Ministry of Defence and NZ Defence Force

Transcription

1 Financial Review briefing to the Foreign Affairs and Trade Committee 2011/12 Financial Year Ministry of Defence and NZ Defence Force 1 6 December 2012

2 2 Assistance to the Committee The Foreign Affairs and Trade Committee is conducting a financial review of the performance in the 2011/12 financial year and the current operations of the Ministry of Defence (the Ministry) and the NZ Zealand Defence Force (NZDF) in accordance with Standing Order 340. The Controller and Auditor-General provides Parliament with assurance on the performance and accountability of public entities. The Office of the Auditor-General typically assists select committees with their financial reviews by providing further details on the results of the annual audit in Part A of our written briefings, and by suggesting lines of enquiry and questions relevant to the particular public entity under review in Part B of our written briefings. Our annual audits provide a high, but not absolute, level of assurance about whether a public entity s financial statements comply with generally accepted accounting practice (GAAP) in New Zealand and fairly reflect its financial position and its financial and service performance for the period audited. Due to the volume of transactions, audit work is planned and performed to obtain evidence on a sample basis. Auditors use professional judgement to assess the evidence and ensure there is reasonable assurance that there are not material misstatements in the financial statements (that is, differences or omissions that would affect someone s overall understanding of the financial statements). We report, in our audit opinion, only material differences or omissions that we find. To identify lines of enquiry for Part B of this briefing, we: analyse the results of the annual audit and the accountability documents; refer to any relevant performance audit or inquiry work; and use our specific knowledge of the entity gained during the audit process and by ongoing contact with the entity. Where necessary, we checked factual information with the department or other entities to ensure that our advice to the committee is accurate. We did not give the entities any of the contemplated or actual advice that is in this briefing. Contact for further explanation If any member of the Committee would like further explanation or elaboration of any aspect of this briefing document, please do not hesitate to contact Bill Robertson, Sector Manager, Parliamentary Group on or bill.robertson@oag.govt.nz at the Office of the Auditor-General.

3 Summary of key issues 3 Part A: Results of the 2011/12 audit Ministry of Defence We issued an unmodified audit opinion on the financial statements and non-financial performance report of the Ministry of Defence (the Ministry). We assessed the Ministry s management control environment, and its financial information systems and controls, as very good. We assessed the Ministry s service performance information and associated systems and controls as needing improvement. Our recommendations for improvement include more explicit reporting against intermediate outcomes to more clearly address the Ministry s unique contribution to outcomes and to better reflect the Ministry s performance in its equipment procurement role. We also gave particular attention in our audit to project management processes for the Protector Remediation Project. New Zealand Defence Force We issued an unmodified audit opinion on the financial statements and non-financial performance report of the New Zealand Defence Force (NZDF). We assessed NZDF s management control environment as good, its financial information systems and controls as needing improvement, and its service performance information and associated systems and controls as good. Main matters arising from our audit included the need for NZDF to enhance its internal controls, improve the quality of information used in valuing specialist equipment, and give greater attention to maintenance of the Defence estate. Part B: Advice to the Committee The key points we cover for the Committee, and suggest questions on, are: Ministry of Defence: Performance Improvement Framework review The Ministry s PIF review report was released in September The report suggests the Ministry should take a stronger leadership role than it is currently taking. We suggest the Committee ask about the Ministry s reaction and response to the PIF report. NZDF: Military staff capacity and capability NZDF s future planning and workforce restructuring is taking place against a backdrop of low morale, high attrition rates, and lower-than-targeted activity due to personnel shortages. We suggest the Committee ask about continuing gaps in military capacity or capability. We suggest the Committee should also enquire into areas in which NZDF is unable to meet planned levels of operation or hold force elements at the desired level of capability. We also suggest questions about NZDF s organisation reform and restructuring initiatives, including the forming of the Joint Amphibious Task Force, and questions about NZDF s progress towards meeting its savings programme target of $350-$400 million by 2014/15.

