1989 Report of the Auditor General of Canada

Main Points

2.1 The financial statements of the Government of Canada are included in Section 2 of Volume I of the Public Accounts. These financial statements continue to be based on certain accounting policies that I believe are inappropriate. As a result, the statements:

• do not include sufficient allowance for Crown corporation borrowing (paragraphs 2.41 to 2.56);
• do not include Crown corporations in the reporting entity (2.57 to 2.61); and
• do not include the full liability for indexing of employee pensions (2.62 to 2.65).

2.2 These are not just technical matters, of interest only to accountants. In my opinion, the result of using these inappropriate accounting policies is that the government's financial statements do not reliably inform parliamentarians and others who read them (2.24 to 2.39).

2.3 In November 1988, the Canadian Institute of Chartered Accountants' Public Sector Accounting and Auditing Committee issued two new pronouncements. Measures recommended in these pronouncements, if implemented by the government, would resolve my concerns with the government reporting entity and with the liability for indexing of employee pensions (2.15 to 2.23).

2.4 Important features of the Canadian system of governing -- consent of the governed, an executive entrusted with great powers, imposed limits on executive powers, and oversight of executive actions -- depend in part on the availability of good financial information. The Public Accounts of Canada are a major source of annually reported financial information (2.66 to 2.72).

2.5 However, the Public Accounts do not include a comprehensive but concise annual financial report similar to annual reports published by corporations in the private sector (2.73 to 2.81).

2.6 In addition, the Public Accounts use inconsistent accounting and classification practices, which make it difficult to compare actual with forecast results or to move easily between summary-level and detailed information (2.82 to 2.93).

Introduction

My audit opinion on the government's financial statements continues to include three significant reservations. In my view, the government's statements do not present information fairly. In addition, the Public Accounts, which contain the statements, are complex and difficult to use.

2.7 The financial statements of the government for the year ended 31 March 1989, and my audit opinion on them, are in Section 2 of Volume I of the Public Accounts of Canada. In this chapter, I present additional information and comments on the government's financial statements and my audit opinion. I also comment on the role of the Public Accounts and offer two suggestions for their improvement.

2.8 The government's financial statements convey a highly summarized financial overview of its various activities. The overview includes the government's cash balances and investments together with amounts owing to and by the government at the end of the year (its financial position); its revenues and expenditures for the year (the results of operations); and the extent to which cash going out exceeded cash coming in (the government's financial requirements).

2.9 My audit opinion tells readers about two matters. First, whether the financial statements were prepared according to the government's accounting policies, applied consistently from year to year. Second, whether users of the statements can rely on them to present fairly the government's financial position, results of operations and financial requirements.

2.10 As in 1988, I have concluded and reported that the government's financial statements do not present fairly its financial position, results of operations and financial requirements. The reason is that three of the accounting policies used by the government in preparing the statements are, in my judgment, inappropriate.

2.11 During the fiscal year, the Canadian Institute of Chartered Accountants' Public Sector Accounting and Auditing Committee (PSAAC) issued two new pronouncements. Measures recommended in these pronouncements, if implemented by the government, would resolve my concerns about two of the three accounting policies that I believe are inappropriate.

2.12 Important features of the Canadian system of governing -- consent of the governed, an executive entrusted with great powers, imposed limits on executive powers, and oversight of executive actions -- depend in part on the availability of good financial information. The Public Accounts of Canada are a major source of annually reported financial information.

2.13 In 1986, published results of a research project undertaken jointly by my Office and the United States General Accounting Office indicated that parliamentarians and others need a comprehensive but concise annual financial report, similar to annual reports published by corporations in the private sector. The government has not developed such a document, although some progress has been made in reshaping Volume I of the Public Accounts of Canada.

2.14 The Public Accounts are complex and difficult to use. Inconsistencies in accounting and classification practices make it difficult to compare actual results with forecast results or to move easily between summary-level information and detailed program accounting information. The complexity can be reduced by making appropriate changes to accounting practices used to prepare departmental Estimates.

The Canadian Institute of Chartered Accountants' Public Sector Accounting and Auditing Committee

Implementation of accounting recommendations issued by the Canadian Institute of Chartered Accountants' Public Sector Accounting and Auditing Committee would help the government present information fairly.

2.15 At present, the federal and provincial governments in Canada prepare their financial statements in accordance with accounting policies that each has developed. These policies differ from government to government. As a consequence, it is difficult for those who use the financial statements to compare one government with another.

