Victorian Auditor-General’s report
9 February 2011

Acquittal Report: 
Results of the 2009–10 Audits 
Background
Parliament rose on 7 October 2010 for the 27 November 2010 election. This significantly shortened time lines for reporting on the annual financial statement audits for the 2009–10 financial year. Accordingly, we produced interim reports on the annual financial statement audits of the portfolio departments, local government, water and public hospital sectors across July, August and September. This report acquits the final results of the 2009–10 audits of all entities with 30 June 2010 balance dates.
This report is the sixth of seven reports to be presented to Parliament covering the results of the audits. Appendix B lists those reports and time frames. 
The purpose of this report is to provide the results of the audit of 445 entities with 30 June 2010 balance dates across:
·	portfolio departments and associated entities
·	local government
·	public hospitals
·	water entities.
It also analyses the quality of financial reporting and comments on financial sustainability.
Overall conclusion
Parliament can have confidence in the financial reports, standard statements and performance statements prepared for 30 June 2010. 
The average time taken by portfolio departments, public hospitals and water entities to finalise their financial statements substantially improved by one to three weeks to be finished within eight weeks of balance date. Timeliness of local government financial reporting remained consistent at around 11 weeks of balance date.
Indicators of financial sustainability show that short-term challenges exist for self‑funded state entities, public hospitals and water entities. There has however been improvement in the financial sustainability of councils. 
Findings
Results of audits
Of the 445 entities included in this report, clear audit opinions were issued on the financial reports of 443 entities. Clear audit opinions were issued on the standard statements of all 79 local councils. Clear audit opinions were also issued on the performance statements prepared by all 15 water entities, and 77 of the 79 local councils. A clear audit opinion indicates that the financial reports and performance statements were prepared in accordance with the applicable reporting framework.
A qualified audit opinion is issued when the financial report or performance statement is materially different to the requirements of the relevant reporting framework, and therefore, is less reliable and useful as an accountability document.
The four entities and the basis for not receiving clear opinions are detailed in Figure A.
Figure A 
Exceptions where clear audit opinions were not issued
Entity	Report 	Exception	
Alpine Shire Council	Performance statement	No opinion issued
Section 132 of the Local Government Act 1989 was not complied with as the council did not prepare a performance statement because the council’s 2009–10 budget did not include the prerequisite performance targets and measures. 	
City of Greater Dandenong 	Financial report 	Qualification
The net underlying result from operations as reported in the comprehensive income statement did not accord with AASB 101 as it excluded $37.83 million of items that are part of normal council operations. This misstated the net underlying result from operations however as these items of expenditure were included in ‘other non operational expenses’ the council’s comprehensive result was not affected.	
Public Transport Ticketing Authority	Financial report	Qualification
As a result of significant control weaknesses in the myki system it was not possible to form an opinion on the completeness and accuracy of myki revenue collections for the 2009–10 financial year.	
Yarra Ranges Shire Council	Performance statement	Qualification
The performance statement did not comply with the Local Government Act 1989 as the reported performance targets and measures were not set in the council’s original budget.	
Source:	Victorian Auditor-General’s Office.
The financial audit framework applied in the conduct of the 2009–10 audits is set out in Appendix C.
In certain circumstances it is appropriate to draw attention to or emphasise a matter in the audit opinion that is relevant to the users of an entity’s financial report but does not warrant qualification of the audit opinion. Clear audit opinions that contained an emphasis of matter were provided for 23 entities drawing attention to the uncertainty around the going concern assumptions recognising proposed legislative changes and other reforms that would:
·	amalgamate the existing 12 regional waste management groups into seven
·	amalgamate the Port Phillip and Westernport Catchment Management Authority with Melbourne Water and establish four natural resource and catchment management authorities to replace the remaining nine catchment management authorities
·	replace the Judicial College of Victoria with a new Judicial Commission of Victoria.
Quality of financial reporting
The quality of financial reporting can be measured by the timeliness and accuracy of the preparation and finalisation of the financial report.
To achieve efficient and cost effective financial reporting entities need to have well planned and managed financial report preparation processes. The financial reporting processes in all sectors were generally adequate. 
An assessment of each portfolio department, local government, public hospital and water sector entity’s financial report preparation process was made against better practice. The elements of better practice financial report preparation are provided in Appendix D.