4 4 Overview of the Ministry of Defence and the New Zealand Defence Force Ministry of Defence The Ministry of Defence is a civilian organisation headed by the Secretary of Defence. It provides defence advice to Ministers and undertakes defence tasks for the Government outside the line of command of the NZDF. 1 The Defence Act 1990 (the Act) gives the Ministry three functions: policy, acquisition, and evaluation. These three functions form the basis for the Ministry s three output classes (or service lines): policy advice; audit and assessment of [NZDF] performance; and management of equipment procurement. By providing these services, the Ministry aims to contribute to four intermediate outcomes: New Zealand identifies all credible military threats to its security environment; New Zealand s military capabilities align with our needs; New Zealand s defence relationships align with our security interests and foreign policy goals; and New Zealand s military deployments support our regional and wider international objectives. These outcomes, in turn, are intended to contribute to the higher-level outcomes that New Zealand is secure and the security of other nations is enhanced by New Zealand s efforts. 2 The Ministry is funded through Vote Defence. Total income in 2011/12 was $ million, and total expenditure was $ million, resulting in a net surplus in 2011/12 of $52, The Secretary of Defence is the Ministry s chief executive. John McKinnon was the Secretary during 2011/12; he has since moved on from the Ministry and the newly appointed Secretary, Helene Quilter, assumes the role in early December Bede Corry, Deputy Secretary (Policy and Planning), has been Acting Secretary in the interim. The Secretary is supported by a senior management group comprising five Deputy Secretaries. The Ministry is relatively small in size, employing about 60 permanent staff Ministry of Defence/New Zealand Defence Force, Briefing for the Incoming Minister of Defence (Background Information), 2011, page 23. Ministry of Defence, Statement of Intent 1 July June 2015, page 6; Ministry of Defence, Annual Report for the year ended 30 June 2012, page 13. Ministry of Defence, Annual Report for the year ended 30 June 2012, page 38. Ministry of Defence, Statement of Intent 1 July June 2015, page 16.

5 New Zealand Defence Force 5 The NZDF is the only provider of armed forces to the New Zealand Government. The Chief of Defence Force (CDF) is the Government s prime adviser on military policy. Under the Act, New Zealand s armed forces are raised and maintained for: the defence of New Zealand and the protection of its interests; the contribution of forces under collective treaties, agreements, or arrangements; and the contribution of forces to the United Nations or other organisations or states for operations in accordance with the principles of the Charter of the United Nations. The Act also allows the armed forces to be made available for the performance of public services. 5 NZDF s primary mission is, To secure New Zealand against external threat, to protect our sovereign interests, including in the Exclusive Economic Zone (EEZ), and to be able to take action to meet likely contingencies in our strategic area of interest. 6 NZDF s outputs fall into three main categories: 7 Sustaining operational missions; Performing predictable or routine tasks such as providing policy advice, multi-agency operations and tasks (MAOT), and community support; and Maintaining the required level of military capability. (This output category consumes about 95% of NZDF s output expenditure.) The outcomes that NZDF seeks to contribute to (as listed below) are currently under review as part of NZDF s output plan review. 8 They are compatible in substance with the Ministry s intended outcomes. Secure New Zealand; Reduced risks to New Zealand from regional and global security; New Zealand values and interests advanced through participation in security systems; and New Zealand is able to meet future national security challenges. Our understanding is that the wording of the Ministry s and NZDF s outcome statements will become more closely aligned in future accountability documents. NZDF is funded through Vote Defence Force. Total income in 2011/12 was $2.194 billion, and total expenses were $2.163 billion, resulting in a net surplus in 2011/12 of $31 million. 9 CDF leads NZDF and commands the three services (Air Force, Army, and Navy) through the three Chiefs of those respective services and the Commander Joint Forces New Zealand. CDF is also supported by the Vice-Chief of Defence Force, the Warrant Officer of the Defence Force, the Chief Operating Officer (a civilian appointment), and the Chief Financial Officer (who is also a civilian). Recent changes to the senior leadership include former Vice-Chief, Rear Admiral Jack Steer replacing Rear Admiral Tony Parr as Chief of Navy, the appointment of former Chief of Army Major General Tim Keating as Vice-Chief of Defence Force, and the appointment of Jo Devine as Chief Financial Officer pending the departure of Maurice Horner in December NZDF has a total of 13,477 people. This includes 8,537 Regular Force, 2,226 Reserve Force, and 2,714 civilian staff members across the three services New Zealand Defence Force, The Statement of Intent, page 10. New Zealand Defence Force, The Annual Report, page 9. New Zealand Defence Force, The Annual Report, page 41. New Zealand Defence Force, The Statement of Intent, page 12. New Zealand Defence Force, The Annual Report, page

