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1996 November Report of the Auditor General of Canada

Main Points

39.2 The "Other Audit Observations" chapter fulfills 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 on audits and studies of issues that relate to operations of the government as a whole. This chapter reports on specific matters that have come to our attention during our financial and compliance audits of the Public Accounts of Canada, Crown corporations and other entities, or during our value-for-money audits.

39.3 The chapter normally contains observations concerning departmental expenditures and/or revenues. The issues addressed generally involve failure to comply with authorities, and the expenditure of money without due regard to economy.

39.4 Observations reported this year cover the following:

• Atomic Energy of Canada Limited needs to disclose its environmental liabilities in its financial statements.
• National Defence's new strategic transport fleet will not fulfill all the strategic roles of the fleet it replaces, and maintaining current strategic transport capabilities is costing $8.5 million.
• Compliance with funding conditions for the Pearson Peacekeeping Centre is lacking.
• Terms of contribution agreements do not protect the government's interest and may contribute to low collections.

Introduction

39.7 Section 7(2) of the Auditor General Act requires the Auditor General to call to the attention of the House of Commons any significant cases where he has observed that:

• 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;
• 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;
• money has been expended for purposes other than for which it was appropriated by Parliament;
• money has been expended without due regard to economy or efficiency; or
• satisfactory procedures have not been established to measure and report the effectiveness of programs, where such procedures could appropriately and reasonably be implemented.

39.9 Consistent with Office policy on the follow-up of matters in our annual Report, other audit observations included in this chapter are normally followed up two years after initial reporting. In our follow-up of the observations included in our 1994 Report, we found that for three of the five observations, either corrective action had been taken to address the matter or we no longer considered the matter to be an outstanding issue. Two observations remain outstanding because they involve matters that we are continuing to monitor, and any lack of corrective action will be reported as deemed appropriate.

Atomic Energy of Canada Limited

Atomic Energy of Canada Limited needs to disclose its environmental liabilities in its financial statements

Background

Issues

39.12 AECL, like other Crown corporations governed by the Financial Administration Act , is required to prepare financial statements in accordance with generally accepted accounting principles. These principles require that decommissioning and site remediation costs be recognized in the Corporation's financial statements in a rational and systematic manner over the estimated lives of the corresponding facilities. Therefore, in failing to properly record these costs, AECL is not providing proper accountability information to Parliament and it is not complying with a specific requirement of the Financial Administration Act .

39.13 We would have expected that, as a leader in Canada's nuclear industry, and as a corporation wholly owned by the Government of Canada, AECL would also be a leader in the disclosure of accountability information related to environmental liabilities.

39.14 These costs are very significant. Had they been properly recorded in AECL's financial statements, the government's equity in the Corporation of $464 million at 31 March 1996 would have been substantially reduced.

39.15 The Corporation refers in its financial statements to two reasons for not recording these costs. As noted in our Auditor's Report, we do not accept these reasons. AECL's first reason is its view that much of the future work could not be reasonably estimated. However, other organizations, notably Canadian utilities that employ nuclear power reactors, have been able to develop an estimate of similar costs in their circumstances, and to properly record and disclose them. In our view, AECL has had ample time to estimate and disclose these costs.

39.16 AECL's second reason for not recording these costs is that, historically, decommissioning activities have been financed through parliamentary appropriations. However, in our view, proper accountability reporting requires the Corporation to estimate and record these costs, regardless of how they are to be financed. Indeed, the possibility that these costs might be financed by appropriation lends more weight to the importance of estimating and disclosing the liability so that the government and Parliament are informed of the magnitude of the possible demand on public resources.

39.17 The respective responsibilities of the government and the Corporation for funding these costs have been the subject of discussions between AECL and government officials for many years. We understand that, from the Corporation's perspective, the responsibilities for funding these costs and proper accounting for them are related issues. As disclosed in AECL's 1996 financial statements, the Corporation is of the view that there has been some progress, in 1995-96, in the discussions on financing a portion of these costs. Although not a prerequisite to proper accounting, we encourage the Corporation and the government to clarify, in the coming year, the responsibilities for funding these costs.

Conclusion

Corporation's response: There is no issue between the Auditor General and AECL over the need to record properly site remediation and/or decommissioning liabilities that fall to the Corporation. The issues are over the reasonable estimation of those costs and funding mechanisms for them.

