Victorian Auditor-General’s report
9 November 2011

Auditor-General’s Report on the Annual Financial Report of the State of Victoria,  2010–11 
Audit summary
Background
Each year the Treasurer prepares a set of financial statements for the State of Victoria that combine the results and balances of the 286 state-controlled entities in terms of Australian Accounting Standards. The financial statements are tabled in Parliament as part of the Annual Financial Report of the State of Victoria (known as the AFR).
The AFR is an important accountability document as it provides Parliament and the public with a report on the state’s revenue, expenditure, and financial position as at 30 June each year. The Auditor-General conducts a financial audit of the AFR and issues an opinion as to the reliability of the financial statements. 
The Auditor-General’s Report on the Annual Financial Report of the State of Victoria, 2010–11 analyses the state’s reported result and financial position for 2010–11 by looking at short-term and long-term indicators of financial sustainability.
The state collected $53.3 billion in revenue in 2010–11 and incurred expenditure of $53.8 billion over the same period.  
Underpinning the growth in state assets is a rolling $35.9 billion investment program, with 10 large projects accounting for $18 billion of this amount. Given their financial impact, this report also comments on the progress of the major projects and initiatives in each sector including in terms of timeliness and cost. 
Conclusion
Parliament can have confidence in the AFR and the reported financial position of the state as at 30 June 2011. 
A clear audit opinion was issued on the AFR on 10 October 2011. The independent audit opinion adds credibility to the financial report by providing assurance that the information is reliable.
The state had a positive financial outcome for the 2010–11 financial year, reporting a net surplus of $1 646.8 million. However, the ability of the state to produce surpluses in future years will be challenged if expenditure continues to grow faster than revenue. 
Major projects reviewed were largely on time and tracking against revised budgets. Opportunities exist for the public sector to enhance reporting and disclosures to provide more transparency on project costs.
Findings
Results of audit
The AFR was tabled on 13 October 2011, one month later than in 2009–10 and one month later than planned. The Department of Treasury and Finance prepared 10 drafts of the AFR with material changes in each version. As a result, the audit was disrupted and protracted.
Timely preparation of the AFR relies on the 46 material entities finalising their financial statements in accordance with AFR milestones. In 2010–11, only 17 per cent of material entities finalised their financial reports by the AFR milestone date. This compressed the time available for the Department of Treasury and Finance to prepare the AFR and increased the risk of material error.
The state’s financial result
The state reported a net surplus of $1 646.8 million for 2010–11: an improvement from the deficits reported in the past two financial years. The net surplus takes into account movements in financial assets and liabilities and, is therefore, vulnerable to economic conditions. The net surplus for 2010–11 reflects improved economic conditions that delivered smaller actuarial losses on unfunded superannuation, and gains on financial assets in excess of financial liabilities. Prior year deficits also included asset write‑downs. None were required in 2010–11.
The net result from transactions was a deficit of $512.5 million for 2010–11. There were negative trends underlying this figure that present risks that the state must manage. Specifically, expenditure continued to grow faster than revenue. There was upward pressure on expenditure from salaries and wages, interest and depreciation, and this is expected to continue. Conversely, revenue received from the Commonwealth is expected to decrease in 2011–12 and across the forward estimates period.
Infrastructure renewal
The state’s infrastructure assets totalled $66 109.4 million at 30 June 2011, increasing by 5.3 per cent in the year. These infrastructure assets have ongoing maintenance requirements which are a funding pressure on the state. 
The infrastructure renewal gap measures the rate of spending on assets compared to the rate of asset consumption, represented by depreciation. The renewal gap for the state moved to 3.65:1 in 2010–11 (2.73:1 in 2009–10), remaining above the threshold of 1:1 which is the point at which investment in assets equals depreciation. The result indicates that the state’s spending on assets is at a level where assets are being maintained.
Debt
State debt grew by 8.7 per cent during the year, totalling $55 634.4 million at 30 June 2011. The additional debt was used to fund infrastructure programs in schools, transport and water. 
We looked at the state’s ability to service this debt by calculating a debt sustainability ratio that divides borrowings and the unfunded superannuation liability, by Gross State Product (GSP). The analysis showed that the state’s ability to service its debt decreased because debt grew at a faster rate than GSP. Specifically, in 2010–11 debt grew by 8.7 per cent and GSP increased by 3.5 per cent.
Significant projects and developments 
This report comments on current state projects with individual budgets exceeding $1 000 million. A snapshot of the projects, actual costs and progress at 30 June 2011 is provided in Figure A.
Figure A
Project costs and progress to 30 June 2011
Project	Actual expenditure ($mil)	Comment on progress	
Building the Education Revolution	2 311	85 per cent of projects completed. Program time lines extended, 290 projects rephased to 2011–12.	
Victorian Schools Plan	1 657	Upgrades to continue. A further $187 million provided for in the 2011–12 Budget.	
Victorian Comprehensive Cancer Centre	10.5	Public private partnership agreement not yet signed. $10.5 million spent on early site works.	