6 6 Part A: Results of the 2011/12 audit This part of our briefing covers two areas: the results of the 2011/12 audit of the Ministry of Defence; and the results of the 2011/12 audit of the New Zealand Defence Force. Ministry of Defence 1 Audit opinion 1.1 We issued an unmodified audit opinion on the financial statements and non-financial performance reporting of the Ministry of Defence. 2 Environment, systems and controls for measuring financial and service performance 2.1 Our conclusions on the Ministry s management control environment, systems, and controls for measuring financial and service performance, for the year ended 30 June 2012, are set out in the table below. 2.2 We made our conclusions in the context of our work in forming an opinion on the Ministry s financial and service performance statements. The purpose of commenting on the underlying environment, systems, and controls is to highlight areas for improvement identified during the audit. The grades assigned for 2011/12 reflect our recommendations for improvement as at 30 June They are not an assessment of overall management performance, or of the Ministry s effectiveness in achieving its financial and service performance objectives. (See the Appendix for an explanation of the grading scale and underlying assumptions.) Management control environment 2011/12 Very good No improvements are necessary. 2010/11 Very good Comment No deficiencies have been noted in the areas we reviewed in 2011/12. Financial information systems and controls 2011/12 Very good No improvements are necessary. 2010/11 Good Comment Deficiencies identified last year have been fully or largely resolved. No deficiencies have been noted in the areas we reviewed in 2011/12.

7 Service performance information and associated systems and controls /12 Needs improvement 2010/11 Needs Improvement Improvements are necessary and we recommend that the Ministry address these at the earliest reasonable opportunity. Deficiencies we identified in 2010/11 year have been resolved in part. Comment The following comments are based on our review of the forecast non-financial performance reports and their supporting systems and controls, and our audit of the actual Statement of Service Performance (SSP) and its supporting systems and controls. We encourage the Ministry to: more explicitly report against its four intermediate outcomes; consider the appropriateness of the current performance measures in the Management of equipment procurement output class so that it is clearer that the specifications for each procurement are right in the first place and that the measures fully reflect the performance story for all of the Ministry s procurement activities; disclose additional information to explain where targets were not met, as this would enable the reader to get a full picture of the Ministry s performance; and provide sufficient information to enable the reader to assess the Ministry s costeffectiveness. Other than the issues mentioned above, and based on the areas we reviewed during 2011/12, we found that appropriate policies, systems, and controls were in place and appeared to be operating effectively. 2.3 The Committee may wish to ask: We note the Auditor-General has recommended improvements to the Ministry of Defence s service performance information and associated systems and controls. What action has been taken or is planned to address these recommendations? 3 Significant matters of audit interest 3.1 We noted the following significant matters of interest from our audit of the Ministry. Non-financial performance reporting 3.2 We are pleased to note that the Ministry had developed outcome measures, which were reported in its 2011/14 Statement of Intent (SOI), and these have been reported against in the 2011/12 annual report. 3.3 In particular, we noted the following strengths in the Ministry s non-financial reporting: The outcome framework in the SOI is itself very good it is clear, succinct, and technically sound. The narrative on outcome measures in the annual report (pages 13-14) is informative, given the complexities in drawing cause-effect conclusions between MOD/NZDF interventions and the security states of the various regions. As such, it is good to see this information presented so succinctly, as this is the essence of what the Defence agencies aim to contribute to.

