Auditor-General’s Report on the Annual Financial Report of the State of Victoria, 2014–15

Conclusions

The 2014–15 AFR was not timely because the legislative time lines for reporting were not achieved. It was also not accurate as the audit opinion was qualified on two points.

The first audit qualification highlights that the AFR failed to record the obligation that the state government had at 30 June 2015 to repay Commonwealth Government funding relating to the cancelled East West Link (EWL) project. The state should have recognised a $1.5 billion liability and corresponding expense.

Secondly, the Department of Education & Training (DET) has failed to maintain a complete and accurate asset register to support the property, plant and equipment balance reported in their financial statements. This meant $16.8 billion of assets held by the state were not supported by proper underlying accounts and records during the 2014–15 financial year.

The state's financial results reported in the AFR showed mixed results. If the EWL project transaction is correctly accounted for, the government's key financial measure of a net result from transactions of at least a $100 million surplus has not been achieved; and the liquidity ratio for the state has fallen.

Findings

Qualified audit opinion

The AFR received a modified financial audit opinion, consisting of two audit qualifications:

• the AFR did not record an expense, and associated liability, recognising the state's obligation to return to the Commonwealth Government $1.5 billion of funding relating to the EWL project
• the property, plant and equipment balances of DET, which are included in the AFR, were not supported by proper accounts and records.

East West Link project

In 2013–14, the Commonwealth Government paid $1.5 billion to Victoria as part of a $3.0 billion contribution to the EWL project. This funding was correctly accounted for as revenue in that year in accordance with Australian Accounting Standard AASB 1004 Contributions. Following the state election in November 2014, the EWL project was cancelled by the state government.

The cancellation of the EWL project, and a formal request from the Commonwealth Government for repayment of the funds, pursuant to the memorandum of understanding, and the related Commonwealth legislation, means that at 30 June 2015 the state had an obligation to repay the money under AASB 1004. Importantly, the Commonwealth Government also has the ability to recover this funding by reducing future funding for other Victorian projects. The correct accounting treatment is to recognise an expense and a liability for $1.5 billion at that time.

By not recording the $1.5 billion expense and associated provision as a liability, the SoV and the GGS net result from transactions is overstated, and other provisions in the balance sheet are understated. This means that the net result from transactions for the GGS would change from a surplus of $1 214.0 million to a deficit of $286.0 million. The state's key financial measure of achieving a net surplus from transactions for the GGS of at least $100 million has therefore not been achieved.

This matter also resulted in a qualified audit opinion being issued on the financial statements for the year ending 30 June 2015 for the Department of Treasury & Finance (DTF).

As detailed in the Auditor-General's Annual Plan 2015–16, tabled in Parliament in June 2015, a Performance Audit of the EWL project has been undertaken. The audit reviewed the key project decisions, costs, events and related advice influencing the project's financial outcomes.

The report on this audit is scheduled to be tabled in Parliament in December 2015.

Department of Education & Training

A disclaimer audit opinion has been issued on the financial statements of DET for the year ending 30 June 2015. The disclaimer audit opinion was issued because DET was unable to provide, and therefore we were unable to obtain, sufficient appropriate audit evidence to support all the balances and/or transactions in the financial report, and those transactions and balances combined had a significant effect on the financial report.

The transactions and balances highlighted within the DET audit opinion are material to the AFR and it was determined that the following financial statement line items were materially impacted:

• land, buildings, infrastructure, plant and equipment—$16.8 billion impact
• land, buildings, infrastructure, plant and equipment revaluation surplus reserve—$7.4 billion impact.

As a result, the audit opinion for the AFR has been modified to include a qualification on these balances.

DET has failed to maintain proper accounts and records, including a complete and accurate asset register to support the property, plant and equipment balance reported in its financial statements. This is a breach of the Financial Management Act 1994 (the FMA), and led to the Auditor-General being unable to obtain sufficient appropriate audit evidence to support a clear opinion.

The asset register issues for property, plant and equipment are not new, having been reported to DET over the past two financial years. DET have not adequately addressed these issues which has caused the audit opinion on the AFR, and DET's financial statements to be modified.

Further comment on the results of the audit of DET will be included in our Portfolio Departments and Associated Entities: 2014–15 Audit Snapshot report, to be tabled in Parliament in December 2015.

Resolution of prior year qualification

The Auditor-General issued a qualified audit opinion on the Annual Financial Report of the State of Victoria, 2013–14 on 2 October 2014.

The qualified opinion was issued regarding the accounting policy applied for measuring the value of school buildings by the former Department of Education & Early Childhood Development (DEECD)—specifically, how economic obsolescence was assessed in calculating a school building's fair value.

This issue has been resolved during the 2014–15 financial year, with DEECD's successor department, DET, changing its accounting policy. An adjustment for economic obsolescence is no longer made to the valuation of school buildings still in use.

DET has made a prior year restatement in their 2014–15 financial statements, which has been incorporated into the 2014–15 AFR. As a consequence, the audit qualification relating to economic obsolescence of buildings by DET in 2013–14 has not been continued in 2014–15.

Delays to the production of the AFR

The FMA requires the AFR to be transmitted to Parliament by 15 October. This date was not met, with the AFR being transmitted by the Treasurer on 4 November 2015, and tabled in Parliament on 10 November 2015.

The timely production of the AFR requires the consolidated entities to produce complete and compliant financial reports in line with a timetable set out by DTF. For 2014–15, the timetable required 47 material entities to provide their draft financial statements to my office by 24 July 2015. Only four material entities (8.5 per cent) achieved this time line.

The financial reporting impacts of the machinery-of-government changes during 2014–15, significant and contentious financial reporting issues which arose during 2014–15, and the loss of financial knowledge and experience at some material entity finance teams in recent years all contributed to the delays in the preparation of the AFR.

Addressing prior period issues

The 2013–14 AFR audit management letter raised a number of issues relating to oversight, scrutiny, and better practice financial management which were applied to the AFR—all based on the obligations of other entities reporting under the FMA.

One important and welcome change this year is that the Treasurer has signed the certification of the AFR. However, although the FMA does not expressly prescribe who should sign the certification of the AFR, it would have been consistent with previous practice for the certification to have also been counter-signed by a chief financial officer in line with Standing Direction 4.2(c), which applies to all other reports prepared under the FMA.

DTF should seek to address our other concerns to ensure that the AFR has the same level of oversight, scrutiny and better practice financial management that is required to be applied by all public sector entities reporting under the FMA.

General government sector

The reported GGS net surplus from transactions was $1 214.0 million. Correctly accounting for the EWL project funding obligation to the Commonwealth Government would have resulted in a net deficit from transactions of $286.0 million. This means that the government has not achieved its key financial measure of a net result from transactions of at least $100 million for the GGS in 2014–15.

Included in the GGS surplus was $841.2 million in dividends received from other state entities. This was $425.1 million more than was included in the 2014–15 State Budget. The Treasurer called upon the State Electricity Commission of Victoria for a $100 million dividend in late June when one had not been budgeted, as well as receiving an additional $31.7 million in interim dividends from three water corporations at the same time.

State of Victoria

The state's reported financial results for 2014–15 were mixed with a reported deficit of $610.7 million from operations, and the state's liquidity ratio falling from 0.97 to 0.84. The state's liquidity is measured as the proportion of current assets against current liabilities held at 30 June. If the EWL project funding obligation was correctly accounted for, this would see the deficit increase to $2 110.7 million and the liquidity ratio fall to 0.79.

