the discussion, the revisions were made in the FY2014-15 Departmental Financial Statements.
• 2. In the review to assess whether the reporting items ( i.e. gain (loss) on disposal/write off and proceeds from disposal of capital assets) were properly presented in the Note 3 Parliamentary authorities, the auditors noted that some of these items were not included in the reconciliations in accordance with Treasury Board Accounting Standard 1.2. In addition, this presentation for the same nature of transactions was not consistent with that of FY2011-2012 and FY2012-2013. Following the discussion with Corporate Accounting, some adjustments were made; however, the inconsistent presentation issue still exists.  As the rationale was not provided at the closing of the audit field work, the auditors were unable to determine the appropriateness of the reconciliations.

In summary, with the exception of the issue identified in the Note 3 reconciliation, based on the above procedures, the revised disclosures related to disposal and write-offs of tangible capital assets are consistent with the requirements of Treasury Board Accounting Standard 1.2.

2.0 Recommendations

As a result of performing the specified audit procedures, the following areas for improvement were identified:

• 1. The Chief Financial Officer should ensure that all disposals and write-offs are recorded in the appropriate accounting year.
• 2. The Chief Financial Officer should review its current reconciliation process of Note 3 a) to the Financial Statements to ensure that all affecting items are included in Note 3 a) reconciliations in accordance with Treasury Board Accounting Standard 1.2.

The management action plan to address these recommendations is contained in Appendix A.

3.0 Conclusion

Based on the audit procedures performed, the auditors concluded that the reported amount of disposals and write-offs in the Departmental Financial Statements were not materially misstated.

Two recommendations were developed to address control weaknesses identified in the audit.

Appendix A: About the Audit

Audit Objective

The objectives of this audit were to perform specified procedures on tangible capital assets disposals and write-offs to assess whether:

• Disposals and write-offs for tangible capital assets were materially misstated in the context of the Departmental Financial Statements;
• Disposals and write-offs for tangible capital assets were properly recorded and reported; and
• Year-end procedures were properly documented and followed.

Audit Scope

The scope of the audit focused on tangible capital assets disposals and write-offs. It excluded any disposals and write-offs not related to tangible capital assets, such as debt write-offs and disposal of surplus materiel.

This audit was intended to perform specified audit procedures in the context of reviewing the FY2014-15 Departmental Financial Statements.  It was not designed to provide an audit opinion on the overall Departmental Financial Statements, but rather, these specified procedures provided information on the accuracy and completeness of the tangible capital assets disposals and write-offs reported.

Audit Approach and Methodology

This audit adopted the previous year’s approach used for specified audit procedures to:

• Obtain the understanding of the roles and responsibilities, business processes, systems and internal controls in the areas of identification, approving, recording and reporting disposals and write-offs of tangible capital assets; and to review the related accounting policy and year-end procedures, as well as the documented business process maps and control matrix prepared by management as part of the requirements of the Treasury Board’s Policy on Internal Control;
• Perform analytical procedures to assess the reasonableness of the total disposals/write-offs reported;
• Perform substantive testing based on established sampling strategy to assess whether disposal and write-offs of capital assets were properly recorded and reported in the proper period; and,
• Review the financial statements and related disclosures areas to assess the accuracy of disposals and write-offs reported and the compliance with the form and content specified in Treasury Board Accounting Standard 1.2.

Appendix B: Management Action Plan

Audit Recommendation 1

The Chief Financial Officer should ensure that all disposals and write-offs are recorded in the appropriate accounting year.

Management Action

Corporate Accounting will meet with all FMAs in November 2015. This session will be supplemented by an information bulletin on year end procedures. The session and information bulletin will review accounting requirements to ensure that asset sale transactions, including disposals and write-offs, are posted in the appropriate fiscal year and that all supporting information is forwarded to Corporate Accounting in a timely manner.

Area Responsible

SMO

Expected Completion Date

March 2016

Audit Recommendation 2

The Chief Financial Officer should review its current reconciliation process of Note 3 a) to the Financial Statements to ensure that all affecting items are included in Note 3 a) reconciliations in accordance with Treasury Board Accounting Standard 1.2.

Management Action

Corporate Accounting will review its current Note 3 reconciliation process and adjust procedures as required by March 31, 2016. Changes will be implemented for the 2015-16 financial statements.

Area Responsible

SMO

Expected Completion Date

July 2016