8 8 3.4 We make the following recommendations: We encourage the Ministry to more explicitly report against its four intermediate outcomes: - New Zealand identifies all credible threats to its security; - New Zealand s military capabilities align with our needs; - New Zealand s defence relationships align with our security interests and foreign policy goals; and - New Zealand s military deployments support our regional and wider international objectives. In our view these intermediate outcome statements are useful and, given both (a) that the Ministry has identified them and (b) that the high-level outcomes are very remote from Ministry intervention, reporting against intermediate outcomes would enable the Ministry to demonstrate its effectiveness and/or value-added. In how the Ministry adds value, it would be useful for it to consider how it can demonstrate the effectiveness of its unique contributions as distinct from other agencies (for example, MFAT and NZDF). We encourage the Ministry to consider the appropriateness of the current performance measures in the Management of equipment procurement output class so that: - It is clearer that the specifications for each procurement are right in the first place that is, that the Ministry procures equipment that is fit for purpose in terms of New Zealand s needs (for example, strategy and environment). - The measures fully reflect performance for all of the Ministry s procurement activities; currently they focus on each new equipment procurement or refurbishment project. - There is a compensating factor in that, for each current project, there is a description in the SSP that gives a sense of how well the project is tracking. Performance is measured against each of the objectives for 2011/12 and, from this information, the reader can see aspects of timeliness and cost being measured. However, it is difficult to assess the quality aspect of performance from the SSP. Additional information should be disclosed to explain where targets were not met, as this would enable the reader to get a full picture of the Ministry s performance. In the 2011/12 SSP, there is a lack of additional narrative information to explain performance measure targets that were not met. Project management: Protector Remediation Project 3.5 We followed up on our prior year review of the Protector Remediation Project. Although the Project involves all seven vessels under the earlier Project Protector, much of the work is focused on HMNZS Canterbury. The Project is planned to be completed in late 2015 or early This year, we continue to note that the Ministry is applying some sound project management approaches to the Protector Remediation Project. 3.7 However, there is an opportunity to further develop some project management arrangements (the project team is aware of these opportunities). We consider that the following opportunities exist:

9 The Ministry needs to remain vigilant with its acquisition strategy for the Project. The reliance on the current dockyard contract with Babcocks (NZ) Limited is appropriate; however, the size and value of that contract has been significantly enhanced by the addition of the Project work. This needs to be taken into account through the regular trade rates reviews that are being undertaken as part of managing the dockyard contract. Some acquisition (such as specialist equipment) is being managed directly by the Ministry. We note that this has involved some sole procurement for which internal approval has been obtained. Sole procurement does create challenges in ensuring value for money, and there is a need to continue providing evidence that this has been considered for each sole-sourced contract. The situation with the sufficiency of Navy resourcing for the Project needs to be carefully monitored. We acknowledge that the Ministry is very conscious of this issue. The Ministry is currently very reliant on its Project Director, as part of a very small Ministry project team, for the successful delivery of the Project. We could not identify what formal succession planning was in place to manage the unlikely event of the Project Director s sudden loss to the Project. Prudent management practice would usually be to have a clearly understood succession arrangement agreed in advance of any potential difficulty. We are not suggesting a need for a deputy Project Director, but we do suggest the need for a clearly understood arrangement (whether interim or otherwise) for succession Some strengths in the approach being taken include: a dedicated project team is established, with additional resourcing being provided through third-party contract arrangements for Project oversight and by the Navy; a two-tier governance arrangement is in place for the Project (Capability Management Board and Capability Steering Group); an acquisition strategy has been prepared and approved; detailed estimates of costs exist, and costs are being reported; a programme for delivery of the Project has been prepared and is being reviewed, with the Project having been reported as being on target ; monitoring and reporting arrangements are in place; and some Project deliverables are now complete, (such as HMNZS Canterbury s echo sounder and engine lubrication work), with considerable feasibility, design, modelling, and other work also completed and production under way in many areas. 4 Legislative compliance 4.1 We reviewed the systems and procedures that the Ministry uses to identify and comply with legislative requirements. 4.2 No issues arose that we need to draw to the Committee s attention.