Areas where further improvement can be achieved are:
·	developing a financial report preparation plan that addresses resources, processes, milestones, oversight and quality assurance practices to be applied in preparing the financial report
·	preparation and timely provision of a shell financial statement to audit so that issues with disclosure requirements can be identified early
·	undertaking a materiality assessment considering qualitative and quantitative thresholds to assist with identification of potential errors
·	performing rigorous quality control and assurance procedures to improve the accuracy of the draft financial report.
Where a performance report is prepared, the requirements and quality control reviews to be conducted on the performance report should be specified in the financial reporting preparation plan. Our review showed that where financial report preparation plans were prepared by water entities, they generally did not include the requirements for preparing the performance report. As a result, performance reports were not subject to the same level of internal quality assurance as financial reports.
The average time taken to finalise financial statements substantially improved in  2009–10 in portfolio departments, public hospitals and water entities. This improvement has been driven in part by a requirement issued by the Premier in 2010 that entities reporting under the Financial Management Act 1994 table annual reports in Parliament on or before 16 September 2010. 
The most significant improvement occurred in the water sector where corporations took an average of 7.4 weeks (10.2 weeks 2008–09) to prepare their financial statements and all financial statements were finalised four weeks earlier than in 
2008–09. Portfolio departments took an average of 7.6 weeks (8.6 weeks in 2008–09) and public hospitals took an average of 7.9 weeks (10.0 weeks in 2008–09), both improvements on 2008–09. 
Given the improved time frames achieved in 2009–10, portfolio departments, public hospitals and water entities should maintain this momentum of earlier reporting.
Figure B shows the average time taken to finalise financial statements in each sector.
Figure B 
Average time taken to finalise financial statements

Source:	Victorian Auditor-General’s Office.
The timeliness of financial report preparation by local councils remained consistent from 2008–09 to 2009–10. The average time taken for a council to prepare their financial report was 11.2 weeks in 2008–09 and 11.1 weeks in 2009–10, considerably longer than the other sectors. As local councils report under the Local Government Act 1989, there was no imperative on councils to report earlier due to the impending state election.
Financial sustainability
To be financially sustainable, entities should have the capacity to meet current and future expenditure as it falls due. They should also be able to absorb foreseeable changes and financial risks materialising, without significantly changing their revenue and expenditure policies.
Insight into the financial sustainability of entities is obtained from analysis of four core financial sustainability indicators over a five-year period from 2005–06 to 2009–10. The four core indicators used across all sectors, excluding regional library corporations, are underlying result, liquidity, self‑financing and capital replacement. These indicators reflect each entity’s funding and expenditure policies, and indicate whether these policies are sustainable.
More detail on the attributes and application of the indicators is provided in Appendix E.
In addition to these four core indicators, other particular indicators are used in the financial sustainability assessments of local government, public hospitals and water entities which focus on areas of risk for each sector.
The financial sustainability indicators and assessments in this report flag departures from the norm that warrant attention. To form a definitive view of any entities financial sustainability requires a holistic analysis that moves beyond financial considerations to include the entities operations and environment.
The trends and risks in this report need to be considered in light of the funding model adopted for public sector entities. Specifically, the current funding model does not provide depreciation funding to budget dependent entities, and capital grant funding is allocated strategically across the public sector rather than progressively to each entity when capital requirements are determined. However, governing boards are accountable for financial management and performance. This situation blurs accountability for governance and performance as management and governing bodies do not have the resources and discretion to make decisions around asset maintenance and replacement which can impact operational performance.
Portfolio departments’ and associated entities
Financial sustainability analysis has been performed on the 46 self-funded state entities that primarily generate their own revenue. 
A summary of the five-year average financial sustainability results for each portfolio is provided in Figure C. 
Figure C
2009–10 financial sustainability risk assessment by portfolio 
– self-funded entities
Portfolio	High	Medium	Low	
Education and Early Childhood Development	–	–	1	
Health	–	2	2	
Innovation, Industry and Regional Development	3	2	–	
Justice	1	3	3	
Planning and Community Development	2	5	1	
Premier and Cabinet	1	2	–	
Primary Industries	–	8	2	
Sustainability and Environment	–	–	3	
Transport	3	–	1	
Treasury and Finance	–	1	–	
Total	10	23	13	
Source:	Victorian Auditor-General’s Office.
Our financial sustainability assessment is that 10 of the 46 self-funded entities have an overall high-risk rating at 30 June 2010. 