There are positive results for the state's debt sustainability and capital replacement indicators. Debt sustainability remains stable because debt is growing at the same rate as the gross state product. This means the state is maintaining its ability to service the debt. Similarly, the asset replacement indicator remains strong, and suggests that the state is replacing or renewing assets at the same pace at which they are being consumed at the whole-of-government level. This does not negate, however, the asset renewal concerns in specific sectors.

Recommendations

1. That material entities, particularly portfolio departments, review the resources and capability of their finance teams and ensure they have the skills and experience to produce accurate and compliant financial statements in a timely manner.
2. That the Department of Treasury & Finance needs to apply the same governance, oversight and better practice financial reporting principles to the Annual Financial Report of the State of Victoria that applies to public sector entities reporting under the Financial Management Act 1994.

Submissions and comments received

We have professionally engaged with agencies throughout the course of the audit. In accordance with section 16A of the Audit Act 1994 we provided a copy of this report to the Treasurer and requested his submissions or comments. In accordance with section 16(3) of the Audit Act 1994 we provided relevant extracts of this report to named agencies and requested their submissions or comments.

We have considered those views in reaching our audit conclusions and have represented them to the extent relevant and warranted. Their full section 16A and section 16(3) submissions and comments are included in Appendix C.

1.1 Introduction

This report informs Parliament and the citizens of Victoria about the financial outcomes and position of the State of Victoria as at 30 June 2015. It does that by analysing and discussing the Annual Financial Report of the State of Victoria, 2014–15 (the AFR), which was transmitted to Parliament by the Treasurer on 4 November 2015, and tabled in Parliament on 10 November 2015. Figure 1A outlines the structure and contents of this report.

Figure 1A

Report structure

Source: Victorian Auditor-General's Office.

This report has been produced in accordance with section 16A of the Audit Act 1994. Pursuant to section 20(3) of the Audit Act 1994, unless otherwise indicated, any persons named in this report are not the subject of adverse comment or opinion.

The total cost of this report was $170 000.

1.2 What is the AFR?

1.2.1 State of Victoria

The AFR is the State of Victoria's financial statements. It is the key financial accountability document that tells Parliament and the citizens of Victoria what the state's financial position is, and how the state has performed in financial terms over the year.

The AFR consolidates the financial results and financial position of all state-controlled entities. Entities are classified into three categories as detailed in Figure 1B. Transactions between the consolidated entities are removed to avoid double counting.

Figure 1B

Categories of state government entities included in the State of Victoria financial result

Source: Victorian Auditor-General's Office.

The number of entities making up the State of Victoria varies slightly from year to year, as entities are created, merged or disbanded. At 30 June 2015 there were 277 entities (279 entities at 30 June 2014) whose financial results were combined to make up the State of Victoria.

1.2.2 General government sector

As well as showing the financial results of the State of Victoria, the AFR reports on the financial position and performance of the general government sector.

Reporting on this group of entities is important as it allows the government to demonstrate their actual results against the State Budget, published as the Estimated Financial Statements (EFS) in Budget Paper 5.

The EFS relates only to the general government sector and is reviewed (not audited) by the Auditor-General at the time of production.

How the general government sector fits into the AFR

Figure 1C shows the difference and relationship between the AFR and the general government sector.

Figure 1C

Entities included in the Annual Financial Report of the State of Victoria

Source: Victorian Auditor-General's Office.

Material entities

Of the controlled public sector entities, 47 were deemed by the Department of Treasury & Finance and my office to be 'material' entities for 2014–15 (48 in 2013–14). A public sector entity is classified as material when its individual financial operations are significant in the reporting of the consolidated finances of the state. Collectively, material entities account for more than 90 per cent of the state's assets, liabilities, revenue and expenditure.

1.2.3 Entities excluded from the AFR

The AFR only reports on state-controlled entities. Therefore, other entities which provide public services, and which may be expected to be included in the AFR, have been excluded as they are not controlled by the state for financial reporting purposes. These entities are detailed in Figure 1D.

Figure 1D

Sectors not included in the AFR

Source: Victorian Auditor-General's Office.

2.1 Introduction

The Auditor-General undertakes a financial audit on the State of Victoria's Annual Financial Report (AFR) in accordance with section 9A of the Audit Act 1994.

Independent audit opinions add credibility to financial statements by providing reasonable assurance that the information reported is reliable and accurate. A clear audit opinion confirms that the financial statements present fairly the transactions and balances for the reporting period, in accordance with the requirements of relevant legislation. A qualified audit opinion is issued where a clear statement cannot be made by an auditor that financial statements are fairly presented in all material respects.

2.2 Audit opinion for year ending 30 June 2015

The Auditor-General issued a qualified audit opinion on the AFR on 30 October 2015. The qualification relates to two areas—the absence of an expense and a liability to recognise the obligation to return the East West Link (EWL) project funds, and an inability to obtain sufficient appropriate evidence for property, plant and equipment assets at the Department of Education & Training (DET). A copy of the opinion is at Appendix A.

2.2.1 East West Link project

At 30 June 2015, the state had an obligation to repay the $1.5 billion received from the Commonwealth Government for the EWL project. However, the AFR did not recognise an expense and provision for this obligation. We do not agree with this omission.

In 2013–14, the Commonwealth Government paid $1.5 billion to Victoria as part of a $3.0 billion contribution to the EWL project. This money was correctly accounted for as revenue in that year in accordance with Australian Accounting Standard AASB 1004 Contributions. Following the state election in November 2014, the EWL project was cancelled.

A memorandum of understanding (MoU) for the project signed by both the Commonwealth Government and the state, and the Nation Building Program (National Land Transport) Act 2009, under which the money was provided, both detailed what was to occur if the EWL project was cancelled. Specifically, if the project was cancelled in its entirety, any payment made on it would be repayable to the Commonwealth Government. Alternatively, the Commonwealth could withhold future funding for the state for other projects to the same amount.

On 12 May 2015, the Commonwealth Government wrote to the Minister for Public Transport and the Minister for Roads and Road Safety requesting the return of all funding previously paid to Victoria for the EWL project. In addition, the Commonwealth accounted for the return of the funding in its 2015–16 Budget.

The cancellation of the EWL project, and the formal request from the Commonwealth Government for the repayment of the funds, means that at 30 June 2015 the state had an obligation to repay the funding. The correct accounting treatment would have been to recognise an expense, and corresponding liability, for $1.5 billion at that time. Australian Accounting Standard AASB 1004 Contributions requires that a liability and an expense be recorded where the conditions of a grant will not be met and the funds are required to be returned. The recognition of a liability in the form of a provision for the return of the funds would also satisfy the requirements of AASB 137 Provisions, Contingent Liabilities and Contingent Assets.

By not recording the $1.5 billion expense and the associated provision as a liability, the State of Victoria and the general government sector's net result from transactions is overstated, and liabilities in the balance sheet are understated. This means that the net result from transactions for the general government sector would change from a surplus to a loss of $286 million, and would see the government not achieve its key financial measure of having a net result from transactions of at least a $100 million surplus.

This issue also resulted in a qualified audit opinion being issued on the financial statements for the year ending 30 June 2015 of the Department of Treasury & Finance (DTF).

While the Treasurer has consistently stated that the money will not be returned to the Commonwealth Government, this intention does not negate the requirement under Australian Accounting Standards to recognise the obligation to return the money.