10 10 New Zealand Defence Force 5 Audit opinion 5.1 We issued an unmodified audit opinion on the financial statements and non-financial performance reporting of the New Zealand Defence Force (the NZDF). 6 Environment, systems and controls for measuring financial and service performance 6.1 Our conclusions on the NZDF s management control environment, systems, and controls for measuring financial and service performance, for the year ended 30 June 2012, are set out in the table below. 6.2 We made our conclusions in the context of our work in forming an opinion on the NZDF s financial and service performance statements. The purpose of commenting on the underlying environment, systems, and controls is to highlight areas for improvement identified during the audit. The grades assigned for 2011/12 reflect our recommendations for improvement as at 30 June They are not an assessment of overall management performance, or of the NZDF s effectiveness in achieving its financial and service performance objectives. (See the Appendix for an explanation of the grading scale and underlying assumptions.) Management control environment 2011/12 Good Improvements would be beneficial and we recommend that the NZDF addresses these. 2010/11 Good Deficiencies we identified in 2010/11 have been resolved in part. Comment Asset management The NZDF has recognised that it faces a risk of failing to maintain the Defence estate due to fiscal constraints. We have recommended that a specific plan be prepared to identify proposals to remedy the significant legacy of deferred maintenance. In addition, asset data (asset inventory, type, age, performance, condition, and value) should be maintained as rigorously as possible to ensure that, when resources permit, the Estate Asset Management Plan can be easily updated. Conflict of interest declaration process We reiterate our 2010 recommendations to enhance the NZDF s conflict of interest process to include: updating the relevant Defence Force Order to reflect good practice; and recording and monitoring mitigation actions for any conflicts of interest. Other than the issues mentioned above, and based on the areas we reviewed during 2011/12, we found that appropriate policies, systems, and controls were in place and appeared to be operating effectively.

11 Financial information systems and controls /12 Needs improvement Improvements are necessary and we recommend that the NZDF addresses these at the earliest reasonable opportunity. 2010/11 Good Deficiencies we identified in 2010/11 have been resolved in part. Comment Payroll controls We have recommended that changes to the payroll masterfile (for example, changes to bank accounts) are appropriately reviewed by an independent person who does not have access to change the payroll masterfile. We have also recommended that a process be put in place to ensure that annual leave records are accurately recorded. Delegations not being complied with There has been an improvement in the correct use of delegated financial authority this year. However we continue to recommend that delegations are accurately recorded in the financial system and complied with. Property, plant, and equipment Property, plant, and equipment is a significant and material aspect to the NZDF s external reporting. We continue to make several recommendations regarding the valuation of military equipment and other property. This includes improving the robustness of the information used to determine the replacement values used in military equipment valuations and enhancing the information required to fully understand the issues facing the Defence estate. Veterans Affairs control issues We recommended that: Where home help contracts are being set up for veterans, there should be segregation of duties between the setting up and monitoring of the contracts. A process should be put in place to reconcile VANZ payments to the WAM (war pensions system) masterfile. Changes to pension payment amounts (that is, changes to the percentage of pension that a Veteran is to receive) should be independently reviewed to ensure that the changes are accurate. Consideration should be given to taking steps to ensure that pensions do not continue to be paid once a veteran has died. The system should be altered to enforce the control whereby a second person must authorise any changes to the supplier masterfile. Credit card expenditure We note that credit card expenditure for senior staff members is approved by delegated members of the finance team. We recommended that all credit card expenditure should be approved on a one-up basis. Journals We continued to recommend that journals should be supported by adequate documentation that allows the reviewer to understand the reason for the journal amount and whether the journal has been raised within delegated authority. In addition, a journal audit report should be run monthly and a sample of journals reviewed to ensure that they are bona fide and accurate, and comply with delegations, procedures, and policies. Other than the issues mentioned above, and based on the areas we reviewed during 2011/12, we found that appropriate policies, systems, and controls were in place and appeared to be operating effectively.

12 12 Service performance information and associated systems and controls 2011/12 Good Improvements would be beneficial and we recommend that the NZDF addresses these. 2010/11 Needs improvement Deficiencies we identified in 2010/11 have been resolved in part. Comment The following comments are based on our review of the forecast non-financial performance reports and their supporting systems and controls, and our audit of the actual Statement of Service Performance and its supporting systems and controls. We recommend that: The relatively large number of outcome measures in the Statement of Intent be reviewed to more clearly differentiate between: - those measures that are truly outcome measures (that is, they demonstrate the effects of the Government s spending); and - those measures that should more appropriately be presented as activities that contribute to the outcomes. The Statement of Intent (SOI) for Veterans Affairs New Zealand should be integrated into the overall NZDF framework. As in previous years, the NZDF SOI has two distinct SOIs within it one for Veterans Affairs New Zealand (which is actually part of the NZDF) and one for the rest of the NZDF. Other than the issues mentioned above, and based on the areas we reviewed during 2011/12, we found that appropriate policies, systems, and controls were in place and appeared to be operating effectively. 6.3 The Committee may wish to ask: We note the Auditor-General has recommended improvements to NZDF s management control environment, financial information systems and controls, and service performance information and associated systems and controls. What action has been taken or is planned to address these recommendations? 7 Significant matters of audit interest 7.1 We noted the following significant matters of interest from our audit. Enhancing the NZDF s non-financial reporting 7.2 We are pleased to note the NZDF s development of outcome measures in its Statement of Intent and the good level of reporting in its 2011/12 Annual Report. 7.3 In our view, the Annual Report provides a good level of information to enable a reader to assess the NZDF s progress against its intended outcomes. This is particularly commendable given the challenges the NZDF faces in reporting on its outcomes and impacts, as its purpose is principally to provide a military capability when required. The NZDF s narrative reporting of its assessment of New Zealand s security status is good, as are the case studies that explain NZDF s influence or impact in various deployments (military and support to civil authorities). As such, we consider that the Annual Report