The portfolios of Innovation, Industry and Regional Development, and Planning and Community Development have three and two entities respectively, which have an overall high-risk rating due to large underlying deficits. These entities generally operate and maintain large state assets and record large depreciation expenses year on year. The current state funding model allocates capital funding based on strategic priorities therefore entities do not receive funding for annual depreciation expenditure. 
Three entities in the Transport portfolio have an overall high-risk rating due to insufficient liquidity as a result of short-term commitments for finance lease repayments and borrowings. These financial commitments are guaranteed by government.
Our financial sustainability assessment is that 23 of the 46 self-funded entities have an overall medium-risk rating at 30 June 2010. 
The entities in the Planning and Community Development, Premier and Cabinet, and Primary Industries portfolios that had an overall medium-risk rating was due to high‑risk self-financing assessments. The entities in these portfolios generally operate large state assets however the revenue generated from their asset holdings is insufficient to cover expenses and renew assets. 
No sustainability issues were identified in the portfolios of Education and Early Childhood Development and Sustainability and Environment.
Local government
Financial sustainability analysis has been performed on the 79 local councils and 12 regional library corporations (RLCs).
In addition to the four core sustainability indicators, two further indicators are assessed for councils:
·	indebtedness—measures a council’s ability to cover non-current liabilities from revenues they generate themselves
·	renewal gap—comparison of the rate of spending on renewing, restoring and replacing existing assets, with depreciation. 
These indicators reflect two particular risks for local councils—managing debt and maintaining assets to sustain current service levels.
The financial sustainability of RLCs is assessed using three of the four core indicators being underlying result, liquidity and capital replacement. The fourth core indicator of self‑financing is not applied to RLCs as they do not generate significant amounts of own-source revenue and are reliant on member councils making annual contributions.
Figure D summaries the sustainability risk assessments for the 79 councils and the 12 RLCs.
Figure D
2009–10 financial sustainability risk assessment – local government
Category	High	Medium	Low	
Councils				
Inner metropolitan	–	1	16	
Outer metropolitan	–	1	13	
Regional city	–	–	11	
Large shire	–	–	15	
Small shire	1	2	19	
Total	1	4	74	
Regional library corporations	2	3	7	
Source:	Victorian Auditor-General’s Office.
Overall, there has been improvement in the financial sustainability of councils with low‑risk rated councils increasing from 71 to 74, and medium-risk rated councils decreasing from eight to four. However, one council has been rated high risk, previously rated medium risk.
Buloke Shire Council is the only high-risk rated council in 2009–10. The council’s liquidity ratio deteriorated in the year and will need to be closely monitored by the council.
Four councils have been assessed as medium sustainability risks due to high-risk capital replacement and or renewal gap indicators. For these councils, spending less on assets compared to depreciation may indicate asset condition is deteriorating which could affect service levels in the longer-term.
Two RLCs had high-risk ratings because of insufficient liquidity. This risk is mitigated as both RLCs have commitments to receive council contributions in the new financial year to meet the operating costs of the libraries for 2010–11.
Public hospitals
Financial sustainability assessments have been performed on the 87 public hospitals.
In addition to the four core financial sustainability indicators, the assessment of public hospitals’ financial sustainability includes an indicator to assess the average number of days of unrestricted cash that is available at year end to cover operating cash outflows. Without adequate unrestricted cash reserves, public hospitals may need to restrict operations or call upon the government for additional funding.
A summary of the five-year average financial sustainability results for each public hospital category is provided in Figure E. 
Figure E
2009–10 financial sustainability risk assessment – public hospitals
Category	High	Medium	Low	
Public hospitals				
Metropolitan	11	7	–	
Regional	8	7	–	
Rural	7	35	12	
Total	26	49	12	
Source:	Victorian Auditor-General’s Office.
Our financial sustainability assessment shows that 26 public hospitals were considered high risk at 30 June 2010 (28 in 2008–09). This arises most commonly because they were assessed as generating insufficient cash to be able to adequately fund their operations.
In 2009–10, 69 public hospitals recorded a negative underlying result compared to 39 in 2008–09. This was due to higher depreciation charges in 2009–10 as a result of the revaluation of hospital buildings at the end of 2008–09.
Prudent financial management practice requires the equivalent of at least one month’s operating cash outflows to be available as unrestricted cash holdings, consistent with the Department of Health funding model. On average the metropolitan and regional hospitals were not able to fund their operations for more than 22 and 27 days respectively, as at 30 June 2010.
