This Web page has been archived on the Web.

1990 Report of the Auditor General of Canada

Main Points

3.1 The Auditor General Act requires the Auditor General to include in his annual report matters of significance that, in his opinion, should be brought to the attention of the House of Commons.

3.2 The Audit Notes chapter fulfils a special role in the annual Report. Other chapters normally describe the findings of the comprehensive audits we perform in particular departments; or they report audits and studies of issues that relate to government operations as a whole. The Audit Notes chapter is a compilation of individual matters that have come to our attention during our financial audits of the Public Accounts of Canada, Crown corporations and other entities. It is also used to report some specific matters that have come to our attention during the performance of our comprehensive audits.

3.3 The chapter contains a wide range of notes. Three relate to Crown corporations, and the balance to departmental operations. The three Crown corporation notes deal with allowances for potentially significant financial losses. Two notes on departmental operations deal with costly unintended income tax benefits provided by the Canadian tax system. The other notes on departmental operations generally concern expenditures of public money without due regard for economy or without adequate authority.

3.4 While the notes report matters of significance, they should not be used as a basis for drawing wider conclusions about matters we did not examine.

Introduction

3.5 This chapter contains matters of significance that have come to our attention during the performance of our audits and that we believe should be drawn to the attention of the House of Commons. They have not been reported in other chapters of this Report.

3.6 Section 7(2) of the Auditor General Act requires the Auditor General to call Parliament's attention to any significant cases where he has observed that:

(a) accounts have not been faithfully and properly maintained or public money has not been fully accounted for or paid, where so required by law, into the Consolidated Revenue Fund;

(b) essential records have not been maintained or the rules and procedures applied have been insufficient to safeguard and control public property, to secure an effective check on the assessment, collection and proper allocation of the revenue and to ensure that expenditures have been made only as authorized;

(c) money has been expended other than for purposes for which it was appropriated by Parliament;

(d) money has been expended without due regard to economy or efficiency; or

(e) satisfactory procedures have not been established to measure and report the effectiveness of programs, where such procedures could appropriately and reasonably be implemented.

Observations on Crown Corporations

Government of Canada

The Government has not yet sought Parliament's authority to guarantee $4.2 billion owing to the Canadian Wheat Board

In our 1989 annual Report, we reported that the government and the Canadian Wheat Board were relying on a guarantee of amounts owing to the Board issued without the authority of Parliament. Since then, the government has not sought the necessary authority of Parliament, and the Wheat Board continues to rely on a guarantee in determining the balances in its pool accounts, which it pays to farmers. Billions of dollars are owed to the Board. A significant amount is owing from financially troubled countries and continues to grow by some $300 million per year.

3.9 In writing last year's Report, we noted that there were indications that the government would move quickly to seek the necessary parliamentary authority. At the time of writing this year's Report, the government had not sought the necessary authority of Parliament. However, in July 1990, a senior government official wrote to us in response to last year's Report and indicated that it was proposed to deal with the issue through an amendment to the CWB Act. However, he was unable to be specific as to when a Bill would be tabled. Department of Agriculture officials indicated that there had been progress in putting together the necessary documentation and that further progress was expected shortly.

3.10 We are concerned about the delay in implementing corrective action, particularly in light of the fact that it is Parliament's prerogative of approving the creation of a liability before it is incurred rather than after the fact that is being infringed upon, and the amount of money involved. The amounts owing to the Board that are covered by the guarantee have grown to $4.2 billion, of which some $3.4 billion are from financially troubled countries. In our opinion, the value of the Board's troubled receivables is impaired by at least $2.1 billion, and this impairment continues to grow at a rate of some $300 million a year.

3.11 CWB's position, as stated in its 1988/89 annual report, which was released in April 1990, is that "the bottom line from the Board's and farmers' perspective is that the government has clearly stated that they are guaranteeing the Board's receivables and bank loans, hence the farmer is not at risk." The Board has taken this position notwithstanding the fact that we have publicly reported that a guarantee of the Board's receivables requires the authority of Parliament and no such authority has yet been sought by the government.

3.12 The CWB Act requires that the Board receive payment in full for the grain that it has sold before it pays the balances in its pool accounts to producers. However, it would appear that, based on this guarantee of the Board's receivables, the Board continues to believe that it has sufficient assurance of receiving "payment in full", if not from its debtors, then from the government, and that it can proceed with payment of these balances to producers. Accordingly, the balances, which for the crop year ended 31 July 1989 amounted to over $335 million, are calculated assuming that no bad debts will be incurred in collecting these receivables and are paid to producers without the Board having received "payment in full".

3.13 We believe strongly that Parliament should be given an early opportunity to debate and decide this matter before it continues any longer and that appropriate parliamentary approval must be received.

Export Development Corporation

Inadequate recognition of sovereign risk continues: Loan losses allowance of at least $500 million not booked in the accounts

The loan portfolio of Export Development Corporation (EDC) as at 31 December 1989 contained $4.718 billion exposure to less developed countries (LDCs). Many of these countries have continued to experience difficulties in repaying their debts as they become due. To cover what management perceives as the risks associated with the collection of these sovereign loans, the Corporation has established a $325 million general allowance for losses on loans. In our opinion, this allowance does not adequately recognize the risk associated with the collectability of the Corporation's sovereign loans. In addition, we believe that the Corporation's current methodology used to estimate the amount of the allowance is inadequate.

3.15 An accurate and fair presentation of EDC's financial statements is important in order to maintain the Corporation's accountability to Parliament. An inaccurate reporting on the cost of operations renders it difficult to properly assess the Corporation's lending operations.

3.16 Related concern. In our view, the Corporation's current methodology used to estimate the amount of the allowance is inadequate. The methodology does not result in any documented link between the amount determined and an assessment on a country-by- country basis of each country's ability and willingness to repay its debt. In our opinion, the Corporation should take prompt remedial action to implement an adequate methodology to recognize sovereign risk and arrive at a more appropriate allowance for loan losses.

Management's response: The Board of Directors and management continue to disagree with the Auditor General's audit opinion. In particular, the Corporation disagrees with the view that, in the case of some of its loans, the principal outstanding may not be ultimately collectable in full.

Farm Credit Corporation

Limitation in the scope of the Auditor General's examination of Farm Credit Corporation's financial statements for the year ended 31 March 1990

The Auditor General has included a reservation in his report on the financial statements of the Farm Credit Corporation (FCC) for the year ended 31 March 1990. This reservation describes a limitation in the scope of the Auditor General's examination of those financial statements, which was such that he did not have sufficient evidence to conclude that the allowance for loan losses (and consequently, certain other items) in FCC's financial statements were fairly presented in accordance with generally accepted accounting principles.

3.18 Farm Credit Corporation's financial statements for the year ended 31 March 1990 include loans receivable of $3,573 million, which are stated net of an allowance for loan losses of $279 million. A summary of FCC's accounting policy for the allowance is that it "represents management's best estimate of probable losses on the loans outstanding at the end of the year." It includes "... a specific component which is based on the review of outstanding undersecured loans and a general component, which is prudential in nature, to provide for loan losses which have not yet been specifically identified."

3.19 Although the Corporation provided us with evidence and analysis in support of the inclusion of $188 million in the allowance for loan losses, it was unable to provide adequate support, in our opinion, for the balance of $91 million. As a consequence, we were unable to satisfy ourselves as to the appropriateness of this additional amount and were unable to determine whether any adjustments might be necessary to FCC's allowance for loan losses, its provisions for loan losses, its net income (loss) for the year and its deficit. This was reported as a scope limitation in the auditor's report on FCC's financial statements.