13 satisfies the legislative requirement to report on the effects (outcomes) of the Government s spending We note that the NZDF has recently begun a review of its output structure, the intent of which is to provide clearer links to the Government s intended outcomes. We understand that the review is intended to result in effects -based output classes (as opposed to the current output class structure, which is largely based on force elements for example, naval combat force, land combat forces). As this work comes to fruition, we will work with the NZDF on any resulting implications for its external, non-financial performance reporting. 7.5 We are also pleased to note that the NZDF has included the previous year s results in its Statement of Service Performance. This provides greater transparency and context for the reader of the NZDF s performance in 2011/ We recommended that: The relatively large number of outcome measures in the Statement of Intent be reviewed to more clearly differentiate between: - those measures that are truly outcome measures (that is, they demonstrate the effects of the Government s spending); and - those measures that should more appropriately be presented as activities that contribute to the outcomes. The SOI for Veterans Affairs New Zealand should be integrated into the overall NZDF framework. As in previous years, the NZDF SOI has two distinct SOIs within it one for Veterans Affairs New Zealand (which is actually part of the NZDF) and one for the rest of the NZDF. Need to enhance the NZDF s internal controls Payroll controls 7.7 We recommend that: the NZDF should continue to review access to the payroll system (ATLAS) and limit the number of people who have access to make changes; a process should be put in place to ensure that all changes to the payroll masterfile are independently reviewed; and pay-run vetting reports should be evidenced as being reviewed consistently across the NZDF. Inaccurate annual leave records 7.8 We recommend that the NZDF continue its work to review all annual leave records to ensure that they are accurate. In addition, systems should be put in place to ensure that leave is accurately recorded in future. 7.9 In 2009/10 the NZDF identified systemic issues in its recording of annual leave, which have resulted in annual leave balances being inaccurately recorded for 2363 personnel (military and civilian). This included 658 people with overstated leave balances and 1705 people with understated leave balances We understand that the NZDF is waiting on a legal opinion before it is able to resolve this matter and make the necessary corrections to the leave records.

14 Annual leave recorded in the payroll system (ATLAS) should accurately reflect annual leave owing to staff. This allows the NZDF to accurately pay its employees, monitor their leave balances, and manage the NZDF s liability. Delegations not being complied with 7.12 In 2010/11, 20% of items we tested within the SAP system were either approved outside delegation or we were unable to find evidence of who approved the transaction. We are pleased to note that compliance with delegations has vastly improved this year. Nevertheless, it is concerning that, from a relatively small sample of expenditure, several issues arose during the year. We have stressed the importance of complying with delegations We continued to recommend that Finance and Directorate of Risk and Assurance (DRA) continue to provide training to NZDF personnel on exercising delegations and direct contact with those personnel experiencing difficulties in meeting their obligations under the delegation policy. Need to improve robustness of information to support valuation of specialist military equipment 7.14 The correct valuation of property, plant, and equipment is important for capital-intensive organisations such as the NZDF. Among other factors, it assists in more effective capital asset management and enables more useful reporting of depreciation Overall, we are satisfied with the value of specialist military equipment (SME) included in the financial statements. The NZDF determined that no revaluation was required this year as there was no material difference between the fair value and carrying value of the assets. We concur with that assessment Given that the NZDF will probably revalue its SME assets next year, we reiterate the recommendations that we have made in previous years: The NZDF should look to improve the replacement cost information it uses to value its significant platforms (for example, the Navy s frigates and specific aircraft). For example, it should refer to recent sales of similar types of assets, ideally within the previous 12 months. The valuation could be based on either the cost to replace the current asset or the cost to replace the capability with the nearest available alternative asset, applying a capability factor adjustment. Some of the information currently used is very dated or from sources where reliability is not assured (for example, Wikipedia has been used as the best source of information for some assets). We strongly recommend that the NZDF should make some effort to improve this. The NZDF should review the remaining useful lives for key assets and components (focusing particularly on those components with a remaining useful life of 10 years or less). We note that some existing assets, such as HMNZS Endeavour and HMNZS Manawanui, have already been fully depreciated and have no further remaining useful life in accounting terms It would be helpful for the NZDF to utilise its own in-house expertise, such as Capability Branch, in improving its valuation practices.