2.16 It is also difficult for those who prepare and audit government financial statements to know when they are presenting information fairly and when they are not. Although a framework is now in place, there is not yet an agreed-upon set of standards for good accounting and reporting practice, to help users get the information they need and to help preparers and auditors assess fairness.

2.17 In March 1981, the Board of Governors of the Canadian Institute of Chartered Accountants established the Public Sector Accounting and Auditing Committee (PSAAC). The 19-person committee is composed of senior public sector officials, public accountants and academics. Public sector officials include deputy ministers, comptrollers and auditors general and senior executives of government-owned corporations from federal, provincial and local governments. Input and advice is sought from about 100 other people, including users, preparers and auditors of government financial statements. PSAAC provides a forum for considering the needs of users, preparers and auditors, and an opportunity to develop and recommend enhanced accounting principles and disclosure standards for consideration by Canadian governments and their legislative auditors.

2.18 The existence of PSAAC does not alter the responsibility of legislative auditors to exercise independent professional judgment when they examine and report on government financial statements. However, PSAAC can help legislative auditors discharge this responsibility better by developing a consensus view of appropriate financial reporting practice that both governments and auditors can refer to in assessing fairness. The result should be financial statements and audit reports that are more attuned to user needs and more comparable, both over time and from government to government.

2.19 During the fiscal year, PSAAC completed a framework for generally accepted accounting principles and financial reporting standards appropriate for governments. This framework comprises the following three pronouncements on accounting:

Accounting Statement 2	identifies five objectives of (1984) government financial statements;
Accounting Statement 3	sets out 35 general reporting (1986) principles and disclosure standards for information in government financial statements; and
Accounting Statement 4	addresses the principles and (1988) criteria for determining which activities should be included in government financial statements, and how these activities should be accounted for if they are brought in.

2.20 PSAAC also issued Accounting Statement 5 in November 1988 dealing with accounting for employee pensions. In addition, a research study on the recording and reporting of physical assets has now been completed. Another project, examining how governments should account for and report transfer payment programs, is well under way.

2.21 The financial statements of the government comply with all but four of the principles and standards recommended in Statement 3. Those recommended in Statements 4 and 5 have not yet been implemented. They are the subject of Reservations 2 and 3 in my audit opinion on the government's 1989 statements.

2.22 The recommendations in PSAAC Accounting Statement 3, with which the government's financial statements do not yet comply, require:

• a statement of changes in financial position;
• disclosure of the government's acquired physical assets on hand and available for use at the end of the year;
• a comparison of actual results with those originally forecast by the fiscal plan; and
• revenues to be accounted for on the accrual basis where practicable.

I have not yet added a reservation to my audit opinion on the government's statements because of its failure to implement these recommendations. However, I believe that they are sound, and I would encourage the government to implement them at the earliest possible date.

2.23 I support PSAAC and recommend its pronouncements to both the government and to parliamentarians.

Background Information on My Audit Opinion

In giving my opinion on the government's financial statements, it is important to realize that I am not guaranteeing the absolute accuracy of the statements. Every year, the government enters into millions of transactions involving many billions of dollars. Errors do creep in, and some may go uncorrected. When I audit the government's statements, I seek reasonable assurance that they do not contain errors whose total effect would be material enough to mislead the reader.

2.24 In the next four sections I consider in more detail what my audit opinion on the government's financial statements means and how I arrived at it.

Mandate for My Audit of the Government's Financial Statements

2.25 The mandate for my audit of the government's financial statements is contained in section 6 of the Auditor General Act. Section 6 states that "the Auditor General shall examine the several financial statements required by section 64 of the Financial Administration Act to be included in the Public Accounts, and any other statement that the President of the Treasury Board or the Minister of Finance may present for audit and shall express his opinion as to whether they present fairly information in accordance with stated accounting policies of the federal government and on a basis consistent with that of the preceding year together with any reservations he may have".

An Overview of My Audit Opinion

2.26 My audit opinion on the government's financial statements consists this year of two paragraphs followed by three reservations. The first paragraph, commonly referred to as the "scope" paragraph, identifies the financial statements that I have examined and reported on and the nature and extent of the audit work that I have performed. The second paragraph, commonly called the "opinion" paragraph, contains my conclusions about the government's financial statements.

2.27 The scope paragraph. The scope paragraph begins by listing the financial statements covered by my opinion. These financial statements, and the information they convey, are summarized below. The Statement of Use of Appropriations that was presented for audit in the past has been replaced by a summary note to the financial statements (Note 3) in the current year. Details respecting the use of appropriation authorities continue to be presented in Volume II (Part I) of the Public Accounts.