Subsequent to year end, the Commonwealth Government indicated that it would allow—on a without prejudice basis and under certain specified conditions—the state to treat the funding as a prepayment to fund the Commonwealth Government's future commitments to other projects. This does not mean an obligation to return the funds at 30 June 2015 did not exist, and withholding future funding from the state would, in substance, result in the same outcome.

DTF had previously sought legal advice which concluded that the state did not have a present obligation to return the funds—therefore there was no requirement under Australian Accounting Standard AASB 137 to recognise a liability and corresponding expense. DTF's legal advisers had also sought accounting advice in preparing their advice to DTF. It is our opinion that an expense, and corresponding liability, should be recognised; a present obligation was created when the Victorian Government discontinued the EWL project and the Commonwealth Government requested the funding to be returned, as set out in the MoU and the Nation Building Program (National Land Transport) Act 2009. In our view, this satisfies the broader accounting definitions of a contract and, consequently, an obligation for financial reporting purposes exists at 30 June 2015.

One of the key qualitative characteristics of financial reporting is that transactions and balances are to be accounted for based on substance over legal form. The legal view of the transaction does not override, or determine, the accounting treatment for the transaction. Our position on the correct accounting treatment for the EWL project funding has been confirmed by preeminent independent accounting experts.

As detailed in the Auditor-General's Annual Plan 2015–16, tabled in Parliament in June 2015, a performance audit of the EWL project has been undertaken. The audit reviewed the key project decisions, costs, events and related advice influencing the project's financial outcomes.

The report on this audit is expected to be tabled in Parliament in December 2015.

2.2.2 Department of Education & Training

A disclaimer audit opinion was issued on the financial statements of DET for the year ending 30 June 2015. The disclaimer audit opinion was issued because we were unable to obtain sufficient appropriate audit evidence to support all the balances and/or transactions in the financial report relating to fixed assets and certain school-based financial information. These transactions and balances combined represented a substantial proportion of the financial report, and had a significant effect on the financial report.

The transactions and balances highlighted within the DET audit opinion are material to the AFR and it was determined that the following financial statement line items were materially impacted:

• land, buildings, infrastructure, plant and equipment—$16.8 billion impact
• land, buildings, infrastructure, plant and equipment revaluation surplus reserve—$7.4 billion impact.

As a result, the audit opinion for the AFR has been modified to include a qualification on these balances.

DET has failed to maintain proper accounts and records, including a complete and accurate asset register to support the property, plant and equipment balance reported in its financial statements. This is a breach of the Financial Management Act 1994. Consequently, we were unable to obtain sufficient appropriate audit evidence to support a clear opinion.

Issues with the integrity of data on the asset register at DET are not new, and there has been a steady elevation of these issues by the Auditor-General. In 2012–13, data integrity issues around asset records were reported to DET as a high-risk item that required immediate action. This same issue was raised again in 2013–14 when appropriate action failed to occur. In addition, two high-risk concerns around the lack of timely asset accounting and inadequate reconciliations of the assets register were raised in 2013–14.

DET had provided commitments to:

• improve the capture, store and management of asset information, and to conduct a data cleanse by November 2014
• implement new asset register software to address weaknesses, review governance controls for reconciliation approvals, and provide training to staff on reconciliations by 30 June 2015.

Notwithstanding these commitments, the fixed asset register did not sufficiently support the account balances and transactions, and therefore we could not obtain sufficient appropriate evidence to support the property, plant and equipment balances reported for 30 June 2015.

DET's inability to address areas of concern raised by my office, within a reasonable time frame was also observed in our report Department of Education and Training: Strategic Planning tabled in October 2015. In the instance of the asset register and data integrity issues, the Auditor-General provided DET with an opportunity to work on the issues raised during 2014. However, progress has been slow and largely ineffective, leading to a modification of the audit opinion.

As shown in Appendix C, the DET Secretary's response to this report accepts the issues discussed above, and DET have made commitments to take action to address the concerns. We will, within the bounds of our independence, provide the department with feedback and advice as they work through resolving these issues.

Further comment on the results of the audit of DET will be included in our report Portfolio Departments and Associated Entities: 2014–15 Audit Snapshot, to be tabled in Parliament in December 2015.

2.3 Prior year adjustments

The Auditor-General issued a qualified audit opinion on the Annual Financial Report of the State of Victoria, 2013–14, on 2 October 2014.

The qualified opinion was issued regarding the accounting policy applied for measuring the value of school buildings by the former Department of Education & Early Childhood Development (DEECD)—specifically, how economic obsolescence was assessed in calculating a school building's fair value.

This issue was resolved during the 2014–15 financial year, with DEECD's successor department (DET) and the AFR, changing their accounting policy. An adjustment for economic obsolescence is no longer made to the valuation of school buildings still in use.

Additionally, DTF has issued updated guidance for the public sector on valuing assets as part of the Financial Reporting Directions of the Minister for Finance, promoting consistency in valuation approaches across all entities reporting under the Financial Management Act 1994 (FMA).

DET has changed its accounting policy and made a prior year restatement in its 2014–15 financial statements, which has been incorporated into the 2014–15 AFR. As a consequence, the audit qualification relating to economic obsolescence of buildings by DET and the AFR in 2013–14 has not been continued in 2014–15.

The 2014–15 AFR has also made several adjustments to the figures reported for the 2013–14 financial year. These changes are detailed in note 37 of the AFR, and consist of:

• crown land—the state has an ongoing project to reconcile records regarding parcels of crown land, resulting in the recognition and de-recognition of assets during the financial year
• superannuation—a change in accounting policy regarding the recognition of franking credits relating to the defined benefit superannuation liability, with future franking credits and other tax offsets now recognised when they arise, rather than estimated in advance.

The overall impact of these changes was a reduction in the net result from transactions for the State of Victoria for 30 June 2014 of $7.4 million; and an increase in net assets held of $990.8 million.

2.4 Timeliness of the AFR

As per section 27(d) of the FMA, the audited AFR must be transmitted to Parliament no later than 15 October. The 2014–15 AFR missed this statutory tabling date.

Figure 2A shows that the finalisation of the AFR has been getting later over the past three years.

Figure 2A

AFR finalisation dates

Source: Victorian Auditor-General's Office.

To meet the statutory date, the preparation and audit of the AFR depends on material entities meeting the timetable set by DTF for the collation of information, and the early identification and resolution of significant accounting and disclosure issues. On 4 August 2015, the former Auditor-General wrote to the Secretary, DTF (and other secretaries) and advised that there were risks to the timely preparation of departmental financial statements that would ultimately have a flow-on effect to the AFR.

Those risks lead to the eventual delay in finalising the 2014–15 AFR with only four (8.5 per cent) of the 47 material entities providing their draft financial statements to my office by the DTF deadline of 24 July 2015. Figure 2B summarises when complete draft financial statements were provided to audit teams over the 2013–14 and 2014–15 financial years.

Figure 2B

Draft financial statements provided to audit by material entities, 2013–14 and 2014–15 financial years

Note: Vertical (green) line shows the date DTF expected material entities to have provided their draft statements to their auditors.

Source: Victorian Auditor-General's Office.

The material entity delays were caused by a number of concurrent issues, including:

• machinery-of-government changes during the 2014–15 financial year which, among other things, required the preparation of a final set of financial statements for the former departments to 31 December 2014, and amalgamated statements for the new departments for 30 June 2015
• contentious financial reporting issues in several sectors and the AFR
• a loss of financial knowledge and experience across certain finance teams following the reduction in staff through voluntary departures under the Sustainable Government Initiative, and machinery-of-government changes.

