Auditor-General’s Report on the Annual Financial Report of the State of Victoria, 2007–08

1. EXECUTIVE SUMMARY

1.1 Introduction

The Annual Financial Report (AFR) is incorporated into the Financial Report for the State of Victoria 2007–08 (the Financial Report), and is a key part of the accountability of the government to Parliament for the management and stewardship of the state’s finances by the Treasurer and the Minister for Finance, WorkCover and the Transport Accident Commission. Chapters 1 to 3 of the Financial Report, which are not subject to audit, provide analysis and discussion.

The Auditor-General is required under Section 9A of the Audit Act 1994, to express an opinion on the AFR of the State of Victoria and by Section 16A to report to Parliament on the audit of the AFR.

This report:

sets out the results of the audit of the AFR
discusses the financial performance and the financial position of the state and highlights some challenges to the state’s long term ability to sustain operations and respond to changing community requirements
outlines changes to the financial reporting framework implemented in 2007–08 and required to be implemented in future years.

The total cost of preparing and printing this report was $170 000.

1.2 Results of audit

An unqualified audit opinion on the 2007–08 AFR was issued on 24 September 2008, the earliest timeframe achieved since the inception of the AFR. The audited AFR was tabled in Parliament on 14 October 2008.

While an unqualified audit opinion was provided, audit noted the opportunity for entities and the Department of Treasury and Finance (DTF) to improve the quality of data submitted by entities for consolidation into the AFR. Twenty-eight (60 per cent) material entities did not undertake appropriate quality assurance processes to ensure that data submitted to DTF agreed with their audited financial statements. In addition, DTF’s quality assurance processes did not detect material variances between financial instrument note disclosures and financial instrument balances reported in the draft balance sheet. These variances were addressed during the audit process.

1.3 The state’s financial result

Chapters 1 to 3 of the Financial Report, which are not subject to audit, include detailed explanations and analysis of influences on the state’s reported results. This information assists users to make assessments about the financial outcomes achieved, and the condition of the state’s finances.

1.3.1 2007–08 financial performance

The AFR reports a negative net result for the state and the general government sector (GGS) for 2007–08. The state achieved a negative net result (including transactions and economic flows) of $3 107 million in 2007–08 (surplus of $7 668 million, 2006–07), while the GGS achieved a negative net result (including transactions and economic flows) of $1 876 million in the year (surplus of $5 307 million, 2006–07).

The major factors contributing to these negative results for the year were:

$1 452 million in losses, comprising realised losses of $379 million and unrealised losses of $1 073 million, due to the decreased value of financial instruments, reflecting the weaker performance of financial and equity markets
an increase of $3 044 million in the state’s superannuation liability due to the decreased value of superannuation plan assets, also reflecting the weaker performance of financial and equity markets.

In its assessment of its financial performance the government excludes the results of the economic flows and considers the net result from transactions to be the most robust measure of the government’s financial management as this can be directly attributed to government policy. The net result from transactions for the state was a surplus of $1 452 million in 2007–08 ($1 217 million, 2006–07), while the GGS net result from transactions was a surplus of $1 482 million in 2007–08 ($1 335 million, 2006–07). This reflects a strong operating performance for the year.

1.3.2 Financial position of the state

During 2007–08, the state’s net assets grew by $5 323 million to $91 650 million, while the GGS’s net asset position increased by $1 903 million to $45 569 million. The growth in assets has been largely driven by an increase in the value of property, plant and equipment from asset acquisitions ($5 631 million) and revaluations ($8 425 million). The overall level of state liabilities increased by $4 978 million in the year, mainly as a result of increases in superannuation liabilities ($3 044 million) and interest bearing liabilities ($1 783 million).

The state’s recent past and current surpluses from transactions indicate continued sustainability.

Both the state and the GGS net results from transactions are again in surplus, but there exists a current underlying tension that the slow-down in economic conditions now forecast may place income estimates at risk. This would inevitably put pressure on the result from transactions. For example, the recent growth in wages brought about by increases in service delivery and related public sector employees and wage bargaining outcomes will be difficult to reverse in the short to medium term, particularly as demand for services has a direct correlation with population growth.

When looking at the ‘bottom line’ by taking into account other economic flows, the significant deficit in the 2007–08 net result clearly demonstrates the state’s exposure to financial markets and economic conditions outside its control. These factors can put at risk longer-term financial sustainability and will need to continue to be monitored closely, to ensure that current income and expenditure policy settings remain sustainable.

In Chapter 3 we draw attention to three significant elements affecting the state’s financial condition that the state needs to continue to manage for continued sustainability:

employee costs
infrastructure renewal
state liabilities.

1.4 Financial reporting framework and issues in financial reporting

During 2007–08, entities were required to comply with the following changes to the financial reporting framework which were applicable for the first time:

AASB 7 Financial Instruments: Disclosures
Financial Reporting Direction (FRD) 103C Non-Current Physical Assets.

Commentary on the state’s implementation of these new reporting requirements and their impacts on the state’s financial performance and position is provided in Chapter 4.

The AFR for 2007–08 will be the last prior to the adoption of AASB 1049 Whole of Government and General Government Sector Financial Reporting. Accordingly, the preparation of the 2008–09 AFR will require compliance, in certain instances with the Australian Bureau of Statistics Government Finance Statistics (ABS GFS) manual, where it does not conflict with A–GAAP. Commentary on the state’s preparedness to apply the AASB 1049 standard and implications arising from its adoption is provided in Chapter 4.

Commentary is also provided on the impacts of other changes on the financial reporting framework for future years AFR in Chapter 4.

1.5 Recommendations

DTF should in consultation with material entities establish an agreed timetable by March each year and improve their quality assurance processes over data provided by entities (Recommendation 2.1).
Material entities should allocate sufficient resources to achieve the AFR timetable and develop adequate contingency plans to address possible complications to their processes in providing data for the AFR. (Recommendation 2.2).
DTF should act to amend FRD 103C Non-Current Physical Assets to incorporate the measurement of all relevant assets at fair value for reporting periods commencing on or after 1 July 2008 and further expedite processes for fair valuing infrastructure assets and include early consultation with external audit (Recommendation 4.1).

RESPONSE provided by Treasurer

I welcome the Auditor-General’s report, which endorses the State’s strong financial performance for 2007–08 and reaffirms the continuing strength of the State’s financial condition.

The audit report acknowledges the significant achievement in 2007–08, of the earliest ever audit sign-off of the Financial Report for the State of Victoria (the AFR), but also notes scope for further improvement in the timeliness and quality of input to the AFR from public sector agencies. To this end, I confirm that the Department of Treasury and Finance (DTF) will continue to work closely with agencies to identify improvement opportunities, particularly focusing on the provision of timely advice on accounting policy and data submission requirements.

To ensure the production of continuing high quality Annual Financial Reports, DTF also has in place comprehensive quality assurance processes and seeks to refine these processes on an ongoing basis. The learnings from recent experiences, particularly in the context of new reporting requirements, are a key input to this continuous improvement process.

In relation to the new accounting requirement for 2008-09 to ‘fair value’ the State’s infrastructure assets, DTF will continue to demonstrate strong leadership in facilitating whole-of-government compliance by actively engaging with all relevant agencies. The expectation is the issuing of a new Financial Reporting Direction later in the year, consistent with the requirements of this new accounting standard.

Finally, I would like to thank your audit team for conducting a highly professional and timely audit, which has added value to the quality of the AFR.