Financial Statement	Information Conveyed
Statement of Transactions	the extent to which cash going out exceeded cash coming in (financial requirements)
Statement of Revenue and	what the government's revenues
Expenditure and	and expenditures for the year
Accumulated Deficit	have been (results of operations)
Statement of Assets and	the government's cash balances
Liabilities	and investments, together with amounts
	owing to and by the government at the end
	of the year (financial position)

It is important to note that my audit opinion relates only to these summary financial statements and related notes contained in Section 2 of Volume I of the Public Accounts of Canada. It does not extend to the more detailed information presented in other sections of the Public Accounts Volume I, or to Volumes II and III.

2.28 The scope paragraph concludes by stating that my audit work on the government's financial statements has been conducted according to generally accepted auditing standards prescribed by the Canadian Institute of Chartered Accountants. I use these standards to ensure that my audit is conducted with appropriate rigour and professionalism.

2.29 The opinion paragraph. The opinion paragraph contains my conclusions about two matters. First, whether the financial statements were prepared in accordance with the government's stated accounting policies consistently applied. Second, whether the financial statements may be relied on to present fairly the government's financial position, results of operations and financial requirements. If I conclude that the statements inform readers reliably, I state that information is "presented fairly"; if they do not, I use the phrase "do not present fairly", and add supporting "reservations" to explain why.

2.30 This year, as in 1988, I have concluded and reported that the financial statements have been prepared in accordance with the government's stated accounting policies. But I have concluded that these stated accounting policies result in a display of information about the government's overall financial position, results of operations and financial requirements that is not reliable. The overall effect on the government's financial statements is not fully determinable. However, each of the statements is materially affected. As a result, I continue to report that the financial statements do not present information fairly, for the reasons set out in three reservations.

2.31 I have made two changes to my opinion paragraph this year. First, I have concluded and reported that the government's stated accounting policies have been consistently applied with one exception. As disclosed in Note 4 (ii), the accounting for income tax refunds has changed. Second, I have deleted reference to the Statement of Use of Appropriations because it has been replaced by a new summary note (see paragraph 2.27).

Materiality and Audit Assurance

2.32 In planning my audit of the government's financial statements, I consider two main factors that determine the nature and extent of the work required. The first of these is a dollar figure called "materiality". This represents a threshold: if total errors fall below this threshold, the financial statements present information fairly; if they exceed this threshold and are not corrected, I refer to them in reservations to my opinion. The second factor is a percentage figure called "audit assurance". This represents how certain I want to be that my audit will reveal total errors that equal or exceed the materiality threshold.

2.33 At the conclusion of the audit, I determine whether the effect of uncorrected errors in the financial statements would mislead those who use the statements. If the effect would be to mislead, I include a reservation in my audit opinion.

2.34 In conducting my audit, I cannot be 100 percent certain that it will reveal all errors in the financial statements that, individually or in total, may be material. The size and complexity of the government, as well as cost considerations, make it impractical for me to examine all or even most of the $1.5 trillion-worth of individual transactions entered into during the year.

2.35 What I can do is verify samples of transactions and account balances, determine whether significant financial controls within the government are working and can be relied on to produce complete and accurate data, and carry out other procedures -- such as confirming year-end balances with third parties and performing analyses -- to identify anomalies in the reported data.

2.36 What this comes down to is exercising professional judgment about how much auditing is required to provide reasonable assurance to users of the statements that they can rely on reported results and not be misled.

Auditing for Compliance with Parliamentary Authorities

2.37 As part of my audit of the government's financial statements, I examine and verify compliance with parliamentary authorities to spend, borrow and raise revenues. I do this to the same level of materiality and audit assurance as that established for my audit of the government's overall financial position, results of operations and financial requirements. However, this level of materiality is significantly larger than many of the authorities being audited.

2.38 For example, spending authority is granted by Parliament in Appropriation Acts, commonly called votes. There were over 400 in the current year. Many departments are responsible for several votes, whose size and complexity vary greatly. Votes range in size from a few thousand dollars to several billion dollars. It would not be practical for me to audit each vote every year to a level of materiality appropriate to its size.

2.39 I have therefore decided to perform detailed verifications of individual authorities on a cyclical rather than an annual basis. The results of this work are included in the applicable chapters in this annual report to Parliament.

Background Information on the Reservations in My 1989 Audit Opinion

2.40 The next three sections present background information on the three reservations stated in my audit opinion on the government's 1989 financial statements.