Observations on Departmental Operations

Atlantic Canada Opportunities Agency

Failure to adequately evaluate the commercial viability of a $5.1 million investment in an ACOA Action Program repayable contribution agreement

Atlantic Canada Opportunities Agency (ACOA) did not adequately evaluate the commercial viability of the proposed product lines of an applicant for an Action Program contribution agreement before requesting ministerial approval for the project.

3.21 The total eligible capital costs were estimated at $11.3 million. ACOA Action Program assistance was projected at $5.1 million. The total of all federal government assistance was projected at $7.1 million.

3.22 As part of the overall evaluation of the application, ACOA requested technical advice from the Department of Regional Industrial Expansion (DRIE). DRIE expressed serious concerns about the proposal, particularly with respect to projected markets and other matters. ACOA requested the applicant to respond to DRIE's concerns. The applicant's responses, however, were not subsequently provided to DRIE for evaluation. ACOA did not obtain other independent advice to assist it in evaluating the responses. ACOA officials informed us that they placed significant reliance on the involvement of the international supplier in evaluating the commercial viability of the project.

3.23 The Minister responsible for ACOA approved the project on the understanding that DRIE supported the initiative to develop this manufacturing capability and that its concerns had been adequately addressed. In our view, DRIE's concerns had not been adequately addressed and the procedures used to evaluate the commercial viability of the project were inadequate.

3.24 ACOA paid $2.23 million to the applicant in accordance with the agreement. Before commercial production could be reached, the applicant encountered financial difficulties. The company's application to appoint a custodian was approved by the Nova Scotia court in early December 1989. In early 1990 the company was placed into receivership.

3.25 ACOA officials consider the procedures used to evaluate the commercial viability of this project to have been appropriate.

Canadian International Development Agency

Lack of a complete feasibility study led to a non-productive expenditure on a Canadian aid project in Pakistan

CIDA provided $2.3 million to finance a coal-washing plant in Pakistan that has been reported to have achieved less than one percent of its designed capacity over the 10 years since it opened. CIDA did not ensure that a complete feasibility study was carried out before the project started. There are indications of other recent instances where CIDA did not ensure that complete feasibility studies were completed before it supported projects.

3.27 Before agreeing to finance this project, however, CIDA did not ensure that a complete feasibility study was carried out. There was inadequate assurance that the washed coal would be purchased by anyone to sustain the viability of the project or, as confirmed subsequently, that it could be transported economically in adequate quantities to an end user. Furthermore, there was inadequate assurance that the equipment specified was suitable for the quality of coal to be washed.

3.28 Our audit revealed that tests on the quality of the coal to be washed were conducted for CIDA after the equipment had been supplied to the plant site. It also showed that the properties of the coal were different from those for which the plant had been designed. The Pakistan government had intended that the washed coal from the plant be used as coking coal in the manufacture of steel, but its sulphur content was too high. Furthermore, there was inadequate assurance that the Pakistan Railways had the capacity to handle the extra traffic involved in shipping the coal on its single-line railway from the mine to potential end users. Operational difficulties were encountered as soon as the plant was opened, and it was unable to process the coal at a sustainable rate. It has been reported that the plant has achieved a rate of less than one percent of its designed output over the 10 years since it opened.

3.29 Efforts to increase the plant's capability to process coal were initiated by CIDA but ceased in 1984, by which time CIDA had contributed over $750,000 in grants over and above the loan amount of $1.6 million in an effort to correct errors and omissions in the management of the project. Thus, the total outlay by Canada in support of this project was $2.3 million. In our view, since the plant totally failed to meet its design objectives, there was little value obtained for the money spent on it.

3.30 We have also noted indications of other recent instances where CIDA did not ensure that complete feasibility studies were carried out before it supported projects. In our opinion, CIDA should ensure that such studies are carried out for all capital development projects it supports.

Management's response: CIDA does not agree with the implication that it was accountable for the failure of the plant. The Agency obviously cannot be held accountable for all aspects of large integrated projects when working in co-operation with a sovereign foreign government. CIDA no longer provides loans to developing countries.

Department of Agriculture

Controls in the Agricultural Stabilization Board need to be strengthened to discharge fully federal responsibilities resulting from the National Tripartite Stabilization Program

In our opinion, adequate management verification systems and procedures are not in place within the Agricultural Stabilization Board (ASB) to allow for proper authorization of federal government contributions to the National Tripartite Stabilization Program. Furthermore, adequate reporting systems are not in place within the ASB to produce timely financial information to meet external reporting requirements. From the inception of the program in 1986 to 31 March 1990, federal government contributions to the program have exceeded $230 million. Payments to producers from the various price stabilization plans have exceeded $800 million for the same period. While the ASB has begun to address these issues, we are concerned that they have not yet been resolved after the program has been operational for almost four years.

3.32 As at 31 March 1990, eight NTSP plans were in place for beef, lambs, hogs, apples, white pea beans and other dry edible beans, sugar beets, honey and onions. From the inception of the first plans in 1986 to 31 March 1990, federal contributions to these plans have exceeded $230 million. Stabilization payments to producers exceeded $800 million for the same period, and loans from Canada as at 31 March 1990 amounted to some $240 million. There are nine participating provinces and some 50,000 producers now enrolled in the NTSP.

3.33 The NTSP agreements define eligible units (e.g., sales or production) relating to a specified time period (e.g., crop year or calendar quarter) for which enrolled producers must remit required premiums to provincial administrators. The NTSP agreements assign to the provinces the responsibility for verifying producer compliance with the agreements.

3.34 Federal funding of the NTSP is made by way of statutory contributions. The ASB is required, when authorizing these contributions, to certify that the terms and conditions of the NTSP agreements are being met. The completeness and accuracy of producer premiums are required in order to support the financially self-sustaining criteria of all NTSP plans. They are also required to ensure fairness amongst all participating provinces and enrolled producers. In our opinion, the ASB authorizes federal contributions without sufficient assurance that the provinces and producers are fully in compliance with the terms and conditions of the related agreements. Control systems and procedures in place at the ASB are not adequate to support these management verification responsibilities. As a result of these circumstances, as auditors of the NTSP plans, we have included scope reservations regarding the completeness of premium revenues in our auditor's reports on the financial information for the Beef and Lamb Plans since their inception in 1986. Similarly, our auditor's report on financial information for the White Pea Bean and Other Dry Edible Bean Plan for the year ended 31 August 1988 also included a reservation. Further, we were unable to express an opinion on the financial information for the Apple Plan for the year ended 31 July 1988.

3.35 The ASB has recognized that there are certain limitations in their management verification procedures and are in the process of developing improved procedures. However, it is unclear whether or not such procedures, if implemented, could provide sufficient assurance to determine compliance with the terms and conditions of the NTSP agreements. In our opinion, this is due, in part, to the nature of the agricultural industry and some of the terms of the NTSP agreements for which it is difficult to assess compliance accurately.

3.36 Furthermore, the ASB is responsible for the preparation of annual reports for each of the eight NTSP plans. Due, in part, to cumbersome financial accounting systems and procedures in place at the ASB that do not support timely financial reporting, the stabilization committees have received these reports for their approval anywhere from seven to 17 months after the financial year-ends of the NTSP plans. While the stabilization committees do receive more timely interim unaudited financial information for their review, it often varies significantly from the audited financial information contained in the annual reports. Such delays in the receipt of final financial information severely limits its usefulness.

3.37 The size of the plans increased significantly in 1989/90 (federal contributions increased from some $43 million in 1988/89 to some $128 million in 1989/90). Prudent management procedures justify the need for improved management, monitoring and reporting processes.