On the first point, over the past decade the government and AECL have been addressing, on an ongoing basis, the remediation of nuclear sites owned and operated by the Corporation in line with AECB regulations and sound management practices. This has been accomplished through a government funding process. As a fundamental part of the development of the Canadian nuclear industry, the Corporation has acquired and operated a variety of nuclear facilities for use in both research and the supply of isotopes for medical use. As well, its sites have been the depository of radioactive wastes on behalf of the government and the medical industry. The variety of these wastes, not all of AECL's making, goes to the heart of the Corporation's view that there are difficulties in making reasonable estimates of all future work required. It is the complexity of such an estimation that distinguishes AECL's situation from that of other entities like Canadian utilities, the nature of whose waste is much more straightforward and therefore predictable.

This question is also inextricably linked to funding responsibilities and funding sources, which raises the second question. Historically the government has accepted responsibility for funding decommissioning or remediation work and AECL believes that this represents the proper locus of the liability, although AECL carries out work on the Crown's behalf. Discussions continue to be held with our shareholder concerning this issue, with a view to finding a resolution to the matter.

AECL's management feels therefore that any decision to irrevocably book the liability must be made in the broader context of the government's total liability for environmental costs. Therefore, it would not be appropriate for AECL to unilaterally accept the Auditor General's proposed accounting treatment without the blessing of the Crown. By the very nature of being an agency of the Crown, any recognition of the liability by AECL simply flows to the books of Canada, through the consolidation of the Crown's equity in AECL.

In short, the government's position is a critical factor in the resolution of the issue. As it becomes clearly articulated, the correct accounting treatment becomes clear. Such a solution is being actively sought. Notes in AECL's annual financial statements highlight the issue and have done so for several years. However, the Corporation believes the framework policy of the government and the needs of safety, health and those of an environmental nature must be fully satisfied, not just the accounting needs.

National Defence

Following government direction to purchase aircraft, National Defence's new strategic transport fleet will not fulfill all the strategic roles of the fleet it replaces, and maintaining current strategic transport capabilities until April 1997 is costing the Department $8.5 million

Retaining two 707s in the fleet until April 1997 to provide needed strategic transport capabilities is costing the Department $8.5 million. After modifications are completed in December 1997, the five A310 aircraft will be able to transport troops and cargo but not carry out air-to-air refuelling. This strategic requirement will be partly met in the interim by tactical air-to-air refuelling aircraft.

Background

39.20 Before this purchase, National Defence had determined that the Boeing fleet would reach the end of its estimated life expectancy by 1996. The Department was reviewing options for either replacing or refitting the planes and extending them to 1999. In February 1992, the Vice-Chief of the Defence Staff advised senior departmental officials that it was imperative that the list of capital projects being considered for submission by the Deputy Minister/Chief of the Defence Staff to the Minister of National Defence be "essential to the core of and consistent with the Defence Policy, affordable, saleable and also have maximum utility for the Canadian Forces."

39.21 Government direction superseded the Department's normal internal process of reviewing alternatives and recommending an affordable course of action. Before being given authority by the Treasury Board to replace the Boeing fleet, the Department had not identified replacement aircraft as affordable or as a priority. In June 1992, the Department advised the government that it could not afford to replace the Boeing 707 fleet. The Boeing fleet was to be replaced in 1999 when the Department expected funds to be available. However, to take advantage of this opportunity, in August 1992 the Department agreed to change its priorities to obtain five aircraft as replacements for the aging Boeing fleet, ahead of the planned replacement schedule. In order to finance this project, National Defence reallocated funds from other defence projects and moved funds from National Procurement to Capital.

39.22 National Defence paid $265 million to three aviation industry firms for five used A310 passenger-configured planes. The Department paid an additional $12 million for modifications. This included the installation of operational equipment, reconfigurations to the interior section and painting of each plane, and fitting one A310 with an Executive Interior for VIP transport. The government required that the fleet be capable of transporting dignitaries with a "head-of-state" status.

39.23 By January 1994, the Department had received all five Airbus passenger aircraft and had entered them into service along with three remaining Boeing 707s yet to be retired. In total, National Defence paid $277 million for five A310s capable of military passenger and VIP transport. A further $81 million, including GST, will be spent on modifications enabling the planes to convert to cargo carriers. Once completed, this $358 million plus other project costs will bring the total to about $440 million.