Reservation 1: Failure to Provide for Crown Corporation Borrowings

This reservation concerns the Canadian Wheat Board, an agent Crown corporation that is not included in the government's financial statements. The government has guaranteed the Board's borrowings, so it is responsible if the Board cannot pay. In my judgment, the value of the Board's recorded assets is not sufficient to repay its borrowings. I believe that an allowance for at least $1.5 billion of the Board's borrowings should be recorded in the government's statements.

2.41 The Canadian Wheat Board (CWB) buys grain from Canadian farmers and sells it on the world market. Under the CWB Act, any profit on operations is distributed to farmers, with any loss being absorbed by the government. The terms of sales generally specify cash on delivery. However, credit sales are also made, but only with the concurrence of the government and within guidelines it has established. The Board finances its accounts receivable from credit sales by borrowing. CWB's borrowings are fully guaranteed by the government. Repayment of its borrowings depends on receipt of payment for its credit sales.

2.42 As described in Note 13 to the government's financial statements, the CWB has borrowed $3.7 billion, mainly to finance these accounts receivable. On 31 March 1989, CWB was owed approximately $3.2 billion in accounts receivable from countries experiencing difficulties in repaying their debts. Included in this figure is about $1.5 billion of interest that CWB has charged the countries. More than one half of this accrued interest has been converted to new principal by CWB at the direction of the government. This was done as part of debt rescheduling to ease the financial burden on countries experiencing repayment difficulties. These difficulties continue and, in some cases, further debt rescheduling is expected.

2.43 I believe that the reported value of amounts receivable from sovereign states has been impaired, putting the government at risk for some portion of CWB's borrowings.

2.44 An allowance has not been established in CWB's financial statements for reducing the value of amounts owed by countries experiencing repayment difficulties, and interest revenue on these amounts is still being recorded in the accounts. This is being done even where payments are not being received. The reason given by the Board for not establishing a valuation allowance for these receivables is that the government is at risk, not CWB, should any of the Board's receivables prove uncollectible. (See Chapter 4 paragraphs 4.10 to 4.16 that deal with a related concern).

2.45 According to the accounting policy stated in Note 1(vii) to the government's financial statements, amounts receivable from sovereign states are not reduced in value unless a state has formally repudiated its debts. But why would a country formally repudiate its debts when a rescheduling agreement can be obtained that spreads out repayments over an extended period and includes a grace period of several years? Moreover, converting past due interest to principal does not necessarily create assets with value, as the Estey Report on the collapse of the Canadian Commercial Bank and the Northland Bank has pointed out.

2.46 The government has used the accounting policy stated in Note 1(vii) to determine whether assets of agent Crown corporations have sufficient value to repay corporate borrowings. If borrowings exceed a corporation's ability to repay, a liability is recorded by the government under the accounting policy in Note 1(i). The purpose of this policy is to recognize borrowings that the government will likely have to repay. However, application of this accounting policy does not permit the risk associated with CWB borrowings to be recognized, because the countries that owe money to the Board have not formally repudiated their debts.

2.47 I believe that the government should provide an allowance for some portion of CWB's borrowings. The allowance would recognize the risk to the government of countries with repayment difficulties not repaying CWB. There are many methods that may be considered in determining the risk of loss on sovereign debts. Most have been developed to value sovereign debts owed to commercial banks. This does not necessarily make them inappropriate for governments.

2.48 A study recently submitted to the Public Accounts Committee of the United Kingdom concluded that there was "...no clear difference..." between the government's Export Credits Guarantee Department (ECGD) and commercial banks. The study explained that "...their objectives differ, but in essence, not their prospects of recoverability. The prudence concept of accounting requires the ECGD to recognize the potential losses on sovereign exposure in the form of provisions in the accounts. The best available measure of such losses is provided by the Bank of England's matrix". (The Bank of England's matrix is the U.K. version of the Canadian Superintendent of Financial Institutions' rules.)

2.49 Accordingly, one method of determining the risk of loss on sovereign debts would be to use the valuation guidelines developed by regulatory agencies of national governments for commercial banks. In Canada, the rules developed by the Superintendent of Financial Institutions provide for the risk of non-payment by requiring that a valuation allowance be established of between 35 percent and 45 percent of loans receivable from countries experiencing repayment difficulties. They also provide for accrual of interest to cease where countries are significantly in arrears. Sound accounting practice requires that interest revenue should not be accrued when the ultimate collectability of amounts receivable is not reasonably assured.