In signing three agreements with Farm Credit Corporation, the Department did not comply with Treasury Board guidance on contracting and, as a result, exceeded its delegated authority for signing sole-source services agreements

The Department of Agriculture signed and implemented three agreements with Farm Credit Corporation between February 1988 and March 1990, for a total of over $1.7 million, without going through the competitive process. In doing so, the Department did not follow Treasury Board guidance on entering into arrangements with Crown corporations, which suggests that these be treated as contracts. As such, Treasury Board approval should have been sought because the amount of each of the agreements exceeded the authority delegated to the Department for signing sole-source services agreements.

3.39 Treasury Board Secretariat officials have advised that, while arrangements between departments and Crown corporations may not be contracts in a strictly legal sense, the conditions of contract entry, the financial security provisions of the Government Contracts Regulations and the dollar limits in the Treasury Board Contracts Directive still apply to these arrangements. This is to maintain consistency with the controls for contractual arrangements. One guideline specifically mentions that the aforementioned regulations and directive apply to such arrangements, although the Administrative Policy Branch of Treasury Board does not view it as mandatory. In discussion with Treasury Board officials, we have been informed that seeking Treasury Board approval is general practice when departments enter into agreement with Crown corporations.

3.40 We have noted three instances where the Department of Agriculture has entered into agreements with the Farm Credit Corporation (FCC) without receiving the required prior Treasury Board approval for amounts exceeding their delegated authority for contracts issued without a competitive process.

3.41 In February 1988, the Department of Agriculture signed an agreement with the FCC for a total cost of $260,000, for the purpose of carrying out a survey of farmers to collect farm financial information and to provide certain data and analysis to the Department.

3.42 In August 1989, while in the process of preparing another agreement with FCC, the Department requested a Treasury Board Secretariat interpretation of the policy on contracting. The Department was advised that a submission to the Treasury Board seeking authority to enter into an agreement with a Crown corporation was required when the value of the agreement exceeds the departmental authority. The departmental authority is set at $50,000 for sole-source non-consulting services contracts. Nevertheless, the Department did not follow this advice and, in November 1989, signed a second agreement with FCC to provide project assessment and monitoring capabilities for a total cost of $475,000.

3.43 Further, as discussed in paragraphs 3.46 to 3.49, in March 1990, a third agreement for a total amount of $995,000 was signed with FCC to carry out the 1990 farm survey.

3.44 The Department ought to have sought Treasury Board approval to enter into these agreements with FCC.

3.45 Discussions with departmental officials involved in the contracting process indicated that they interpreted the Treasury Board guidelines in this area to be sufficiently flexible to permit the Department to enter into these agreements. Treasury Board officials, while acknowledging the possible ambiguity in the guidelines, have subsequently recommended that the Department prepare a submission seeking the Board's ratification of the current agreements with FCC and approval of the advance payment made in regards to the agreement for the 1990 farm survey.

$525,000 payment in advance of need

On 30 March 1990, the Department of Agriculture made a $900,000 payment to Farm Credit Corporation (FCC) for costs related to the 1990 farm survey. According to documentation that the Department subsequently requested from the Corporation, $525,000 of this amount was paid in advance of need. At the time of payment, FCC had not yet incurred all of the costs that the payment was intended to reimburse. Additionally, the Department did not follow sound contract administration practices in executing this agreement.

3.47 Subsequent to the payment of the invoice, the Department requested additional documentation from FCC. This additional documentation indicated that only $375,000 of the costs had been "recorded" by FCC up to 31 March 1990 and, as such, were valid charges against the appropriation for 1989/90. Accordingly, $525,000 was paid in advance of need, resulting in increased financing costs to the Consolidated Revenue Fund.

3.48 In addition to the above, we noted several other concerns related to this agreement.

• The payment terms required the Department to pay up to $995,000 "on receipt of an invoice by 31 March 1990." There were no standards of performance explicit in the agreement upon which to determine what amounts should be paid. Good contract administration would have stipulated clearly the basis on which payment was to be made. As indicated above, $525,000 was paid in advance of need.
• There was no audit provision in the agreement, no requirement that invoices be accompanied by supporting documentation and no requirement that FCC demonstrate tothe Department's satisfaction that the expenses FCC submitted for payment were eligible for reimbursement under the terms of the agreement. Departmental officials have responded that, in their view, risk of loss is minimal under the circumstances, as both parties to the agreement are accountable to the same Minister and both parties recognize that a full accounting would be provided by FCC on completion of the agreement.
• The agreement did not define "incremental costs". However, a detailed estimate of costs was provided by FCC at the time the agreement was drawn up and both the Corporation and the Department indicated that a clear understanding exists on what is included in incremental costs.
• The Department exceeded the $50,000 authority level delegated to it for signing sole-source services agreements. This was done despite the Department having received specific advice from a staff officer of the Treasury Board Secretariat in August 1989, stating that entering into an agreement such as this with a Crown corporation required a Treasury Board submission and approval (see also paragraphs 3.38 to 3.45).

Department of the Environment

Payments in advance of need to avoid lapsing funds resulted in additional interest costs

The Department of the Environment has entered into agreements with various provincial and municipal governments to contribute funds to environmental clean-up projects. In the two cases we examined, the Department paid the federal share of costs before the funds were needed. Although the payments were legal under the terms of the agreements, they resulted in additional interest costs of approximately $127,000 to the federal government.

3.51 For several years, we have reported instances where departments have made payments in advance of need, often to avoid lapsing funds. Payments made in advance of need can result in additional borrowing costs to the government. The Office of the Comptroller General (OCG) has been working with departments to improve cash management practices, including ensuring that payments are not made in advance of need. The OCG has noted significant savings resulting from improvements in cash management practices in government, including the Department of the Environment. Nevertheless, instances still arise where departments make payments in advance of need to avoid lapsing funds.

3.52 The Department of the Environment received Treasury Board approval to contribute $23.97 million to the cost of cleaning up the Tar Ponds in Sydney, Nova Scotia, and $1.25 million to the cost of cleaning up the Windermere Basin in Hamilton, Ontario. Near the end of the 1988/89 fiscal year it became apparent that, due to delays beyond the control of the Department, the funds required in 1988/89 for the two projects would be less than had been allocated and the amount required in future years would be more, by a corresponding amount.

3.53 The Department avoided lapsing funds by paying $1.26 million for the Sydney Tar Ponds clean-up and $478,000 for the Windermere Basin clean-up before the funds were required. Although the payments were legal under the terms of the agreements, they were contrary to good cash management practices as set out in Treasury Board policy and guidelines. As a result, the federal government incurred additional interest costs of approximately $127,000.

3.54 In December 1989, the Treasury Board announced that the carry-over of a portion of lapsed operating funds would be allowed in certain circumstances beginning with the 1990/91 fiscal year. However, this change does not apply to contributions. At the time of writing, Public Service 2000 was examining options that would allow departments more flexibility in managing their budgets, including contribution budgets for major projects.

Department of External Affairs

Need for Parliament to clarify Export Development Corporation's statutory borrowing limit

Section 14 of the Export Development Act needs an amendment to clarify the method for computing the borrowing limit of Export Development Corporation (EDC). The wording of the Act in this regard is ambiguous. The large deficit that in our opinion exists at EDC is unprecedented, and was therefore possibly not contemplated at the time legislation was enacted in 1983.

3.56 In our audit report dated 1 March 1990, addressed to the Minister for International Trade, we stated that the effect of recognizing losses of at least an additional $500 million on sovereign loans would result in the reported retained earnings of $8 million becoming negative (i.e. a deficit of at least $492 million, see paragraph 3.14), which would cause a significant impairment of shareholders' equity. This is an unprecedented situation for the Corporation. It is unclear whether such a deficit position was contemplated in 1983 when the wording of section 14 was drafted.