2.5 Unresolved prior period issues

The financial audit of the 2013–14 AFR raised three governance and oversight issues that were bought to DTF's attention and raised in our report Portfolio Departments and Associated Entities: Results of 2013–14 Audits (tabled in February 2015). Figure 2C provides an update on these issues as at September 2015.

Figure 2C

Update on 2013–14 management letter issues

Source: Victorian Auditor-General's Office.

DTF has yet to address two of the issues raised in the audit of the 2013–14 AFR, and consequently the same level of oversight, scrutiny and better practice financial management that is required to be applied by all public sector entities reporting under the FMA has not been applied to the AFR.

In addition, while the Treasurer and Secretary, DTF, signed the 2014–15 AFR, the chief financial officer did not. This is not consistent with previous practice and with the standards set by the FMA for applicable public sector entities when preparing financial reports.

Recommendations

1. That material entities, particularly portfolio departments, review the resources and capability of their finance teams and ensure they have the skills and experience to produce accurate and compliant financial statements in a timely manner.
2. That the Department of Treasury & Finance needs to apply the same governance, oversight and better practice financial reporting principles to the Annual Financial Report of the State of Victoria that applies to public sector entities reporting under the Financial Management Act 1994.

3.1 Introduction

Entities in the general government sector (GGS) provide goods and services to the community, often at no or low cost to users. These goods and services are the core public services provided by the state—therefore measurement of financial performance and outcomes at this level provides information about how economically they have been delivered.

The state prepares its annual budget at this GGS level. In this Part we review and make comment on the financial position and performance of the GGS for the financial year ending 30 June 2015 including an assessment against the published budget.

3.2 Conclusion

The Annual Financial Report (AFR) reported a GGS net surplus from transactions of $1 214.0 million in 2014–15, against a budgeted outcome of $1 326.7 million.

This result excludes recognition of the $1.5 billion Commonwealth Government funding for the East West Link (EWL) project, which the state had an obligation to return at 30 June 2015. If this was correctly accounted for the net result from transactions would have been a deficit of $286.0 million. As a result, it has not achieved its key financial measure of at least a $100 million net surplus from transactions for the GGS.

3.3 Budget to actual

The estimated financial statements (EFS) are part of the State Budget and they set out the expected financial result and position for the GGS for the next financial year, as well as providing forward financial estimates for the outward three years. The EFS is a budget for the GGS sector, not the State of Victoria.

The EFS is reviewed, but not audited, by the Auditor-General, and a review conclusion is published as part of the Budget document. A clear review report was issued by the Auditor-General on the 2014–15 EFS.

Figure 3A shows a comparison between the actual and budgeted net result from transactions for the GGS for 2014–15 and the previous four financial years. It shows that the actual result for the GGS has varied from the predicted result in most financial years.

In 2014–15, the GGS reported a net result from transactions of $1 214.0 million, against a budgeted result of $1 326.7 million. However to provide context to these results, the total revenue from transactions for the GGS for 2014–15 was $53.8 billion and the budgeted net result from transactions was 2.5 per cent of revenue and the actual net result from transactions was 2.3 per cent of revenue.

Figure 3A

Net result from transactions for the financial year ending 30 June for the general government sector

Source: Victorian Auditor-General's Office.

The net result from transactions of $1 214.0 million was achieved by omitting the recognition of an expense for the requirement to return the EWL project funding to the Commonwealth Government. Figure 3A shows that the net result from transactions is a deficit if the expense had been correctly recognised as is required by Australian Accounting Standards. A deficit would mean that the government had not achieved its key financial measure of at least a $100 million net result from transactions surplus for 2014–15.

The net result from transactions, as published, shows the 2014–15 result also did not achieve the budgeted outcome of $1 326.7 million, falling short by $112.7 million.

3.3.1 Dividends

In 2014–15, the GGS received $841.2 million in dividends from other state entities outside the GGS. This $841.2 million is more than double the $416.1 million that was budgeted to be received. Details of the budget and actual dividends received by the GGS from other state entities are shown in Figure 3B.

Figure 3B

Dividends paid to the GGS in the 2014–15 financial year – budget to actual

Source: Victorian Auditor-General's Office based on Victorian Budget 2014–15 and Annual Financial Report of the State of Victoria, 2014–15, Department of Treasury & Finance.

The extra revenue received as dividends by the GGS was largely due to:

• interim dividends declared in 2013–14 by the Treasurer—from the Transport Accident Commission and WorkSafe Victoria—had been previously deferred; but were paid in 2014–15
• an unbudgeted interim dividend paid by the State Electricity Commission of Victoria of $100 million, determined by the Treasurer on 22 June 2015, for payment by 30 June 2015
• an additional $31.7 million in interim dividends relating to the 2014–15 financial year from three water corporations determined by the Treasurer in late June 2015 and paid on 29 June 2015.

The payment of dividends is determined by the Treasurer, in consultation with the entities impacted. Without the additional $425.1 million of dividends received in the year, the 30 June 2015 reported net result from transactions for the GGS would have been $789.0 million, 40 per cent less than the budgeted result.

4.1 Introduction

This Part reviews the financial position and performance of the State of Victoria for the financial year ending 30 June 2015.

4.2 Conclusion

The state's financial statements had mixed results for 2014–15, generating a net deficit from transactions of $610.7 million. While we observed positive indicators for the level of asset renewal and debt sustainability, if the state correctly accounted for the $1.5 billion East West Link (EWL) project obligation at 30 June 2015, there would have been a significant decline in its liquidity position and net result.

On the positive side, although borrowings had a small increase, the state's ability to service this debt has remained stable. Spending on new assets and asset renewal also appears to be keeping pace with the consumption of assets at the state level. This is notwithstanding our sector-based reports flagging asset replacement risks at individual public hospitals, water entities and other state entities.

4.3 Financial performance of the state

To get a complete picture of how the state has performed financially in 2014–15 requires consideration of key measures on both the comprehensive operating statement and balance sheet. Figure 4A provides a summary of key measures in both main statements and a calculation of liquidity. It includes the numbers reported in the Annual Financial Report of the State of Victoria 2014–15 (AFR) and demonstrates the impact on the financial results and financial position of the state if the correct accounting treatment had been adopted for the return of the EWL project funding to the Commonwealth.

Figure 4A

Key balances for the State of Victoria for the financial year ending 30 June ($ million)

Source: Victorian Auditor-General's Office.

The net result from transactions shows the surplus or deficit the state has made from its operational revenue and expenditure for the year. This includes revenue and expenditure attributable to government policy, but excludes changes in values of assets and liabilities due to market fair value re-measurements—such as financial investments and non-financial fixed assets.

For 2014–15, the state reported a deficit from transactions of $610.7 million. This is a significant change from 2013–14 when the state achieved a net result from transactions of a surplus of $787.6 million. Figure 4B shows the net result from transactions for the state over the past five financial years, and it demonstrates that the surplus in 2013–14 was an unusual occurrence.

Figure 4B

Net result from transactions for the financial year ending 30 June for the State of Victoria

Source: Victorian Auditor-General's Office.