2.50 Another method of valuing loans by commercial banks to sovereign nations, which could be used, is by reference to prices in what is called the secondary market for foreign country debts owed to commercial banks. Banks buy and sell in this market to rearrange their holdings of sovereign loans receivable. The secondary market is relatively small compared with other financial markets and does not deal in sovereign-to-sovereign debts. It does, however, assign a value to the risk associated with amounts owed to commercial banks by countries experiencing repayment difficulties.

2.51 As explained in Note 13 to the financial statements, the government believes that payment delays on amounts receivable from sovereign nations are not necessarily indicative of a future loss requiring a valuation allowance (emphasis added). This may be so, but the individual circumstances of each country must be looked at separately. There may be situations where payment delays do indicate future losses. The government does not necessarily receive preferential treatment.

2.52 Moreover, history shows that defaults on sovereign debts do cause real losses. The debt crises of the 1870s, 1890s and 1930s were quite similar to the situation faced today. Although outright repudiation by countries was relatively infrequent, sovereign debtors often sought relief from external debts through complete or partial suspension of repayments followed by renegotiation of the terms and conditions of their loans. In order to settle the defaults, creditors often had to reduce interest rates, reduce the nominal value of the defaulted bonds, or both. In other words, defaults caused real losses.

2.53 Recent proposals to ease the financial burden of external debts on countries experiencing repayment difficulties are strikingly similar. They call for reductions in interest rates and/or reductions in the nominal value of loans and/or extended grace periods. Even the International Monetary Fund and the World Bank -- two of the largest sovereign lenders -- recognize the risk of loss on sovereign debts in their published financial reports.

2.54 I believe that an appropriate allowance for Canadian Wheat Board borrowings should be recorded in the Government's financial statements. There is no simple right answer for the amount of sovereign debt risk to be recognized in this manner. But prudence requires that some reasonable amount be included in the government's financial statements to keep them from being misleading. Clearly, with CWB's receivables in arrears and being rescheduled, there is a very real risk that amounts owing to the Board will ultimately not be repaid. Even if amounts due were ultimately to be repaid, there is the risk of costs associated with repayment delays. And there is the risk of impairment in the present value of amounts owing from what may become virtually "perpetual renegotiation".

2.55 Our analysis indicates that the allowance could range from $1.5 billion to $2.0 billion. In my judgment, the government should record an allowance of at least $1.5 billion. If this were done, reported liabilities and the accumulated deficit would be increased by at least $1.5 billion ($1.3 billion in 1988).

2.56 In saying this, I am not in any way suggesting that CWB should write off its accounts receivable from debtor countries. Sound collection practices must prevail if public assets are to be protected. An allowance for loss on sovereign debts can be recorded in the government's financial statements, without naming specific sovereign debtors. There is no reason why recording such an allowance should in any way impair collection of amounts due. The government is clearly at risk for at least $1.5 billion in borrowings by the CWB that it has guaranteed, and the government's summary financial statements should reflect this reality.

Reservation 2: Failure to Include Crown Corporations in the Government Reporting Entity

In my judgment, the government's financial statements are incomplete. They include government activities of departments, but they do not include government activities of Crown corporations. The government is bigger, and its activities more diverse, than the statements now reveal.

2.57 Although disclosure is now provided in Note 8, the assets, liabilities, revenues and expenditures reported in the separate financial statements of Crown corporations are excluded from the financial statements of the Government of Canada as described in Note 1(i). As a result, I believe that the government's financial statements do not provide a comprehensive and complete summary of the full nature and extent of the financial affairs and resources for which the government is responsible. As of 31 March 1989, the net investment in Crown corporations whose financial statements are excluded from the government reporting entity amounted to approximately $19 billion or about 44 percent of the government's total financial assets.

2.58 In November 1988, PSAAC issued Accounting Statement 4, Defining the Government Reporting Entity. This Statement recommended an approach to accounting for government organizations that, if implemented, would make the government's financial statements more comprehensive and complete. If this approach were taken, the financial statements of government-owned corporations that are non-commercial in nature, such as the Canadian Broadcasting Corporation and the Canada Council, would be "consolidated" into the government's financial statements. This means that their assets, liabilities, revenues and expenditures would be added, on a line-by-line basis, to the assets, liabilities, revenues and expenditures of government departments and agencies. Transactions and account balances between these corporations and departments and agencies would be eliminated.