3.57 The issue. Ambiguity exists in section 14 of the Act as to whether any deficit of the Corporation should be taken into account in determining the statutory borrowing limit.

3.58 At least two interpretations of section 14 are possible. First, if the Corporation incurs a deficit, the amount of the deficit (negative retained earnings) would be used to reduce the government's investment in the Corporation when determining the statutory borrowing limit. This would be similar to the requirements applicable to chartered banks. Second, the amount of the deficit would not be deducted from the government's investment. Instead, the borrowing limit would be determined by assuming retained earnings of zero. This is the Corporation's and the government's position.

3.59 Our concern. Our concern is the ambiguity in the interpretation of section 14. The way the Corporation and the government have interpreted this section of the Act allows the Corporation to continue borrowing even when the government's net equity in the Corporation (shareholders' equity) deteriorates through accumulated deficits. Under the present interpretation and practice, higher amounts are advanced to the Corporation via borrowings from the international capital markets while the risk to the taxpayer increases.

3.60 Because of this ambiguity, Parliament may want to clarify the Corporation's statutory borrowing limit.

Management's response: The Department informed us that, unlike private banks and other commercial financial institutions, EDC has been set up to facilitate and develop trade between Canada and other countries by means of the financial and other powers provided by the Export Development Act. EDC was not set up to maximize the commercial return on money invested by the government in the pursuit of export financing business. Similarly, according to departmental officials, section 14 of the Act was not intended to define capital adequacy ratios that would serve to ensure that the Corporation was financially self-sustaining. Rather it was established to control the total amount of risk exposure to Canada via its agent, EDC. Therefore, the Department does not agree that it needs to seek clarification by Parliament of this section of the Act.

Need to improve control of monies advanced to employees

The existing organizational structure and processes in the Department of External Affairs do not provide adequate control of monies advanced to employees. The amounts involved, according to departmental records, have increased from $15 million at 31 March 1986 to $25 million at 31 March 1990.

3.62 We found that there is no clear accountability for monitoring, following up and recovering amounts due to the Crown. The accounting records and management reports that would highlight the need for timely action are so poor that there is no assurance that the amounts due from employees as recorded in the accounts of Canada are accurate. Nor does the Department know what percentage of these accounts is overdue or how long amounts outstanding have remained overdue. In our audit of the 60 overdue advances, we found that for 35 of the advances the follow-up by the Department was ineffective and in some instances non-existent and that the other 25 advances had not been followed up in a timely manner. In addition, we found that five of these advances had not been recorded correctly in the financial records of the Department. The three following examples illustrate the need to improve controls.

3.63 Ineffective follow-up. An amount of $17,000 advanced to an employee for medical expenses in July 1985, due to be repaid to the Crown at least by October 1987, remained outstanding at the end of March 1990. We could not find any documentation on the follow-up of this advance after August 1987.

3.64 Delayed follow-up. An advance of $15,000 made in Canada in June 1988 to an employee at a mission for vacation leave purposes, which was due to be settled by September 1988, was not fully settled until April 1990. Approximately $9,000 of this advance was refunded to the Crown 18 months late. Follow-up procedures in Ottawa did not commence until 14 months after the advance became due.

3.65 Poor accounting records. An advance of $56,000 to an employee to cover future hospitality expenses was identified, in the departmental financial system at headquarters, as outstanding since August 1988. However, the accounting system at the mission showed that only $1,000 was outstanding. No one had investigated the discrepancy between the two sets of records. We noted that an expense claim of $1,000 was processed for this employee in April 1989, but the transaction was not recorded in the departmental accounting system at headquarters or at the mission. A review of records at the mission disclosed that the full balance of $56,000 had been settled during the 1988/89 fiscal year.

3.66 We believe that there are at least six reasons why this situation has arisen:

• There is no focal point at headquarters to manage these advances. Responsibility for monitoring and follow-up is not well defined. For some types of advances we were unable to find any group responsible for follow-up and recovery of outstanding balances.
• The departmental reporting system provides information only on individual advances and not on the total amount of monies advanced to each employee. It also does not identify the amounts overdue.
• Financial officers at missions, who are responsible for managing these advances, do not always receive the reports they need to perform their duties.
• Follow-up and recovery procedures at Ottawa are delayed or not pursued, because they are given a lower priority than other responsibilities.
• Follow-up in certain instances is not actively pursued, because employees responsible for collection action believe that the departmental accounting system does not contain accurate records of the advances and they cease collection action if the employee states that the monies were repaid.
• When employees receive new postings, the balances in their advance accounts are not transferred to the new responsibility centre for monitoring and recovery.

3.68 It is important that management of the Department correct deficiencies in managing monies due to the Crown and ensure that public money has not been improperly retained by employees of the Department. The overall management of these amounts should be centralized, and responsibilities should be clearly defined and communicated to those who support the function. The management information system should provide appropriate reports for those managing the function, including consolidated records on each individual or firm owing monies to the Crown, as well as on amounts that are overdue. The information in the accounting system should be reviewed and all inaccurate data removed.

3.69 The management of the Department has acknowledged the seriousness of the situation and has recognized the need to resolve the problem. It has informed our Office that the Department's senior financial administration staff have begun a course of action to address this problem, as well as problems with other receivables. It has stated that the project proposal to correct these problems will be provided to our Office for review when it is complete. In addition, it has suggested that a review of this area be conducted by our Office in one year to provide assurance that appropriate accounting controls have been re-established.

Responsibility for providing information to Parliament for the Canada Account and related responsibility for managing the account remain unclear despite Treasury Board requirements to rectify the problem

The need to clarify responsibility for providing information to Parliament regarding loans to support export trade was brought to Parliament's attention in our 1989 Report, but still has not been properly addressed. In addition, a Treasury Board requirement, issued subsequent to our 1989 Report, for the submission of a report by 31 December 1989, was not carried out. This report was to identify which organization has responsibility for managing the Canada Account and describing the decision-making procedures that support this arrangement.

3.71 Part II of the Estimates for the Department of External Affairs indicates that the planned levels of disbursements through the Canada Account are $225 million for 1989/90 and $435 million for 1990/91. This represents a significant portion of the government's expenditures on international trade development.

3.72 Our concerns. As we stated in our 1989 Report, we have been unable to determine which arm of the government is responsible for providing information to Parliament that justifies expenditures and states the costs and benefits to Canadians of facilitating and developing export trade through the operations of the Canada Account. EDC has maintained that it is merely responsible for the administration of the Canada Account. It has not accepted responsibility for justifying the expenditures or for reporting on the overall net economic benefits to Canada arising from its activities. The Department of External Affairs, on the other hand, has not considered the Canada Account a departmental program for which departmental officials were responsible.

3.73 Arrangements for accountability to Parliament for the substantial expenditure of public moneys relating to the Canada Account need to be clearly established. As pointed out in our 1989 Report, Canada Account operations should be disclosed either as an activity of the Department of External Affairs (and therefore included in its Part III), as an activity of EDC in its summary corporate plan, or by some other appropriate means determined by the government. Without this information, certain loans to sovereign nations may escape proper parliamentary scrutiny.

3.74 In addition, in response to our 1989 Report, the Treasury Board issued a requirement in September 1989 for the submission of a report by 31 December 1989, identifying which organization has responsibility for managing the Canada Account and describing the decision-making procedures that would support this arrangement. The requirement had not been carried out at this writing.