The accounting for the EWL project funding has had a significant impact on the state's finances in the current and previous year. The surplus in 2013–14 was achieved because $1.5 billion in grant funding for the EWL project was provided by the Commonwealth Government during June 2014, $1 billion more than the state was expecting in that year. Conversely, in 2014–15 the broken line in Figure 4B demonstrates the impact on the net result from transactions if the correct accounting treatment had been adopted for the EWL project funding. The net result from transactions would have been a deficit of $2.1 billion.

Underpinning the net result from transactions is the fluctuation in revenues the state generates and expenditures that are incurred. Figure 4C illustrates the trends in revenue and expenditure transactions for the state over the past five years.

Figure 4C

Revenue and expenditure transactions for the financial year ending 30 June for the State of Victoria

Source: Victorian Auditor-General's Office.

Figure 4C shows that revenue fluctuates year to year compared to expenditure which has had a steady growth over the past five years. The revenue fluctuations are mainly caused by receipt of Commonwealth Government grants, which are generally significant in amount, but the timing is largely outside of the state's control. Large amounts of Commonwealth Government funding can be provided for capital projects and this fluctuates depending on what projects the state is delivering.

4.3.1 Sources of revenue for the State of Victoria

In 2014–15, the state received $61.1 billion in revenue from transactions ($60.3 billion in 2013–14). As shown in Figure 4D, the largest components of the state's revenue are Commonwealth grants and state taxation.

Figure 4D

Composition of revenue from transactions received by the State of Victoria in 2014–15

Note: Inter-sector transactions of $9.5 billion (in 2014–15) eliminated from consolidation to State of Victoria.

PNFC = Public Non-Financial Corporation. PFC = Public Financial Corporation

Source: Victorian Auditor-General's Office.

Grants from the Commonwealth Government accounted for 39.9 per cent of the revenue that the state received in 2014–15 (41.5 per cent in 2013–14), and is the state's largest source of revenue. Taxation made up 29.4 per cent of revenue (27.3 per cent in 2013–14).

4.3.2 Expenditure reported by the State of Victoria

As reported in the AFR, in 2014–15 the state incurred expenditure of $61.7 billion ($59.5 billion in 2013–14) primarily on the delivery of services to, and maintenance of infrastructure for, the Victorian public (expenditure from transactions).

Almost half of the state's reported spending was on health and education as shown in Figure 4E which depicts the services on which the state is spending its money.

Figure 4E

Composition of expenditure from transactions reported by the State of Victoria in 2014–15

Source: Victorian Auditor-General's Office.

To deliver services, the principal costs that the state incurs are employee expenses and the purchase of goods and services. A further $4 453.7 million of expenditure is depreciation ($4 334.1 million in 2013–14) which approximates the level of assets consumed in the financial year to deliver the state's goods and services.

4.4 Financial position

4.4.1 Liquidity

An internationally accepted indicator of short-term financial health is the ability to pay all short-term financial obligations as they become due. Liquidity is measured by comparing the state's current assets against current liabilities. A ratio of more than one indicates a low risk in meeting short-term obligations as there are more cash and liquid assets than short-term liabilities. The stronger the ratio the better able you are to meet ongoing and unexpected costs.

The state's liquidity was less than one at 30 June 2015. Figure 4F graphs the state's ratio of current assets over current liabilities over the past five years, and shows that liquidity has always been below one and it has significantly declined from 2014 to 2015.

Figure 4F

Liquidity ratio as at 30 June for the State of Victoria

Source: Victorian Auditor-General's Office.

The decline in liquidity from 0.97 at 30 June 2014 to 0.84 at 30 June 2015 is driven by an increase in current borrowings of $1.4 billion; which has been moved from longer-term borrowings by the state's financial entity, Treasury Corporation of Victoria. The change in the composition of the state's borrowings has been undertaken to take advantage of low interest rates for shorter-term borrowings.

When the correct accounting treatment is applied to recognise a liability for the return of the EWL project funding, the broken line in Figure 4F shows liquidity would decline further to 0.79.

4.4.2 Capital replacement

Maintaining existing infrastructure, and providing new infrastructure, to enable the state to continue to provide services to the community is a significant challenge for the government. An indicator of how well the state is renewing or replacing assets is to compare the spend on assets in the financial year to the depreciation expense. This is illustrated in Figure 4G.

Figure 4G

Capital replacement ratio for the State of Victoria at 30 June

Source: Victorian Auditor-General's Office.

In 2014–15, the state spent $6.6 billion on new and replacement assets, against a budgeted spend of $6 971.5 million on capital projects.

Figure 4G indicates the state is renewing and/or replacing assets at a good rate against their use—as measured through depreciation. However, it should be noted that this ratio can be distorted by large projects for new assets—such as the completion of the Peninsula Link.

It is important to make sure that the state also continues to maintain existing assets, so that services to the Victorian public are not compromised through a lack of appropriate facilities. Analysis included in our sector-specific audit snapshot reports over the past financial years has continually indicated that spending on hospital, water and other state assets has not kept pace with their usage.

4.4.3 Debt sustainability

In purely financial terms, sustainable debt is the level of debt that can be repaid while balancing factors such as economic growth, interest rates, and the state's capacity to generate surpluses in the future.

The value of borrowings as a percentage of gross state product (GSP) is an indicator of debt sustainability. A low percentage indicates that the state is better able to service its debt obligations.

Figure 4H

Debt sustainability ratio for the State of Victoria at 30 June

GSP = Gross state product.

Source: Victorian Auditor-General's Office.

Figure 4H indicates that the state's ability to service debt is relatively unchanged from the prior year because total debt is growing at the same pace as GSP meaning the state is not making gains in this area. However, debt sustainability has improved compared to recent years when there was a sharp decline that coincided with a sharp increase in borrowings.

Total borrowings, as depicted in Figure 4I have stagnated this year coming after four years of consistent growth.

Figure 4I

Cash and interest bearing liabilities balances at 30 June for the State of Victoria

Source: Victorian Auditor-General's Office.

The increasing levels of borrowings indicate that the state has been funding large capital projects from borrowings and other sources—such as public private partnerships—rather than through cash. However, the ability to service this debt has not been flagged as a concern.

5.1 Introduction

The 2014–15 State Budget provided details of public sector capital projects that were either underway or starting in the 2014–15 financial year. The total value of these projects is around $72 billion.

In 2014–15, the state government spent $6.6 billion on purchases of new and replacement assets.

In the Budget Papers, the government identified 36 of these projects as 'high value, high risk' (HVHR) major projects. These are projects with a budget of more than $100 million, and/or which are considered to have a higher risk profile than normal. As a result, they are subject to increased oversight, particularly from the central agencies such as the Department of Treasury & Finance (DTF), throughout their planning and development phase.

We have previously reviewed the high value, high risk system in our report Impact of Increased Scrutiny of High Value High Risk Projects, tabled in Parliament in June 2014. This report found that the increased scrutiny applied through the HVHR process has improved the quality of the business cases and procurements underpinning government's infrastructure investments. However, these improved practices are yet to ensure that project development and implementation consistently and comprehensively meets DTF's better practice guidelines. This means government is still exposed to the risk that projects fail to deliver intended benefits on time and within approved budgets. A robust HVHR process is critical to effectively managing this risk.

Our subsequent report Applying the High Value High Risk Process to Unsolicited Proposals, tabled in Parliament in August 2015, highlighted that DTF has not consistently applied the HVHR process to unsolicited proposals. DTF's guidance falls short of providing the transparency needed to enable affected stakeholders and the wider community to understand the full impacts of these projects.