2.59 Government-owned corporations that are commercial in nature, such as Petro-Canada and the Canadian National Railway System, would be included in the government reporting entity on what is known as the "modified equity" basis of accounting. This would mean that the government's investment in commercial Crown corporations would be increased by the government's share of corporate net profits (decreased by corporate net losses), with a corresponding increase (decrease) in its non-tax revenues. Corporate assets, liabilities, revenues and expenditures would not be added to those of departments and agencies on a line-by-line basis as in "consolidation".

2.60 The exclusion of Crown corporations from the government reporting entity has a significant effect on the government's reported financial position and results of operations. Note 8 to the government's financial statements discloses what the statements would look like if prepared as recommended in Accounting Statement 4.

2.61 The figures in Note 8 do not include provision for sovereign debt risk for either the Canadian Wheat Board (CWB) or the Export Development Corporation (EDC). The need for a provision in respect of CWB is discussed in paragraphs 2.41 through 2.56. EDC is discussed in Chapter 4 of this report (paragraphs 4.17 to 4.19) and also in my audit opinion of the Corporation's 1988 financial statements reproduced in Volume III of the Public Accounts of Canada.

Reservation 3: Unrecorded Liabilities

This reservation concerns unrecorded employee pension liabilities. Basic pension benefits are fully provided for in the government's financial statements, but indexed benefits are not. In my view, an additional liability for employee pensions should be included in the government's statements.

2.62 The government has defined liabilities as financial obligations to outside organizations and individuals, resulting from events and transactions recorded as of the closing date (31 March). However, in accordance with the accounting policy stated in Note 1(v), and as described in Note 12, financial obligations related to the indexing provisions of employee pension plans (including those of the public service, the Canadian forces, the Royal Canadian Mounted Police, Members of Parliament and judges) have not been fully recorded. I believe they should be.

2.63 Although Note 12 is informative, it does not change the fact that, until the government adjusts the financial statements to reflect an additional liability for pension indexing, the burden is on the reader to do so. I consider this both undesirable and unfair. A reader unfamiliar with financial statements may get quite a different picture than a reader with more experience.

2.64 Government officials have advised me that they will record an appropriate liability for indexing when revised employee pension legislation becomes law. At the date of signing my opinion on the government's financial statements, this revised legislation had not been presented to the House of Commons.

2.65 In November 1988, PSAAC issued Accounting Statement 5, Accounting for Employee Pension Obligations in Government Financial Statements. This Statement recommended an approach to accounting for employee pension obligations that, if implemented by the government, would result in financial obligations in respect of indexing being fully recorded in the government's financial statements. Implementation of these recommendations would allow me to delete Reservation 3 from my audit opinion on the government's statements.

The Role of the Public Accounts of Canada

Important features of the Canadian system of governing depend in part on the availability of good financial information. The Public Accounts are a major source of annually reported financial information.

2.66 The features of the Canadian system of governing that depend in part on the availability of good financial information are:

• consent of the governed;
• an executive entrusted with great powers;
• imposed limits on the executive's use of its powers; and
• oversight of executive actions.

2.67 Government in Canada is based on consent, formally given by representatives in Parliament through the annual appropriation of supply, approval in principle of the Budget and passage of specific legislative proposals. Information on the intended benefits, costs and financial effects of government proposals is needed before Parliament gives its consent. Subsequently, periodic reporting of financial information is needed to compare actual costs, tax burdens and other financial effects with those intended and for which consent was given.

2.68 The system in Canada provides for a strong executive entrusted with great power. The historical reasons for a strong executive are several, including the belief that legislation cannot be formulated to foresee every eventuality; consequently, the executive is trusted to exercise discretion in the application of the laws. Reports of the actual costs and financial effects of government activities are needed to assess whether, from a financial point of view, executive discretion was appropriately exercised.

2.69 Limits on the use of executive authority are a constitutional strategy to protect individuals' liberty from abuse by the powers of the state. Some limits are financial (for example, the system of parliamentary appropriation) and financial records are needed to show whether the executive has complied. Another important limit is jurisdiction; for example, the National Parole Board has sole authority to decide who is released on parole. The practice of granting separate appropriations by department or agency facilitates the control imposed by jurisdictional limits and promotes financial accountability of ministers and public service managers.

2.70 The oversight of the executive in Canada is performed by parliamentarians, the public and interest groups. Parliamentary oversight is as extensive as Members of Parliament make it. Some oversight is accomplished through the news media. The possibility of review helps deter behaviour such as unfairness, fraud, waste, extravagance, embezzlement and misappropriation.