3.75 Furthermore, the Treasury Board decision required the annual submission of a five-year plan for the Canada Account operations, in conjunction with EDC's annual corporate plan. These arrangements were to commence with EDC's 1990-94 corporate plan. At the writing of this report, this had not been done either.

Management's response: Officials of the Department of External Affairs informed us that the Minister for International Trade intends to table a report on Canada Account operations in Parliament this fall. The report is being prepared by EDC in co-operation with the Department, and the Minister intends to table it as soon as it has been finalized. In the future, the Department expects that it will be tabled with EDC's Corporate Plan Summary.

Officials of the Department of External Affairs also informed us that a recommendation on accountability to Parliament for the Canada Account, clarifying the respective roles of EDC and the Department, is being developed for ministerial approval.

Department of Finance

Canadian tax system can provide an unintended benefit to foreign tax systems

It is possible for a Canadian company to finance its U.S. business operations through the Netherlands and Netherlands Antilles and to "twice" deduct the interest costs for tax purposes. This could result in lost tax revenue for Canada and increased tax revenue for the foreign jurisdictions.

3.77 A hypothetical Canadian corporation ("Canada Co.") with taxable income in Canada will invest $100 million in its U.S. subsidiary ("U.S. Co.") for use in its active business operations. As a result of that investment, U.S. Co. will earn $20 million taxable per year, ignoring any cost of financing the $100 million.

3.78 The transaction (which is not without costs and risks) would be structured as follows:

• Canada Co. borrows $100 million from a Canadian financial institution at an interest rate of 10.5 percent, and makes a $25 million capital contribution to U.S. Co.
• Canada Co. then incorporates a company ("N.V.") in the Netherlands Antilles, to be resident there and owned 100 percent by it. N.V. incorporates a wholly-owned subsidiary ("B.V.") in the Netherlands that will be resident there.
• Canada Co. makes a $75 million contribution of capital to N.V., which then makes an $11 million capital contribution and a $64 million interest-free loan to B.V.
• B.V. makes a $75 million loan to U.S. Co. at 11 percent interest.

3.80 In computing its income for U.S. tax purposes, U.S. Co. would be entitled to deduct interest on the $75 million loan it had received from B.V. Under Dutch law, B.V. would be taxed as though it had paid about 10.75 percent interest on the $64 million interest-free loan from N.V. and that "notional" interest had been re-invested in it by N.V.

3.81 After all the U.S., Netherlands and Netherlands Antilles taxes had been paid, amounting to about $6 million, Canada Co. would net approximately $14 million of the $20 million earned by U.S. Co. -- $14 million on which it would have paid no Canadian income taxes.

3.82 This transaction would be attractive to Canada Co. because it could deduct interest "twice" -- thus the term "double dip".

Interest deductions would be as follows.

3.84 The Minister of Finance has announced that his Department is completing a thorough review, begun in 1987, of the rules concerning the deductibility of interest and other financing costs.

Management's response: The deductibility of interest in Canada does not provide any benefit to foreign tax systems since the Canadian tax system has no influence nor any jurisdiction over a foreign tax system. The real issue in so-called "double dip" transactions is the appropriateness of the interest deduction in Canada. This should be determined by reference to the matching of that expense with related income and other considerations, such as international competitiveness, and not on the basis of a foreign country's tax system. This area has been the subject of extensive review with a view to arriving at a proper tax policy.

Corporate income not taxed by Canada can earn federal and provincial tax credits for shareholders

Under Canadian tax law, it is possible for a company to earn income offshore that is not taxed on entering Canada, but that carries with it federal and provincial tax credits on dividends paid out to Canadian shareholders.

Exhibit not available

3.86 This can be illustrated by a hypothetical case in one of the designated countries, Barbados, whose significant tax incentives for international business companies can produce highly favourable Canadian tax advantages.

3.87 Assume that Barbados Co., incorporated and resident in Barbados, is an international business company and a wholly owned subsidiary of a Canadian company, Canada Co.

3.88 Under Barbados income tax laws, Barbados Co.'s income would be subject to a 2.5 percent flat rate of tax. No withholding taxes are imposed by Barbados on dividends paid to non-residents. Nor are dividends subject to Canadian income tax.

3.89 Canada taxes corporations on their profits and taxes individuals on dividends they receive from those profits. To encourage investment by Canadians in Canada and to compensate individuals for some of the taxes that corporations have paid on their behalf, a dividend tax credit system is used. Since Canada Co. would have paid no Canadian tax on its income from the profits of Barbados Co., presumably there would be no reason to compensate its Canadian shareholders. Nevertheless, under Canadian tax laws those shareholders would be entitled to a dividend tax credit.

3.90 A numerical analysis of the tax consequences of our hypothetical case follows.

3.92 Such instances provide Canadian individuals with unintended benefits equal to a reduction in their income tax rate of about one third.

3.93 The Department of Finance has advised us that it intends to review the foreign affiliate tax rules.

Management's response: The amount of tax credits claimed in cases such as those described is not likely to be of significant magnitude to warrant legislative action, which would inevitably result in complex and unadministrable rules designed to trace sources of corporate earnings through numerous levels of corporations. As well, the note ignores the dual purpose of the dividend tax credit - the recognition of underlying corporate tax to prevent double taxation on essentially the same income and the inducement to invest in shares of Canadian companies. While it is not intended that dividend tax credits provide perfect integration, a major tax policy objective is to encourage investment in the shares of Canadian corporations.

Interest cost due to delay in authority to tax

The delay between the date of effect and the legal due date of increases in commodity taxes can result in an interest cost to the Crown.

3.95 For example, the following excise levies and taxes announced in the 27 April 1989 budget were to take effect on 28 April.

3.97 If the increased tax collected was not remitted until 12 December 1989, using a 12 percent rate of interest, the benefit to those collecting the taxes and the consequent loss to the Crown would have amounted to about $22 million.

3 .98 We understand that more and more companies are exercising their option to retain the funds until Royal Assent.

The Department of Fisheries and Oceans

A specified purpose trust account for the Sea Lamprey Control Program was improperly maintained and incorrectly used to avoid lapsing funds at year-end

The Department of Fisheries and Oceans carries out sea lamprey control work on behalf of the Great Lakes Fishery Commission. The Department had improperly transferred budgetary appropriations into a non-budgetary specified purpose trust account, for part of its share of the cost of this work. In addition, the Department incorrectly used the account by transferring an additional $118,000 of its own operating funds into it to avoid lapsing this money. The Department did not follow the terms of the memoranda of agreement with the Commission by failing to turn over surplus operating funds on an annual basis as agreed.

3.100 The Department placed part of each year's appropriations for Commission work in a specified purpose trust account, which it administered. Specified purpose trust accounts are to be maintained only for funds received from outside parties. From 1987 the Department incorrectly placed funds directly from its own budgets into a non-budgetary, specified purpose trust account. The Department changed this specified purpose trust account to an "other specified purpose" account in May 1990. A 1989 policy by the Comptroller General required departments to review and modify existing specified purpose accounts, to ensure financial control and accountability. As a result of this review, the Receiver General and the Comptroller General have concluded that any specified purpose account is not appropriate in this case. The specific conditions in the government's policy, under which a transfer of appropriations to a specified purpose account is permissable, were not met.

3.101 The Department incorrectly used the trust account by transferring additional appropriations into it to avoid lapsing the money at year-end. In 1988/89, an additional $118,000 was transferred into the account. These funds were transferred into the account at the end of the 1988/89 fiscal year and carried over into the next year to avoid lapsing at year-end. In 1989/90, $95,000 of this amount was transferred back from the account to departmental appropriations, and the balance of $23,000 was left in the account. Of the $95,000, $27,000 was spent, and the remaining $68,000 was transferred back into the account and carried over the 1989/90 year-end, which again resulted in funds not being lapsed.