Section 5.4 provides an update on another significant project impacting the State of Victoria—the proposed Port of Melbourne lease. This item is discussed as a subsequent event in note 38 of the 2014–15 Annual Financial Report of the State of Victoria (the AFR), but does not impact the financial transactions reported in the AFR. It was included in the 2015–16 State Budget, and may impact assets held by the state in the future.

5.2 Different types of major projects

Of the 34 projects identified by the government as high value, high risk, some are delivered by the government, while others are being delivered using a public private partnership (PPP).

The 19 PPPs for which the state government had outstanding commitments at 30 June 2015 are detailed in note 34(b) of the 2014–15 AFR. Of these, three PPPs are not yet commissioned, meaning that their construction has not been completed. This Part provides an update on these PPPs as at 30 June 2015. They are:

• Bendigo Hospital
• Victorian Comprehensive Cancer Centre (VCCC)
• Ravenhall Prison.

This Part also details the status of the Regional Rail Link—a major project—as at the same date.

What are public private partnerships?

A PPP is a long-term contract between the public and private sectors generally covering the design, construction, maintenance, management and financing of an infrastructure asset. Common characteristics of a PPP are:

• the private entity funds the design and construction of the asset
• the private entity manages the asset for an extended period—usually over 20 years—and usually leases it to a public sector entity
• the public sector uses the asset to deliver services and usually makes a regular payment to the private entity for leasing and maintaining the asset
• after the lease period, the asset is returned to public sector ownership, which can then continue to use, or dispose of, the asset as required.

Auditing PPP arrangements

Due to the complex nature of PPP arrangements, and the high level of public money that will be spent on these arrangements over the life of the contract, it is important that these arrangements are subject to the same scrutiny as other public spending.

However, as the state has increasingly sought partnerships, alliances or other service delivery models involving the private sector, the provisions of the Audit Act 1994 have failed to keep pace with these developments. As a result, the Auditor-General's mandate to review public expenditure on large projects has diminished. This means that PPPs cannot be held to the same level of transparency or accountability as other areas of public spending.

5.3 Analysis of selected major projects

5.3.1 Bendigo Hospital Redevelopment PPP

The Bendigo Hospital development involves the construction of a new hospital on a site adjacent to the existing hospital. The project is being delivered in the following stages:

• stage 1—development of a new hospital, an integrated cancer centre, 372 inpatient beds and an 80 bed integrated mental health facility
• stage 2—development of a multi-storey car park and helipad.

The Department of Health & Human Services (DHHS), in consultation with Bendigo Health, is responsible for delivering the project.

In May 2013, the state entered into a PPP with a private sector consortium to design, finance, build and maintain the new hospital for 25 years, before transferring ownership to the state.

Construction of stage 1 commenced in June 2013 and is scheduled to be completed in December 2016. At 30 June 2015, the concrete structure had been completed and the building facade was progressing.

Construction of stage 2 is scheduled to commence in January 2017 and be completed in June 2018.

Cost to the state

Figure 5A details the state's financial commitments to the consortium and other costs it expects to incur over the life of the PPP.

At 30 June 2015, the PPP is progressing on time and on budget. The completed leased asset and liability will be reported in Bendigo Health's financial statements on completion which is expected to occur in December 2016.

Figure 5A

Bendigo Hospital and associated infrastructure: estimated cost of construction and operation, as at 30 June 2015

(a) Discount rate of 8.06 per cent and 8.07 per cent used to calculate the net present value of the interest portion of stage 1 and stage 2 costs, respectively. Discount rate of 7.18 per cent used to calculate the net present value of all other operating costs.

(b) Direct costs associated with establishing the contractual and lease arrangements, critical infrastructure work, fire services upgrade, demolition, enabling work, and relocation and building of five new ambulance stations around Bendigo.

Source: Victorian Auditor-General's Office.

The expected value of the asset will include construction costs which will be funded by a $566.0 million state contribution, payable to the consortium upon commercial acceptance of stage 1 work. As at 30 June 2015, the state had incurred $79.8 million of expenditure relating to this project.

5.3.2 Victorian Comprehensive Cancer Centre PPP

The VCCC is intended to be a world-class cancer centre. Scheduled to be operational by June 2016, the facility will:

• house the relocated Peter MacCallum Cancer Centre
• provide new cancer research and clinical care facilities for Melbourne Health
• provide cancer research space for The University of Melbourne.

VCCC will consist of a north and south facility. In December 2011, the state entered into a PPP with a private sector consortium to design, finance and construct the south facility. The consortium will maintain the south facility for a 25-year period after which ownership will revert to the state. The consortium will also complete the north facility, however, these works do not form part of the PPP and are being delivered under a traditional procurement approach.

At the north facility, four new floors will be constructed on top of an existing Royal Melbourne Hospital building.

At the south facility, a new 13 floor building will be constructed on the site formerly known as the Royal Dental Hospital.

The north and south facilities will be connected by enclosed bridge links crossing Grattan Street, Carlton.

As at 30 June 2015, construction was progressing to schedule.

Construction of the four additional floors is near completion, with internal building fit-out well progressed. The three new clinical floors were handed over to Melbourne Health (the hospital operator) in October 2015. The north facility is scheduled to be completed and available for service delivery in late 2015.

Construction is underway for the south facility, with the building's facade being substantially complete and the internal fit-out progressing. Commercial acceptance of the south facility is scheduled for June 2016.

Cost to the state

North facility

A breakdown of budget, actual and committed expenditure, and the expected completion date for the north facility as at 30 June 2015 is provided in Figure 5B.

Figure 5B

VCCC north facility: budget, actual and committed expenditure, and expected completion date, as at 30 June 2015

Source: Victorian Auditor-General's Office.

As at 30 June 2015, costs of $104.0 million had been incurred by the state for the north facility. Upon completion, the state will be responsible for the ongoing operation and maintenance of the north facility.

South facility

Figure 5C details the state's financial commitments to the consortium and other costs it expects to incur on the south facility. As at 30 June 2015, costs of $310.4 million had been incurred by the state for the south facility.

Figure 5C

Victorian Comprehensive Cancer Centre south facility: estimated cost of construction and operation, as at 30 June 2015

(a) The leased asset and liability will be recognised on commissioning of the new south facility which is expected to occur in June 2016. The finance leased asset and liability will be reported in the Peter MacCallum Cancer Centre financial statements in 2015–16.

(b) Includes $300 million that the state will contribute towards the design and construction of the VCCC south facility during the construction phase.

(c) Discount rate of 9.17 per cent used to calculate net present value.

(d) Discount rate of 8.33 per cent used to calculate net present value.

(e) Management of project development, state delivered works, ICT, enabling works and relocation allowance.

Source: Victorian Auditor-General's Office.

5.3.3 Ravenhall Prison PPP

On 15 September 2014, the state contracted a private company to design, build, finance, operate and maintain a new medium-security prison to be located at Ravenhall in Melbourne's West. The project will be located on Department of Justice & Regulation land at Ravenhall, adjacent to Riding Boundary Road and the Deer Park Bypass.