Issues

39.25 Beginning in October 1992, National Defence and Public Works and Government Services Canada worked with the contractor on defining the cargo modifications for a contract. National Defence developed technical specifications and expected that the cargo modifications would be subcontracted to the Airbus partner referred to in the Minister's letter. A Request for Proposal was issued on a sole-source basis in November 1993 and a proposal was received from the contractor in May 1994.

39.26 Initially, one plane was to be modified in Europe as a prototype and the remaining three in Canada. However, the contractor stated in May 1994 that the cost of this option was "exorbitantly high" and recommended that an alternative, less expensive approach be sought. The Department therefore reviewed other options, which included following its own procurement strategy without the involvement of the contractor. The Department determined that the modifications would continue to be sourced through the contractor. A request for a revised proposal, changing the contract to have all work done in Europe, was issued on a sole-source basis in October 1994.

39.27 The contractor accepted bids from the Airbus partner referred to in the Minister's letter and from a second firm. The second firm offered the least-cost option and, in January 1995, was chosen by the contractor to do the cargo modifications. National Defence questioned the contractor's technical assessment and, in order to address the Department's concerns that technical specifications were not being met, the contractor returned to its subcontractor for clarification and confirmation of compliance.

39.28 In June 1995, a contract was signed for $81 million, which includes $8.6 million in project management fees to the contractor and $5.3 million for GST. In February 1996, the first A310 arrived in Europe for cargo modification work. Modifications to all four planes are scheduled for completion by the end of December 1997.

39.29 The cargo conversion is delayed by almost two years. Initially, receipt of a cargo-modified A310 fleet was to coincide with the retirement of the five Boeings. Although some overlap was planned, the Department had expected to be flying only the Airbus by the time the Boeings approached the end of their estimated life expectancy in 1996. The preliminary discussions and negotiations for a cargo modification contract lasted almost two years longer than initially planned and delayed delivery of a cargo/passenger- combination capable aircraft by 18 to 24 months. The Department will not have four cargo-modified aircraft to coincide with the originally anticipated 1996 Boeing retirement date.

39.30 The five A310s will not have the same capability as the planes they replace. The Department's submission to the Treasury Board for approval to purchase five A310s outlined the four roles expected of the strategic transport fleet: strategic airlift of personnel, strategic airlift of freight, VIP transport and air-to-air refuelling. The Department decided that A310 strategic air-to-air refuelling, though highly desirable, could be excluded from approval in its Treasury Board submission as it was acquiring five Hercules aircraft with shorter-range tactical air-to-air refuelling capability. The longer-range strategic air-to-air refuelling was therefore not included in the final funding approval for the A310s. National Defence explained in its submission that a new project would be instigated when strategic air-to-air refuelling was reclassified to "essential". It began this project in May 1993. In the A310 Master Implementation Plan, the Department stated, "The [Airbus] is planned to be modified to be air-to-air refuelling capable." However, lack of funds has resulted in postponing any decision on this project, which would require roughly $80 million in additional funding. Upon completion of the Airbus modifications in December 1997, National Defence will have the capability to fulfill only three of the four strategic transport roles.

39.31 The strategic transport fleet is currently using seven aircraft to accomplish a role previously fulfilled by five aircraft. At present, the Department's Airbus fleet can provide only passenger transport and has limited cargo space. In order to remain ready to fulfill its commitments, National Defence has kept two Boeing 707s to overcome deficiencies in the Airbus fleet. These two planes are retained for cargo transport and strategic air-to-air refuelling support to the CF-18 fighter aircraft. The Department currently is maintaining seven aircraft in its fleet for a role that previously required only five. It plans to retire the remaining Boeings by April 1997.

39.32 National Defence is incurring $8.5 million in costs to maintain its strategic transport capability. The Department estimates that $8.5 million in costs incurred are a result of maintaining two Boeing 707 aircraft in the fleet beyond their expected June 1996 retirement date. The 707s are being used for cargo and strategic air-to-air refuelling not provided by the five A310s.