3.102 The Department has not followed the memoranda of agreement signed in 1986/87 and 1987/88. Each agreement stated that any unexpended operational funds remaining at the end of the period would be refunded to the Commission. The Commission has formally requested that approximately $27,000 be turned over for 1986/87 and $51,000 for 1987/88. The Department has not returned these funds on an annual basis as required by the agreement. A settlement has now been reached between the Commission and the Department. However, the accounting provided to the Commission by the Department did not include the additional $118,000 transferred into the trust account. The Commission has agreed to accept only a part of the funds requested to allow the Department to credit the remainder against expenditures made above those specified in the memorandum of agreement.

Management's response: The Department has agreed to discontinue use of the account. In the interim, the Department was permitted to temporarily maintain an "other specified purpose" account by the Receiver General, pending the results of the review by the Comptroller General. This review was requested because the Department had an opinion from the Department of Justice that supported the rationale for the account's continued existence.

Department of Industry, Science and Technology

Program terms and conditions not respected in the special programs for the Laprade and Thetford-Mines regions

The Laprade Fund was established with the $200 million remaining when construction of a heavy water plant in the Laprade region of Quebec was stopped in 1978. In October 1986, the $87.3 million remaining in the fund was assigned to the Department of Regional Industrial Expansion. A special program for the Laprade region was established to contribute to economic development projects that create permanent jobs. An additional $8 million was allocated to a similar program for the Thetford-Mines region. We observed several instances where initial departmental analysis indicated that projects did not meet basic program eligibility criteria. These projects were later approved. We also observed cases where the level of financial support given to a project was more than departmental analysis identified as the amount necessary for the project to proceed. Little or no documented rationale was available to explain these decisions.

3.104 In October 1986, the $87.3 million remaining in the fund was assigned to the Department of Regional Industrial Expansion (now known as the Department of Industry, Science and Technology). A special program for the Laprade region was established to contribute to economic development projects that would create permanent jobs. An additional $8 million was allocated to a similar program for the Thetford-Mines region.

3.105 The terms and conditions governing the operation of the programs were approved by Treasury Board on 30 April 1987. These terms and conditions set out the basic program criteria for eligibility of applications, which included the creation of permanent jobs, the need for public funding, the provision of economic benefits for the region and Canada, commercial viability, and the absence of major contractual commitment prior to receipt of the request for assistance. The terms and conditions also identified the industry sectors and activities eligible for assistance, the types of projects eligible within these sectors, and the maximum assistance allowable. All project approval decisions were to be made by a committee of three ministers. One was the departmental minister, and the others represented electoral districts in the Laprade and Thetford-Mines regions. This was later revised to a minimum of two ministers - the departmental minister plus one of the others. Departmental staff were to analyse projects and make recommendations to the ministers.

3.106 The terms and conditions gave the ministers discretion to extend the program, to include other sectors, activities or types of projects, or to increase the level of assistance beyond the allowed maximum for specific projects. Projects still would have to meet the basic program eligibility criteria.

3.107 In 1989/90, payments totalling $21 million were made under these programs, and all funds had been committed as of 31 March 1990.

3.108 We examined a number of approved projects to determine whether they were consistent with the terms and conditions set for the programs. Our sample included 38 projects, representing 23 percent of the number and 53 percent of the dollar value of projects approved.

3.109 In some instances the ministers exercised their discretion, as permitted, to include another industry sector or to provide higher funding. However, we observed several other instances where projects were approved despite initial departmental analysis indicating that they did not meet basic program eligibility criteria. These included cases where:

• projects were approved despite indications that they would have a negative impact on other companies elsewhere in Quebec or Canada;
• the need for departmental assistance was questionable, because of the company's financial situation or because the project was nearly completed at the time of the application.

3.111 In these instances, very little or no documented rationale was provided to explain why projects were funded or to justify the amount of support provided. Departmental staff explained that, once a decision was made, their responsibility was to implement it, not to develop a rationale after the fact.

3.112 The following are illustrations of some of the problems we observed:

• In April 1988, the Department received a request for $850,000 to support a complex of greenhouses to grow tomatoes year-round. Departmental analysis of the proposal indicated that this new capacity would displace production and have a negative impact on other producers in Quebec and in another province. This meant that the criterion of economic benefit for the region and Canada was in question. In August 1988, a contribution of $1,171,000, or 15 percent of eligible costs, was approved. This was $321,000 more than the amount requested. We noted that in another greenhouse project the applicant received $1,138,000, or 15 percent of eligible costs, despite the same concern about the overall economic benefit for the region and Canada.
• In March 1987, the Department received a request for financial assistance to construct a clubhouse for a golf course. Construction had started in December 1986 and was slated for completion in early April 1987. To be eligible for assistance, program criteria required that no significant contractual commitment was to have been made before the date the request was received. Although this project was nearly completed when the request was received, a contribution of $148,500, or 16.5 percent of costs, was approved in January 1988. Reimbursement of costs was allowed, retroactive to 30 September 1986, even though this preceded the date of receipt of the request and the 7 October 1986 decision by Cabinet to establish the Laprade Special Program.
• In June 1987, the Department received a request for support for completion of a business incubator complex (a business incubator is an enterprise that provides facilities and administrative and professional services to new companies, until they are able to operate autonomously). This project did not meet several eligibility criteria. The application indicated that it would not create any permanent jobs. Support for incubators themselves was to be restricted to operating costs, and then only after Cabinet had approved a national policy on business incubators. Because the project was 41 percent complete at the time of application, significant contractual commitments had been entered into by the applicant. In September 1988, a contribution of $977,887 was approved toward capital costs of $3,259,625. The documentation approving the project described it as an industrial motel, although the proposal had not changed. There was nothing on file to support this revised description or the fact that reimbursement of costs was allowed retroactive to 30 April 1987, a date prior to receipt of the request. Also, the national policy on incubators had not been approved.
• In June 1987, a company requested assistance for a recreation project involving construction of an arena housing two ice surfaces. The Department was concerned about the financial viability of the project and recommended that the feasibility of a two-phase approach be considered. In July 1987, a revised request was received for a first phase of the project, which was to involve an arena with one ice surface. In August 1987, a contribution of $250,000 was approved. This was the maximum allowed for a recreation project. On 9 October 1987, the contribution agreement signed by the company was received by the Department. The same day, the Department received a request for assistance from the company for the second phase of the project. This phase was described as enlarging the building and installing a second ice surface. Although construction of the first phase had not yet started, the Department treated the second request as a separate project, and another contribution of $250,000 was approved in December 1987. Project documentation given to the ministers did not disclose that no work had been done on the first phase of the project. In December 1987, a contract was let for construction of an arena with two ice surfaces, as originally requested in June 1987. In effect, this project received double the funding allowed at the time.

3.114 Although some discretion in applying criteria for regional development programs is reasonable, the approved terms and conditions governing the operations of programs should be respected or, if considered inappropriate, should be revised.

Inappropriate method of supporting an industrial project

In 1984/85, the Department of Regional Industrial Expansion gave a repayable contribution totalling $25 million to a petrochemical company, to cover 1983 and 1984 operating losses. The contribution agreement called for repayment to be made from future profits. An initial repayment of $5 million became due in 1989 when the company recorded profits of $107 million for 1988. Rather than collect the $5 million owing, repayment was deferred for five years to help finance a $218 million expansion project proposed by the company in 1989. This method of providing financial support is cause for serious concern, because the assistance provided is not visible to Parliament through the Estimates or Public Accounts. In effect, parliamentary scrutiny is by-passed.