Ravenhall Prison will initially accommodate 1 000 prisoners with a capacity for 1 300 prisoners should this be required in future. The new prison will include a mix of low-rise accommodation, administration, programs, health and mental health facilities, industries and recreation buildings surrounded by a solid perimeter wall. The facility will include:

• accommodation for mainstream and protection prisoners
• 75 inpatient forensic mental health beds
• a 25 bed 'close supervision unit' for a small but highly complex group of prisoners with particularly challenging behaviours
• a self-contained 25 bed unit that can be adapted to cater for prisoners with particular needs, initially providing a residential drug treatment program for younger prisoners.

The private operator will operate and maintain the facility for 25 years.

Project costs

The net present cost of the consortium's proposal is $2.5 billion, based on a discount rate of 5.5 per cent per annum. This includes design, construction, operating and maintenance costs for the term of the PPP, and forms part of the total estimated cost of the project to the state of $3.1 billion (excluding GST).

To date, no payments have been made by the state to the consortium. The first payment will be due on commercial acceptance of the prison. The total estimated commitment as of 30 June 2015 is $6.8 billion (nominal cost excluding GST).

The project's key milestones and current status are set out in Figure 5D.

Figure 5D

Key milestones of Ravenhall Prison PPP

Source: Victorian Auditor-General's Office.

5.3.4 Regional Rail Link

The Regional Rail Link project was substantively complete in June 2015. The first passenger train service along the new dedicated regional tracks through Melbourne's west occurred on 14 June 2015, and the final section of the project through Tarneit and Wyndham Vale opened to commuters on 21 June 2015.

The project provided:

• approximately 50 kilometres of dual track and 40 kilometres of single track between Southern Cross Station and West Werribee, via Sunshine
• five new or upgraded train stations
• two new platforms at Southern Cross Station
• thirteen grade separations
• two level crossing removals.

The project was delivered in a number of works packages.

Project expenditure

A breakdown of budget, actual and committed expenditure for each works package, as at 30 June 2015, is provided in Figure 5E.

The total expected cost of the project is $3.65 billion, which is consistent with the revised 2015 budget. The Commonwealth Government provided $2.7 billion for the project, with the state providing the remaining funding.

Approximately $100 million of expenditure is expected to be incurred after 30 June 2015 to complete the project, of which $72 million was contractually committed at 30 June 2015. Future costs relate to land settlements, post completion activities and some construction costs.

Figure 5E

Regional Rail Link project: budget, actual and committed expenditure, as at 30 June 2015

(a) These two works packages are now included as part of the Footscray to Deer Park works package.

(b) This works package is now being delivered through the government's Level Crossing Removal program.

Source: Victorian Auditor-General's Office.

Due to a number of amendments to the Regional Rail Link project plan throughout its life, the project budget was subject to several revisions during construction. The reason for budget revisions are summarised in Figure 5F.

Figure 5F

Regional Rail Link project: Budget revisions

Source: Victorian Auditor-General's Office.

5.4 Analysis of proposed transaction

5.4.1 Port of Melbourne lease

The Port of Melbourne is Australia's largest maritime hub for shipping containers and automotive cargo. With over 3 000 commercial ships visiting the port each year, the Port of Melbourne handles over 2.5 million '20-foot equivalent units' (TEU) and 350 000 new motor vehicles annually.

Established on 1 July 2003 to provide for the strategic management and development of the Port of Melbourne, the Port of Melbourne Corporation (PoMC) manage the port under the provisions of the Transport Integration Act 2010, Port Management Act 1995 and other relevant legislation.

In addition to the shipping channels within the port, PoMC owns and manages around 510 hectares of port land with 36 commercial berths contributing to a total berth length of nearly seven kilometres. In 2014–15, PoMC generated a profit before income tax of $51.3 million ($102.3 million in 2013–14) and at 30 June 2015 reported net assets of $3.4 billion ($1.7 billion at 30 June 2014).

The lease transaction

On 5 May 2014, the Treasurer of Victoria and the Minister for Ports confirmed the state's intent to lease the commercial operations of the Port of Melbourne to help fund the government's infrastructure program.

The transaction involves leasing the port's commercial operations for 50 years, with the state having the ability to grant an additional term of up to 20 years to the leaseholder. The state will retain ownership of the freehold title to the land, and at the end of the lease term the port will return to the state's control. During the lease, the Victorian and Commonwealth governments retain responsibility for regulating the port's safety, security and environmental functions. The leaseholder will be required to comply with these regulations.

The financial impact of the proposed lease on the state's balance sheet was reflected in the 2014–15 State Budget, however, to preserve the state's commercial interests ahead of a leasing process, the specific expected results were not separately identifiable.

In its 2014–15 Budget, the Commonwealth Government announced its Asset Recycling Initiative (ARI). Under the ARI, the Commonwealth Government offers financial incentives to the states and territories to privatise mature government-owned assets and reinvest the returns into new, productivity-enhancing infrastructure. The state and territory governments are responsible for managing asset sales and delivering the new infrastructure projects. The sale must be completed, and new assets commenced, before 30 June 2019 to be eligible for the funding.

The state may be eligible for a 15 per cent payment on the net proceeds of the port lease through the ARI.

Legislation

The government introduced the Delivering Victorian Infrastructure (Port of Melbourne Lease Transaction) Bill 2015 (the Bill) into the Legislative Assembly in May 2015. If passed, the Bill facilitates the transaction and modifies current legislative frameworks to allow assets and functions to be separated between the state and the leaseholder. The Bill:

• authorises the transfer of PoMC's assets and liabilities to the leaseholder
• authorises a 50‐year lease and, under regulation, the ability to grant an additional term of up to 20 years to a leaseholder
• authorises and facilitates an efficient and timely restructure of PoMC's assets and liabilities and the transfer of the commercial port operations to the private sector
• authorises a strengthened economic regulatory regime to provide enhanced protection for port users for the 50‐year lease term
• enables the transfer of employees, preserves employee entitlements and provides a two-year employment guarantee for permanent non‐executive employees.

The Bill establishes the Victorian Transport Fund (VTF) and directs proceeds of the lease, which are to be paid up front, into the VTF. The Bill requires the proceeds in the VTF to be used for the Level Crossing Removal Program and other infrastructure projects.

The Legislative Assembly passed the Bill in June 2015. It was then debated in the Legislative Council in August 2015, where it was referred to a Select Committee Inquiry for consideration of items such as:

• the structure and duration of the proposed lease
• the potential impacts of the proposed lease on the development of a second container port in Victoria
• how the proposed lease balances the short-term objective of maximising the proceeds of the lease with the longer-term objective of maximising the economic benefits to Victoria of container trade
• any other relevant matters.

The reporting date for this inquiry is 30 November 2015.

Items impacting on the potential value of the lease

Port Capacity Project

The $1.6 billion Port Capacity Project, announced in April 2012, aims to expand the Port of Melbourne's container and automotive terminal capacity. Its centrepiece is the redevelopment of Webb Dock and the construction of a new international container terminal capable of handling at least one million standard containers per year. The project also includes the consolidation of Victoria's car and automotive trade at a new facility to be built at Webb Dock. The new facilities are expected to become progressively operational from late 2015. At 30 June 2015, the project remains on schedule to be completed within approved milestones and under budget.

PoMC is currently responsible for funding and delivering the base infrastructure for the project, at a budgeted cost of $921 million. Base infrastructure includes site preparation, roads and services works, and maritime works including the delivery of a new 920 metre wharf at Webb Dock West and berth works at Webb Dock East. Delivery of uncompleted base infrastructure will become the responsibility of the new leaseholder at the commencement of the lease.