2.71 In the early days of Confederation, protection of the taxpayers' purse was accomplished by publishing the detailed records of financial transactions. These detailed publications evolved into the present-day Public Accounts. Modern government is much larger and more complicated. Publishing financial information at a level of detail comparable to what was published 50 or 100 years ago is not practical; there is a need to be selective in what is published. The government should continue taking the initiative to provide in the Public Accounts basic information that will help the system of governing operate properly. But Parliament must also demand good information.

2.72 A unique opportunity to improve the Public Accounts and related financial information is now developing. The electronic information age has arrived. Its possible effects on the government's 20 year old central accounting and reporting systems, and on departmental systems, are now being studied by central agencies. The government is identifying and pursuing opportunities for improvement at a rapid pace. Parliamentarians can have a voice in these deliberations.

The Need for a Concise Annual Financial Report

Publication of a comprehensive but concise annual financial report, similar to annual reports published by corporations in the private sector, would help parliamentarians and others obtain a complete picture of government without getting buried in massive amounts of detail.

2.73 In 1986, the results of the two-year Federal Government Reporting Study (FGRS) were published. FGRS was a research project undertaken jointly by my Office and the United States General Accounting Office. Its purpose was to identify the financial information users need to have about federal governments. The results of the study have been provided to Members of Parliament, the government and PSAAC for its consideration. Copies of the reports on FGRS are available from my Office.

2.74 One question we dealt with in FGRS was how the government's annual financial statements should be communicated. At present, the financial statements are presented in the Public Accounts of Canada, a three-volume set of documents of massive proportions. Users found this presentation cumbersome and difficult to work with. They called for a simpler, more focussed approach to presenting the government's overall numbers. And they wanted some context for the numbers in plain, non-technical language.

2.75 The prevailing view of user respondents was that a comprehensive but concise annual financial report by the federal government would be extremely valuable. They wanted such a report to provide a broad picture and a more complete understanding of the government's activities and resulting financial position and to serve as a key to the more detailed information the government provides in other financial documents.

2.76 Besides basic financial information, such as the government's assets, liabilities, revenues, expenses, deficit and borrowing requirements, most users wanted an annual report to contain other information that would increase their understanding of these indicators. Supplementary information often requested included data on tax expenditures, common measures of the performance of the economy, the effects of inflation, regional breakdowns of revenues and expenses and government employment. Users recognized that such information can be presented in an annual financial report only in a highly summarized format. Nevertheless, they wanted such summary information included, along with references that would allow them to find detailed information on matters they might want to examine further.

2.77 Many users also thought graphs and charts would allow information to be captured quickly and communicated easily. They wanted the charts to provide data for 10 years, where possible; numerical values should also be included to facilitate analysis of trends.

2.78 Since the publication of FGRS, I have been pleased to observe that the government has taken a number of steps to improve the way in which it communicates summary information to users. In 1987, Section 1 of Volume I of the Public Accounts of Canada was completely redone. The section now includes a financial overview containing tables, charts and explanatory narrative, together with more detailed supplementary information. Where possible, data are presented on a comparative basis for 10 years. Topics covered include the deficit and net debt, factors affecting the deficit, and factors affecting financial requirements. Public Accounts Volume I has also been reduced in size. Information not directly related to the government's summary financial statements has been moved to Volume II. With additional work, Volume I of the Public Accounts might well become the sort of concise annual financial report that users need.

2.79 In addition, the Department of Finance continues to publish two four-page documents entitled The Fiscal Monitor and The Economy in Brief. These quarterly publications are attractively presented and contain tables, charts and text designed to help users obtain a complete picture, without getting buried in massive amounts of detail.

2.80 In April 1989, the Department of Finance also published a highly informative financial overview, entitled Where Your Tax Dollars Go . This new document summarizes and explains federal spending, with a primary focus on who received federal funds.

2.81 I encourage the government to continue improving the presentation of summary information to users.

The Need for More Consistency

More consistency in accounting and classification practices within the Public Accounts would make it easier to compare actual with forecast results and to move between summary-level and detailed information.

2.82 The Budget is prepared on one basis of accounting while the Main Estimates are prepared on another basis. The Budget also includes reserves for Supplementary Estimates net of lapses. There is a lack of clear, obvious links between similar information in these two documents. For example, Table 4.4 from the 1989-90 Budget Fiscal Plan and Table 4.1 from Part I of the 1989-90 Estimates both present expenditures by type of payment (see Exhibit 2.1). The only amount in the 1989-90 columns that is the same in both tables is $39.4 billion of projected public debt charges. The 1989-90 projected expenditure totals differ by $12 billion. This difference is analyzed in Table 2.2 of Part I of the 1989-90 Estimates.