3.116 The Department's agreement with the company called for repayments to be made from future profits, based on the lesser of six percent of pre-tax profits for a particular year or $5 million per year. The company met this condition for repayment in 1988 when it had pre-tax profits of $107 million. As a result, $5 million was due to the federal government in 1989.

3.117 At that time, the company was seeking additional financial assistance for a $218 million expansion project. In May 1989, Cabinet decided to provide financial support to the project by deferring the collection of any amounts due for repayment during the fiscal years 1988 to 1992, inclusive. In October 1989, Treasury Board approved the amendments to the repayment requirements of the original contribution agreement. An order-in-council authorizing the changes was issued in November 1989. An amount equivalent to simple interest of 10.5 percent would be charged to the end of 1992 on any repayments so deferred. Beginning in 1994, and based on 1993 profits, repayments would be limited to the lesser of six percent of pre-tax profits or $5 million per year.

3.118 The revised repayment schedule extends to at least the year 2000, with no amounts equivalent to interest being charged after 1992. We calculated that these terms result in an undisclosed subsidy to the company from the federal government of over $5 million in 1989 dollars.

3.119 This method of providing financial support to a company is cause for serious concern because the assistance is not visible to Parliament through the Estimates or Public Accounts. In effect, Parliament is by-passed. Normal departmental practice is to provide financial support for a project through a direct contribution which is recorded as an expenditure against a vote approved by Parliament. Any money owing from a previous project is repaid to the Consolidated Revenue Fund. In this way both transactions are recorded and open to scrutiny by Parliament.

3.120 Repayable contributions are widely used as a means of providing financial assistance to companies by the Department of Industry, Science and Technology. When money owed from these contributions is not collected in order to fund other industrial assistance projects, a substantial erosion of Parliament's ability to scrutinize the use of public funds occurs.

Continuing problems in the management of repayable contributions

The Department of Industry, Science and Technology approved approximately $475 million in repayable contributions between 1983 and 1989, for projects under the Industrial and Regional Development Program. We examined the Department's information on repayable contributions under this program and its procedures for ensuring that repayments are made. We found a number of problems in the management of these repayable contributions.

3.122 We found a number of problems in this information system and in the procedures in place for ensuring that repayments due are recorded and paid as required.

• There were several errors in the total amounts shown as repayable.
• For many contributions with repayment conditional on sales, due dates were inaccurate or not all listed, or there were old due dates with no indication of company contact to follow-up on sales. This was the case for about half the contributions of this type that we examined.
• The fields showing amounts due and due dates for a contribution could be altered, with nothing in the information display for that contribution to indicate that a change had been made, and what had been changed.

3.124 The framework for managing repayable contributions needs examination by the Department to solve these and other problems. We believe that a higher priority needs to be given to the overall management of repayable contributions, to ensure that amounts owed are repaid when due.

Department of Transport (Canadian Coast Guard)

Mid-life modernization of CCGS Louis S. St. Laurent: A major Crown project without a demonstrated need and with escalating costs

The requirement for the mid-life modernization of this 21-year-old icebreaker was not justified on the basis of defined levels of service. The Coast Guard did not follow its own vessel modernization and acquisition strategy in proceeding with this project, and did not adequately define the statement of work and the costs at the outset.

3.126 In our 1983 Report, we noted that the lack of a defined level of service weakened the Coast Guard's ability to plan and control its activities, including determining the number of ships it required. We also noted that after nine years and two extended deadlines, the Department had yet to meet the 1974 Treasury Board requirement to define its levels of service. We further noted that when Cabinet approved Coast Guard's Fleet Capital Investment Plan (FCIP) in principle late in 1979, it did so subject to the Coast Guard specifying levels of service before the end of 1981. The Department did not meet that deadline and has not yet specified its levels of service.

3.127 In our 1989 Report, we stated that, for the icebreaking program, the Coast Guard did not know the extent to which its existing fleet met or exceeded program requirements, and that, in spite of this lack of information and analysis on requirements, the Coast Guard had spent approximately $686 million since our 1983 audit in acquiring or modernizing vessels capable of undertaking icebreaking missions.

3.128 Canada's largest and most powerful icebreaker, the Type 1300 CCGS Louis S. St. Laurent (LSL), was built in 1969. The ship is costly to operate because of its large crew and the inefficiency of its propulsion system, which consumes far more fuel than other propulsion systems. Over the five-year period preceding her mid-life modernization, the vessel's utilization averaged under 30 percent (calculated on the basis of 365 days per year). The low utilization was attributable to its time in maintenance and to management decisions to utilize the vessel for primary arctic missions, and in southern waters only in cases of urgency or unavailability of other Coast Guard icebreakers.

3.129 In August 1988, the Coast Guard delivered the LSL to the shipyard for mid-life modernization.

3.130 We expected a project of this magnitude to have been justified by a thorough needs and options analysis based on defined levels of service. The term "level of service" refers to the amount and quality of a given service. In defining an appropriate level, the objective is to choose one that can be justified on the grounds of demand for the service, while taking into account the costs and benefits of providing it.

3.131 Our audit did not attempt to establish whether the vessel was needed in the Coast Guard fleet, but focussed on the Department's analysis leading to the decision to modernize the vessel and on subsequent events.

3.132 Needs and options analysis. The Coast Guard has stated that the FCIP constitutes its basic requirements/needs analysis for the mid-life modernization project. We found no defined levels of service for icebreaking or analysis of demand to justify the mid-life modernization of the LSL. Approval of the FCIP by Cabinet does not constitute approval for the mid-life modernization project listed in this capital program. This interpretation is consistent with Treasury Board Circular No. 1983-25, which states that a long-term capital plan is not used to seek approval for specific capital projects.

3.133 According to the FCIP, it has been determined that in terms of cost effectiveness, the practical life of an icebreaker is approximately 30 years, provided that a mid-life modernization is carried out after 15 to 20 years. The Coast Guard stated that the mid-life modernization of the LSL was intended to extend the vessel's life for an additional 20 years, at which time the LSL will be approximately 45 years old.

3.134 Preliminary cost limitations. The guidelines provided in the FCIP are based on the fact that, on average, the capital required for mid-life modernization has been 20 percent of the unit replacement value. For the Type 1300 vessel, the FCIP estimated the unit replacement value at $250 million. The guidelines thus provided for $50 million in 1987/88 constant dollars for the LSL modernization. The Coast Guard planned an expenditure of $51 million for the project between 1987 and 1991.

3.135 Sole-source contract. An unsolicited proposal to modernize the LSL was submitted by Halifax-Dartmouth Industries Limited (HDIL) in October 1986. In reviewing this proposal, the Coast Guard stated the ceiling price for the contract would reach $71.2 million, whereas the Coast Guard's planned cost was $51 million. The Department stated that the cost difference was in keeping with the estimated 20 percent savings that have accrued historically when competitive bidding has been used instead of a sole-source contract. The Coast Guard recommended that the Crown proceed with a competitive tendering process for the mid-life modernization of the LSL. However, in June 1987, Cabinet directed that the modernization of the LSL be sole-sourced to HDIL as the prime contractor, for socio-economic reasons.