Conclusion

Department's response: The A310 Airbus was not intended to fulfill all the roles of the Boeing strategic transport fleet. The acquisition of five Hercules aircraft, with shorter-range tactical air-to-air refuelling capability, allowed the Department to defer a decision on how best to satisfy our longer-range air-to-air refuelling capability. Two Boeing 707s were extended to provide limited strategic air-to-air capabilities in the interim. This meant they were also available for carrying cargo. The $8.5 million expenditure is attributable to the decision to continue the operation of the Boeing 707 fleet beyond its original date, thereby providing the Department with the opportunity to consider options to address our strategic air-to-air refuelling capability.

National Defence and Foreign Affairs and International Trade

Lack of compliance with funding conditions for Pearson Peacekeeping Centre

Background

39.35 The Centre was established in support of both the foreign and defence policies. Both departments agreed with the concept of the Centre as well as with the financial contributions from their respective departments.

Issues

39.37 In October 1994, the Institute submitted a five-year business plan to National Defence and Foreign Affairs. We could find no indication that either department had analyzed the plan in sufficient depth to determine whether it was workable, as required by the terms and conditions of the Treasury Board approval. Nevertheless, initial funding totalling $3 million was disbursed in 1994-95.

39.38 The 1994 business plan soon proved to be unrealizable. The Centre encountered significant unforeseen start-up expenses. In the initial stages, it seriously underspent on such items as library and audio-visual aids, due to high unforeseen costs for items such as furniture, office equipment and vehicles. As well, the Centre could not reach a rental agreement with the Cornwallis Park Development Association (CPDA), as called for in its 1994 business plan. To the end of our audit in September 1996, there was still no resolution between the two parties and the Centre still had not paid rent. The Centre incurred additional unforeseen costs when the CPDA made tenants responsible for their own utilities. The Centre installed stand-alone boilers at a cost of over $500,000.

39.39 In March 1995, the Canadian Institute for Strategic Studies submitted a new business plan for the Centre for 1995-96. National Defence and Foreign Affairs reviewed the plan and informed the Centre that it was inadequate. Among other reasons, it did not identify future marketing strategies to ensure the Centre's success in recovering operating costs from tuition fees. The Treasury Board approval called for the departments to reduce or terminate their contributions if the Institute and the Centre were not complying with the terms and conditions of the approval. An important condition was that they develop a workable business plan.

39.40 National Defence conducted a program evaluation of the Centre in the fall of 1995. Foreign Affairs managers were also monitoring the situation. The National Defence evaluation concluded that the Centre did not have a viable business plan, and would not be self-sufficient in the foreseeable future. After March 1999, the Centre would require as much as $1.4 million per year in federal subsidies to continue operations. To the end of our audit, the Centre still did not have a viable business plan. Nevertheless, both departments continue to provide funding because of the Centre's potential to meet their policy and training goals. To the end of our audit, they had contributed a total of $6.3 million. The evaluation also noted that the UN had identified 18 peacekeeping training facilities, but that none is required to be self-sufficient in the manner of the Pearson Peacekeeping Centre.

39.41 The Treasury Board approval also required both departments, at the end of each fiscal year, to report to their respective deputy ministers on the conduct, management and achievements of the Centre, and the outlook for the forthcoming fiscal year. To date, neither department has adequately fulfilled this requirement. However, in early 1996, National Defence staff apprised the Deputy Minister of the results of the program evaluation. In Foreign Affairs, an assistant deputy minister was involved in monitoring the Centre's programs.

39.42 The National Defence program evaluation noted that there is almost no background information on the rationale used to determine the federal government's financial contribution of $10 million to the Centre. National Defence supported the Centre by providing the majority of course participants and by funding over 85 percent of the Centre's students, but did not identify specific training objectives for Canadian Forces attendees. At various times, National Defence and Foreign Affairs both expressed concern to the Centre that it was not attracting enough students from other sectors involved in peacekeeping. In 1996 National Defence conducted a study on peacekeeping training that considered the potential role of the Centre. It identified 5 out of 13 areas where the Centre could potentially provide peacekeeping training. If National Defence selects the Centre to provide this training, it will have to identify sources of departmental funding. To the end of our audit, Foreign Affairs had sent only two students.