(This exhibit is not available)

2.83 The differences in accounting between Budget and Estimates are reflected in the Public Accounts. Detailed information in Volume II of the Public Accounts often cannot be easily tied in to the government's summary financial statements in Volume I. Consider the question: What was the effect of government activities related to employment and insurance on the deficit in 1987-88? The possible answers are shown in Exhibit 2.2. Depending on one's knowledge of government organization and accounting expertise, the two possible answers differ by almost $2 billion. The correct answer -- $2.447 billion -- could be determined only by someone who knows the composition of the government's valuation allowances. This information is not available from published sources.

(This exhibit is not available)

2.84 In paragraphs 2.66 through 2.72, we set out the uses of financial information in the Canadian system of governing: it is the basis for consent to executive action; for imposing financial limits; and for oversight by Parliament and the public. These uses can be better served if financial information is comprehensive in its coverage of government activities and understandable to those who need to use it.

2.85 As part of the 1986 Federal Government Reporting Study (see paragraphs 2.73 through 2.81), we consulted Members of Parliament on their financial information needs. The study report summarized the characteristics such information should possess:

It needs to be presented in a way that allows the Member to move easily from summary-level data to the more detailed accounting of the particular issue of concern. Information should allow first an overview and then a more detailed analysis of individual departments' expenditures and performance. This information requirement extends to the review of the government's Budget, the Estimates of the various departments and agencies, and the annual reports of the various government-owned corporations. In carrying out their parliamentary activities, Canadian Members want to be able to compare reported actual results with forecasts in the Budget and Estimates (requests for spending authority) and with spending and borrowing limits set by acts of Parliament. It is essential, therefore, that there be consistency in classification and format among the basic financial reports of the government.

2.86 In our view, financial information in the Public Accounts, Budget and Estimates does not have the characteristics that Members believed to be essential to their activities. Inconsistencies in accounting and classification practices make it difficult to compare actual results with forecast results or to move easily between summary-level data and detailed program accounting data.

2.87 Government accounting, like all accounting, is continually evolving. Major trends in government summary financial reporting over the last 20 years have been:

• the elimination of internal transactions and balances so as to report in terms of transactions with outside parties;
• the grossing up of amounts of revenues netted against expenditures and of expenditures netted against revenues;
• a more complete reporting of the liabilities of the government; and
• the provision of allowances to reduce the recorded values of financial assets to estimated amounts realizable.

2.88 The changes in accounting policies and practices have resulted in substantial improvement to the completeness and comprehensiveness of reporting in the government's summary financial statements and in the Budget. However, many of the changes were implemented by making accounting adjustments only at the summary level. The accounting changes have not been implemented at the program level where the departmental Estimates are prepared. The Estimates and program-level reports in the Public Accounts continue to follow accounting practices developed for reporting on the use of appropriation authority. The government abandoned these practices for purposes of summary reporting because they were considered to be inappropriate.

2.89 The complexity can be reduced by carrying down to the program level the adjustments now made only at the summary level. There would then be a single definition of expenditure used for summary reporting, for preparing Estimates and for reporting expenditures at the program level. There would be a corresponding single definition of revenue. This accounting change would eliminate the current difficulty in relating detailed program information to summary-level information. It would also reduce the complexity of tables in the Public Accounts.

2.90 The government should prepare its spending Estimates and account for and report its revenues and expenditures at the program level in accordance with the accounting policies and practices it uses for summary reporting.

2.91 The accounting changes over the last 20 years reflect a trend toward accounting for revenues and expenditures in terms of gross transactions with outside parties. The gross amount of revenues and expenditures is needed to understand the full magnitude of government financial activity and its impact on the economy. It is also needed to fully report on the use made of revenue and spending authorities.

2.92 Current Budget presentations do not fully gross up all the revenues from or expenditures to outside parties. In excess of $2 billion of tax and non-tax revenues are netted against expenditures. As disclosed in Note 4 to the government's financial statements, a further $2 billion of expenditures, in the form of refundable tax credits, are netted against tax revenues. One effect of netting refundable tax credits is that the income tax load on individuals, when compared with that on corporations, is understated by $2 billion. I have not commented on the practice of netting in a reservation to my opinion on the government's financial statements because it has no effect on the reported deficit for the year. However, if the practice becomes more pervasive, reported revenues and expenditures may become so distorted that a reservation will be required.

2.93 The government should account for and report its revenues and expenditures consistently in terms of gross transactions with outside parties.