3.136 Increasing costs. Treasury Board granted effective project approval in July 1987 for a total estimated cost of $75.8 million, which provided for a $71 million contract limit for HDIL. In January 1988, a preliminary estimate provided by HDIL indicated a cost of $97 million. As a result, the Coast Guard reduced the statement of work to include only the core items. Consultants were hired to determine a reasonable cost for the project to be used in the negotiations with HDIL. In June 1988, revised funding was approved by Treasury Board at $95.5 million. This price included a contract ceiling of $82.3 million for HDIL. A number of items removed from the original modernization plan will be added to the separate refit budget, which now has a total estimated cost of $6.7 million. The Coast Guard states that the average annual refit budget for this vessel is $2 million.

3.137 Project schedule. In April 1990, the project was estimated by the Department to be about half-completed, based on work units in the shipyard. This meant that the project was five months behind schedule, which would affect the scheduled completion date of November 1990 unless compensating measures were taken by HDIL to expedite the work. However, serious problems have since arisen, because of steel deterioration, that threaten to delay the project by another two years and to increase the cost of the mid-life modernization. The additional cost has not been fully determined but could run as high as 25 percent of the total cost of mid-life modernization, and is subject to Treasury Board approval.

3.138 Steel deterioration. The extensive steel corrosion was identified on the LSL part way through the mid-life modernization. The affected areas included both the hull and internal steelwork, some of which had previously been inaccessible to inspection. Confirmation of the extent of deterioration in the vessel's steelwork was determined by the Coast Guard while carrying out an inspection similar to the 20-year survey conducted by the societies that set standards for all vessels. This inspection was started when the LSL entered drydock for the mid-life modernization and was still going on at the time of our audit.

3.139 This was not the Coast Guard's first indication of corrosion problems on the vessel. In 1984, an ultrasound survey of the steel showed varying degrees of corrosion, although not massive at the time. In 1987, prior to the modernization, a pre-mid-life condition survey was carried out but did not identify the extent of the problem.

3.140 The Coast Guard advised us that it is normal practice to replace corroded steel in any mid-life modernization. We expected that a provision for doing this would have been included as a major element of the estimated expense in this mid-life modernization project, because of:

• the Coast Guard's experience with previous mid-life modernizations and a recent life-extension project;
• the age of the vessel; and
• the inspections, condition surveys, and other indications of corrosion dating back to 1982.

3.141 Conclusion. After over 10 years and in spite of the conditions of Treasury Board approval, the Department has yet to define its levels of service for icebreaking. The Department's decision to complete a mid-life modernization of the LSL continues the pattern, identified in our previous audits, of major capital expenditures not based on a demonstrated need. The decision taken for the LSL mid-life modernization is inconsistent with the strategy in the FCIP related to vessel life and costs. As with the "R" Class icebreaker project, the early capital cost estimates for the mid-life modernization of the LSL did not provide a good indication of the eventual cost. The modernization began with a planned cost of $51 million and, according to the Coast Guard, could now reach around $125 million.

3.142 We will continue to monitor this project.

Management's response: The Department advised us that, in its view, the decision to proceed with the modernization of the LSL followed the least-cost strategy. It stated that because of the unique capability of this vessel, it was decided to upgrade the machinery package and the bow. The Department stated that this improvement, which resulted in work much more extensive than a routine mid-life modernization, will make the vessel more effective and efficient and extend its life. The Department further stated that it is defining levels of service for icebreaking operations, and considers that these levels must take into account climatic and geographic considerations to be accurate. In the Department's opinion Canada requires, at a minimum, at least one 1300-class capability icebreaker to meet the obligations arising out of our claim to the arctic region. According to the Department, without this capability Canada would rank seventh among other nations having icebreaker capability, including West Germany, Japan and Argentina. The Department stated that such a situation would undermine Canada's credibility among polar nations.

Department of Transport

Lester B. Pearson International Airport Terminal 1 Parking Garage: Inadequate safeguarding of a Crown asset and monitoring of public safety

Lack of action by the Department of Transport has contributed to increases in the estimated cost of restoration by up to $38 million, and there is no guarantee of how long the structure will remain safe without major repairs.

3.144 Subsequent reports in 1984 and 1986 stressed the need for action on the garage. In 1988, six years after the deterioration had been detected, the Department awarded contracts for $5.6 million for incremental restoration in areas of the garage where public safety was in question. The Department stated that it would implement an upgraded inspection program to maintain the safety of the garage. The contractor later determined that the deterioration was so extensive that revisions to the contract specifications would be necessary, including some design changes and revision of certain unit prices and quantities. This would increase the cost by another $7 million. The Department chose instead to continue work up to the financial limits of the existing contract and to terminate the contract without the entire scope of the intended work having been delivered.

3.145 A 1989 engineering consultant report, accepted by the Department, stated that it was "impossible to even suggest how long the current structure can continue to be safe without major repairs." The report recommended two solutions. A short-term solution costing $40 million would extend the life of the facility an estimated 10 to 15 years; a long-term solution costing $51 million would lengthen its life by over 20 years. These solutions were based on construction costs ranging from $362 to $552 per square metre.

3.146 Deferring the decision to restore the parking garage has contributed to increased estimated costs to the Crown of from $28 million to $38 million and has impacted on the safety of the structure. At the time of our audit, there was no upgraded inspection program of the garage to monitor deterioration levels and there were no plans to restore the structure. The Department has informed us that it will make a decision after the next airport master plan is completed. Currently there is no completion deadline.

Management's response: The Department has advised us that it has made repairs when required to ensure the continued safety of the structure. The Department has stated that its commitment to public safety was paramount. The Department has also stated that it is currently considering a rehabilitation plan.

Department of Western Economic Diversification and Former Department of Regional Industrial Expansion

Approval for turbocharger project questionable, and contribution payments not adequately justified

An Alberta company received $99,900 in Industrial and Regional Development Program funding toward the development of an engine turbocharger. Total project costs of $312,600 included the purchase and rebuilding of a dragster for testing the turbocharger. Two departments were involved in this project: the Department of Regional Industrial Expansion (DRIE) during the approval and initial funding stages and the Department of Western Economic Diversification (DWED) for the final contribution payments. The initial assessment of this project by DRIE did not address some key issues. Final payments totalling $26,884 were made by DWED even though a report required by the agreement, containing technical results and benefits obtained, was not requested.

3.148 The statement of work in the agreement sets out technical objectives for the project. Even though the agreement required the applicant to submit reports satisfactory to the Minister, neither department translated the technical objectives into a reporting format, against which the results of the project could be measured.

3.149 DRIE had referred the project to the National Research Council for advice, but did not deal with the concerns expressed by the NRC. The NRC pointed out that retrofitting engines not designed for turbocharging could be dangerous and of limited value for general automotive use. It noted that if the project was aimed at special purpose vehicles, such as dragsters or stock racing cars, a different market estimation would be needed.

3.150 The prototype turbocharger was tested on racetracks in the United States in a dragster with a 488 cubic inch, or eight-litre displacement engine.

3.151 In August 1987, the government established the Department of Western Economic Diversification. This new department became responsible for the IRDP and some other existing programs previously administered by DRIE in the West. The turbocharger project was one of those transferred to DWED.

3.152 In January 1989, DWED made a second payment of $16,894. At that point, although the applicant had made all its project expenditures, it had not provided the Department with information specified in the monitoring section of the agreement. That section required progress reports every three months and a final report containing a summary of the technical results and a description of the benefits that had accrued. Only two progress reports were received, both in 1986. The applicant did not submit a final report and the Department requested no further technical results or benefits information.

3.153 DWED discovered in March 1989 that the prototype turbocharger had been destroyed in 1987. The contribution agreement required the company to notify the Department in writing if the turbocharger were sold, leased or otherwise disposed of. This was not done. Nonetheless, in March 1989 DWED made the final payment of $9,990.

3.154 In our view, the payments to the company were not adequately justified.