Consistent with this outcome and our liquidity risk assessment, the Department of Health concluded that 30 public hospitals in 2009–10 (31 in 2008–09), did not comply with the going concern test in the Australian accounting standards. Those respective hospital boards were provided with a letter of comfort outlining that the department would provide adequate cash flows to enable them to meet their financial obligations up to September 2011, should this be required.
Water entities
Financial sustainability assessments have been performed on 19 water entities.
The financial sustainability assessments were conducted using the four core indicators and the following two particular indicators:
·	interest cover—measures an entities ability to meet ongoing interest payments and ability to service debt
·	debt-to-equity—longer-term measure that compares all current and non-current interest-bearing liabilities to equity. It complements the liquidity indicator, which is a short‑term measure. A low-risk assessment indicates less reliance on debt to finance the capital structure of an organisation.
Water entities have a high reliance on debt, therefore these additional indicators focus on their ability to meet interest commitments and repay debt. 
A summary of the outcomes of the sustainability assessment by water category is provided in Figure F.
Figure F
2009–10 financial sustainability risk assessment – water entities
Category	High	Medium	Low	
Water entities				
Metropolitan	4	–	–	
Regional urban	5	–	8	
Rural	1	–	1	
Total	10	–	9	
Source:	Victorian Auditor-General’s Office.
Overall, our financial sustainability assessment is that 53 per cent (10 of 19) water entities have a high-risk rating. This was mainly because of underlying deficits and/or a poor liquidity position. Generally, these entities have approval to refinance their maturing debt and in recent years have refinanced the debt for a new term rather than repay the debt.
The liquidity of the sector is deteriorating with 73 per cent of water entities receiving a high-risk rating for liquidity in 2009–10 (37 per cent in 2005–06). The deterioration is due to increased debt taken on to fund large scale infrastructure projects. The four metropolitan entities have a high-risk rating due to tight liquidity. However, the four entities have a strong interest cover position, indicating an ability to service their debt as they generate profits and have positive cash flows from operating activities.
While the ability of the metropolitan and the regional urban sectors to fund new assets and/or replace existing assets using cash generated by operations has declined, the capital-replacement indicator shows an increase in the capital spend. The increased spending has predominantly been financed by new debt.
The results of the indicators should be analysed in the context of the regulatory and commercial environment in which these entities operate. Pricing arrangements are regulated by the Essential Services Commission so that water entities have a sustainable revenue stream, and all borrowings are obtained from the Treasury Corporation of Victoria, which reduces the re-financing and liquidity risks in the short term.

Recommendations
Recommendation	Page	
Water entities who prepare a performance report should integrate the preparation and approval of this report into their year-end financial reporting plan and processes.	Annex D: 	7	
Entities should adopt the shortened annual reporting time frames achieved for the 2009–10 reporting cycle as the standard for future reporting cycles.	Annex A: 
Annex C:
Annex D:	12
8
9	

Structure of this report
This report provides an overview of the results from the 2009–10 financial statement audits of 445 entities with 30 June 2010 balance dates in four sector categories. The details in relation to entities within each category are reported in annexes as follows.
Report annex	Sector description	
Annex A: Portfolio Departments 
and Associated Entities	Provides the results of the audit of the 11 portfolio departments and 198 associated entities.	
Annex B: Local Government
	Covers 104 entities comprising 79 local councils, 12 regional library corporations and 13 companies, trusts and joint ventures controlled by local councils.	
Annex C: Public Hospitals	Covers 112 entities comprising 87 public hospitals and 25 associated entities.	
Annex D: Water Entities
	Covers the 20 entities comprising four metropolitan water entities, 13 regional urban water corporations, two rural water corporations and one controlled entity.	

Submissions and comments received
In addition to progressive engagement during the course of audits, in accordance with section 16(3) of the Audit Act 1994 a copy of this report, or relevant extracts from the report, was provided to all portfolio departments and named agencies with a request for submissions or comments.
The agency views have been considered in reaching our audit conclusions and are represented to the extent relevant and warranted in preparing this report. Their full section 16(3) submissions and comments, however, are included in Appendix F of this Acquittal Report and in Appendix C of each relevant annex.
Audit conduct
The cost of preparing and printing the total report including Annexes A to D, was $475 000.