Conclusion

Departments' joint response: The Department of Foreign Affairs and International Trade and the Department of National Defence believe they have largely met the conditions set by the Treasury Board. Where there may have been lack of compliance, it was as a result of our wishing to support the tremendous pace with which the Pearson Peacekeeping Centre (PPC) set out to implement its mandate within its first two years of operation. The PPC was therefore able to train 251 foreign officers from 57 countries in critical peacekeeping functions.

The results of these efforts must be recognized. By developing and implementing the New Peacekeeping Partnership, the PPC has provided a unique approach to peacekeeping research, education and training, unmatched by the approximately 30 other peacekeeping training centres worldwide.

There is also no precedent in Canada for the establishment of a peacekeeping training centre. Decisions concerning initial funding levels, infrastructure requirements and curriculum development were made without benefit of historical data. For example, the additional unforeseen infrastructure start-up costs were of such a magnitude that they seriously distorted the initial business plan. It should also be noted that in accordance with the Treasury Board submission, the general supervision of the PPC (e.g. the responsibility for the development of a workable business plan) rested with the Canadian Institute of Strategic Studies.

At the time of this audit, it was recognized by Foreign Affairs and International Trade and National Defence that there was not yet a business plan that would enable the PPC to attain self-sufficiency by the end of the contribution agreement. Therefore both departments decided to initiate an independent review of the PPC to examine its financial management, administration and operational procedures. On completion of the review, the departments will convene a meeting to determine the future financial viability of the PPC. The departments will then consider initiating a Treasury Board submission so that they can fully exercise their oversight responsibility and seek additional funds if so determined.

Western Economic Diversification Canada

Terms of contribution agreements for three large projects do not protect the government's interests and may contribute to expected low collections of conditionally repayable financial assistance

Background

39.45 Since 1995-96, the Department has had an arrangement with the Treasury Board that a portion of its annual appropriations will be based on revenues it collects. The Department will need to collect repayments in order to finance its future programs.

Issues

39.47 These agreements can be complex. We would expect that they would contain a clear statement of intent between the parties, and that repayment terms would be structured in such a way that a recipient's financial success would lead to repayment.

39.48 When providing conditionally repayable assistance, linking success and repayments can be complicated, and a recent departmental analysis of one of its many conditionally repayable projects notes, "Experience has shown that trying to tie repayment to anything other than gross revenues does not work... it is an unambiguous figure, and not easily manipulated by any party...[the recipients are] no doubt aware of the vehicles available to them under the current repayment clause to avoid repayment." Three steps necessary for achieving this link are summarized in Exhibit 39.2 .

39.49 We reviewed three large projects that together represent $26 million or 31 percent of total conditionally repayable assistance to ascertain what contributed to the Department's expectation of low collections and high risk.

39.50 Our review of the cases revealed that repayment triggers and contractual conditions do not establish unambiguous conditions for repayment in order to protect the government's interests. Exhibit 39.3 provides an example.

Conclusion

Department's response: It is the position of Western Diversification (WD) that the audit does not present a complete picture of the project or the use by WD of conditional repayments. In particular, it fails to acknowledge that the project described in Exhibit 39.3 has been highly successful in terms of economic diversification through the creation of a world-class research and development facility in Western Canada, the development and transfer of new technologies in partnership with government and academic research institutions, and the creation of highly skilled jobs. This would not have occurred without assistance from governments.

The project described in the exhibit was a three-way partnership between the federal government, the provincial government, and a private sector company to undertake a high-risk initiative in leading-edge areas of technology.

The total federal contribution was $30 million and the provincial contribution was $40 million. The investment by the private partner to date exceeds $70 million. Because of the significant potential benefits of the project, and the desire of the federal and provincial partners to encourage long-term reinvestment in research and development and financial self-sufficiency of the facility, a repayment structure was chosen that would require repayment should retained earnings exceed the amount agreed to by the partners to maintain the facility as a self-funded research and development facility.

Prior to the adoption of conditionally repayable contributions by WD as an innovative way to include the potential for repayment in high-risk projects, federal funding for these projects was typically non-repayable. In general, WD's agreements, which include the provision for repayment, contain several clauses designed to protect the government's investment. These clauses provide for the recovery of all or part of the government's assistance in the event of a project default for reasons such as abandoning the project, the sale or transfer of the supported assets, the failure to provide adequate financial information, and the breach of repayment conditions.