Social housing	1 096.2	Construction of new social housing 75 per cent complete. Repairs and maintenance works completed on 9 363 dwellings, exceeding the original target of 7 000 dwellings.	
Desalination plant	218.9	No contract payments made. The state may recover $14 million if certain conditions are met, as commercial acceptance and project completion delayed. 	
Food Bowl Modernisation Stage 1	558.9	Completion revised from December 2012 due to floods and the need to seek alternative channel remediation solutions.	
Northern Sewerage Project	482.0	Melbourne Water works to be commissioned by October 2011. Yarra Valley Water Limited works to be commissioned by February 2012.	
myki	771.6	Cost of modifications announced by the government not yet determined. Assets of $27.6 million written off due to the modifications.
Farebox guarantee extended due to delays in rollout. $76.1 million paid under the guarantee in 2010–11.  	
New trains	486	23 of 38 new trains received, 15 on order. Contracted for seven more trains at total cost of $210.4 million.	
New trams	34.6	$272 million contract for design and construction of 50 trams. $537.6 million to be spent on project costs and infrastructure.	
Regional Rail Link	251	Budget under review. Upward pressure from land acquisitions, signalling costs and construction complexities.	
M1 upgrade	1 299	Project completed. $41 million in future costs means project completed on budget.	
M80 upgrade	358	Expected completion 2018–19. 	
Peninsula Link	50.4	Total estimated nominal cost $2 802 million over 25-year contract period.	
Western Highway upgrades	188	Stages 1A and 1B commenced. Budget increased to $311 million.	
Source:	Victorian Auditor-General's Office.
Presentation of the cost of public private partnerships
Public private partnerships (PPP) are contractual arrangements entered into by the state with the private sector typically designing, constructing, financing and operating a public asset in exchange for periodic payments. At the end of the contract period, ownership of the asset reverts to the state.
At 30 June 2011 the state had 19 PPP contracts, with state commitments totalling $9 496.9 million (net present value).
Under the requirements of Australian Accounting Standards, PPP contracts are accounted for as finance leases. Reporting by departments, agencies and at the AFR level satisfies the standards’ requirement to report and disclose these contractual liabilities in general purpose financial statements. 
However, the full cost to the state of PPP projects is difficult for a reader of general purpose financial statements to ascertain. This is because the related costs incurred directly by the state are not drawn out and reported beside the contractual obligations. Direct costs paid by the state are typically for land acquisition, site preparatory works, environmental assessments and project management. 
For the two PPP projects discussed in this report, the Desalination Plant and Peninsula Link, direct costs added 14 per cent and 3 per cent, respectively, to the contractual costs.
There needs to be enhanced disclosure of PPP costs to provide transparency to the public of the full cost implications to the state. This would remove the ambiguity that surrounds the total cost of these projects and their reporting in the public arena.
Opportunity cost of delayed repayments
Within the Business and Innovation portfolio, loans provided to two portfolio agencies have not been repaid in accordance with signed loan agreements. This is an opportunity cost to the state as the money not repaid, is not available to fund other planned activities.
A loan of $31.5 million was provided to Central City Studios Holdings Pty Ltd (now Docklands Studios Melbourne) in 2002. No principal or interest payments had been received by the state when the loan was converted to equity in August 2010. The conversion increased the state’s investment in the company, in effect, outside the normal equity investment decision‑making process of government.
The Melbourne Convention and Exhibition Trust (MCET) is required to meet 50 per cent of the cost to the state of the new Melbourne Convention and Exhibition Centre. To do this, MCET was lent $227.7 million on 1 April 2009, against which principal and interest repayments were to be made from the time the facility commenced operating. 
However, financial modelling by the Department of Business and Innovation in 2009 predicted that the additional revenue generated by the centre would enable MCET to service a loan of $173 million only.
The centre opened on 5 June 2009. MECT has reported larger operating deficits than predicted, principally due to higher interest on the loan. As a consequence, MCET has been unable to make interest or principal repayments against the loan and will be unable to meet the continuing terms of the loan unless financial results improve.  
Recommendations
Number	Recommendation	Page	
1.	That the Department of Treasury and Finance review its AFR processes to improve quality assurance over the material produced and to introduce a realistic timetable for delivery of quality drafts to audit in order to reduce delays and inefficiencies in financial reporting.	8	
2.	That the Department of Treasury and Finance require material entities to align their reporting time frames to meet AFR milestones.	8	
3.	That the Department of Treasury and Finance prepare and seek approval of the Appropriation Certification earlier so that all material entities can achieve the AFR milestones.	8	

Submissions and comments received
In addition to progressive engagement during the course of the audit, in accordance with section 16A and 16(3) of the Audit Act 1994 a copy of this report, or relevant extracts from the report, was provided to the Treasurer and all relevant agencies with a request for submissions or comments.
The Treasurer’s and 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 16A and 16(3) submissions and comments, however, are included in Appendix E.