Private sector participants are responsible, among other things, for financing, delivering, and operating the new international terminal at Webb Dock East, the automotive terminal, and a pre-delivery inspection hub. PoMC or the leaseholder will not contribute to the construction or operating costs of these components during the lease term.

A breakdown of the budget, actual and committed expenditure, and expected completion dates for each component of the base infrastructure works as at 30 June 2015 is provided in Figure 5G.

Figure 5G

Port capacity project base infrastructure: budget, actual and committed expenditure, and expected completion dates as at 30 June 2015

(a) Other expenditure supports the delivery of the base infrastructure works packages. It includes a risk event allowance to be utilised if identified risks eventuate at any stage during the project.

Source: Victorian Auditor-General's Office.

Total expenditure of $405.8 million had been incurred to 30 June 2015. This includes $376.2 million of capital expenditure and $29.6 million of other operating expenditure. Future contractual commitments of $185 million were reported by PoMC at 30 June 2015.

Revaluation of property, plant and equipment

In accordance with the requirements of Australian Accounting Standard AASB 116 Property, Plant and Equipment and Financial Reporting Direction 103F Non-financial Physical Assets issued by the Minister for Finance, PoMC is required to value its property, plant and equipment at fair value. Fair value is defined under Australian Accounting Standard AASB 13 Fair Value Measurement as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The value of property, plant and equipment at the Port of Melbourne increased by $1.43 billion in 2014–15, as a result of a formal independent revaluation. This was fairly presented for financial reporting purposes. Figure 5H shows the increase in value for each class of asset.

Figure 5H

Increase in value of property, plant and equipment, 2014–15

Source: Victorian Auditor-General's Office from Port of Melbourne Corporation's financial statements for the year ended 30 June 2015.

The increase in the value of land in 2014–15 reflects new lease agreements being signed for previously vacant sites. Land currently under development as part of the Port Capacity Project has been valued on the basis that it will be fully developed in future years.

Repayment of debt

On 15 May 2015, the Minister for Ports, at the request and with the approval of the Treasurer, directed PoMC to repay all its borrowings on or before 30 June 2015 in order to prepare the commercial operations to be leased to a new operator on a debt free basis.

A cash contribution to PoMC of $652.3 million from the Department of Treasury & Finance enabled this repayment to occur on 25 June 2015. $579.5 million was paid to the loan provider—Treasury Corporation Victoria—consisting of $538.9 million of outstanding borrowings and $40.6 million of 'break costs' incurred due to early repayment. Residual monies not paid to Treasury Corporation Victoria will be used by PoMC in 2015–16 for working capital purposes.

Port growth regime

It is proposed that a Port Growth Regime, which guarantees container capacity up to a certain level, will be incorporated into bids for the Port of Melbourne lease.

The Port Growth Regime is designed to reduce the leaseholders risk exposure to a second container port being developed by the state during the lease term. It also provides for compensation to be paid to the leaseholder if a second port is developed by the state during the lease term that takes international container trade away from the Port of Melbourne, although there are circumstances in which this will not be paid.

Strengthened economic regulatory regime

The strengthened economic regulatory regime proposed in the Bill will see Victoria's independent economic regulator, the Essential Services Commission, overseeing the pricing structure for port users. The government is seeking to ensure port users and Victorian consumers are safeguarded from unexpected price increases by:

• providing independent oversight over more prescribed services
• ensuring prices reflect underlying efficient costs
• capping price increases at the Consumer Price Index for 15 years.

At the end of the 15-year period the leaseholder would be able to set prices based on a range of pricing and cost allocation principles developed in a Pricing Order.

The strengthened economic regulatory regime will provide the leaseholder with some certainty by limiting the scope for re-regulation.

RESPONSE provided by the Treasurer

Acting Auditor-General's response to the Treasurer of Victoria

The Treasurer has noted that the audit qualification on the Annual Financial Report of the State, 2014–15 (AFR) relating to the AFR's failure to recognise the state's obligation to return the East West Link project funds is a technical accounting disagreement. This is not correct. The requirements of the state's memorandum of understanding with the Commonwealth Government, the relevant Commonwealth legislation, related correspondence from the Commonwealth Government and Australian Accounting Standard AASB1004 Contributions are all clear and straightforward in this regard.

Further, as also set out in this report, we note that the Department of Treasury & Finance obtained legal advice on this matter, and that their legal advisers had sought some accounting advice in preparing their advice. One of the key qualitative characteristics of financial reporting is that transactions are accounted for based on substance over legal form. The legal view of a transaction does not override, or determine, the accounting treatment for a transaction. Lastly, our position on the correct accounting treatment for the state's obligation at 30 June 2015 to return the East West Link project funds has been confirmed by pre-eminent independent accounting experts.

Consequently, this is not a technical accounting disagreement.

It is also important to note, that while the Commonwealth Government had requested the return of the East West Link project funds prior to 30 June 2015, it can also recover those funds by reducing future funding for other Victorian projects. The Commonwealth has subsequently indicated that it may take this later course of action by allowing the state to treat the funding as a prepayment, under certain specified conditions. Whichever course is ultimately chosen by the Commonwealth, the impact on the state remains the same in substance.

Liquidity

The Treasurer has stated that the liquidity ratio adopted in this report can be misleading and has little relevance to the public sector. I maintain our position of last year on this matter. That is these comments are incorrect and inappropriate. The liquidity ratio used in this report is accepted around the world as a valid indicator of liquidity for reporting entities.

I note that the Treasurer references another liquidity ratio reported in Note 33(j) of the AFR. However this ratio is not a complete indicator of the state's ability to pay all existing short-term debt and interest obligations as it does not consider all short-term financial obligations of the state, such as payables. Refer to page 23 of this report. Therefore this ratio is not sufficiently indicative of the state's position.

Delay to the completion and release of the AFR

The Treasurer acknowledges the unprecedented number of significant issues at an entity level subject to more extensive audit examination which had converged with the machinery-of-government impacts to delay the finalisation of financial reports, as highlighted in this report. To be clear, I am required by the Australian Auditing and Assurance Standards to adopt appropriate audit procedures in response to significant and contentious matters that arise during the preparation and audit of a financial report. The level of audit work undertaken is determined after assessing the risks and controls in place at each entity, and this is assessed during both the planning and execution phases of an audit.

In section 2.4 of this report, we outline that only four of the 47 material entities provided complete draft financial statements to audit on time. My office cannot audit what we have not received. It is a credit to my financial audit practice that they were able to reschedule and change the composition of audit teams as unprecedented and contentious issues arose during the preparation and audit of often late draft financial reports. These extended to the AFR itself.

I acknowledge the Treasurer's support for our related recommendations in this regard.

Management certification of the AFR and Prior Period Issues

It is an important and welcome change that the Treasurer signed the certification of the 2014–15 AFR. However, contrary to previous practice, a chief financial officer did not sign the certification of the AFR this year. Page 12 of this report specifically highlights that the absence of a chief financial officer signing the AFR is inconsistent with the standards required of all public sector entities reporting under the Financial Management Act 1994 (FMA) and is a change of practice for the AFR. The AFR is prepared pursuant to the FMA, however, the FMA does not expressly prescribe who should sign the certification of the AFR.

Further, having the Treasurer and Secretary sign the certification is not over and above what is required for public sector entities reporting under the FMA. However, not having a chief financial officer sign the certification is less than that required of public sector entities reporting under the FMA.

RESPONSE provided by the Secretary, Department of Education & Training