15 Management of the Defence estate The NZDF has recognised that it faces a risk of failing to maintain the Defence estate due to fiscal constraints. The Defence White Paper has recognised that under-investment has resulted in a Defence estate that is generally in adequate condition but faces a significant risk of rapid deterioration In August 2011, the NZDF developed a Roadmap, which identified a comprehensive direction for change that will affect the Defence estate and involve shifting resources to front-end defence capabilities. The changes will reduce the costs of owning and managing the Defence estate and will involve the disposal of surplus assets. To achieve this, a change programme has been identified comprising many projects, including base rationalisation and consolidation, the transfer of units and functions to other locations, and some investment to facilitate this. We acknowledge the huge scale and complexity of the proposed change programme, and we note that significant slippage has occurred with some of the initiatives included in the change programme A reliable asset inventory (age, type, performance, condition and value) is critical. The three-year, rolling programme to update asset condition is not being progressed at some bases and, at present, the NZDF may hold current condition information for only 60% of its assets. We suggest that the NZDF reviews what condition information is outstanding for those Defence estate assets it expects to retain and plans to obtain that information. Inadequate information on asset condition can affect almost every aspect of asset management planning and, in particular, the ability to properly plan for and forecast the cost of maintenance and renewals. The risk of unplanned failure of assets increases. Valuations and the assessment of depreciation may be compromised, and some impairment of asset values may need to be considered It is evident that, although some additional funding has been provided, the current level of funding for the maintenance of Defence estate assets remains short of what is required to address the legacy of deferred maintenance. This continues to be a major constraint on effective Defence estate asset management. It creates a risk of continuing deterioration in the condition of assets, with a consequential effect on levels of service and an increased risk of unexpected asset failure. A specific plan to address the problem with deferred maintenance would be advisable. Conflicts of interest declaration process 7.22 Proper management of conflicts of interest is important in the public sector. In 2009/10, we made some recommendations which have yet to be fully implemented, including: updating the relevant Defence Force Order (DFO 1) to reflect good practice; ensuring that all conflicts of interest are being formally recorded in an appropriate register (preferably a centralised register); ensuring that mitigation action is recorded and monitored for any conflicts of interest; and regularly, and at least annually, requiring all staff in senior positions to formally confirm the accuracy of the information held in the conflicts of interest register We note that a process has been implemented since 1 July 2011 whereby DRA requests (and receives) regular declarations of interests from all senior officers (one star and above). However we continue to recommend that, where conflicts are identified, mitigations should be appropriately considered, approved, and recorded.

16 16 Non-compliance with generally accepted accounting practice; Nonconsolidation of controlled entities 7.24 We continue to recommend that the NZDF should prepare group accounts that incorporate its controlled entities, in accordance with the relevant accounting standard, NZ IAS 27: Consolidated and Separate Financial Statements. The controlled entities are the three service museums and 11 non-public funds established under the Defence Act We have accepted non-consolidation of the controlled entities only because of their relative immateriality to the NZDF s financial statements some $100 million of net assets As in previous years, we note that the NZDF has disclosed key information about the controlled entities in note 27 to its financial statements. While this information does not constitute full compliance with generally accepted accounting practice, it does enable a reader of the financial statements to assess the likely effect of consolidating these entities. 8 Legislative compliance 8.1 We reviewed the systems and procedures that the NZDF uses to identify and comply with legislative requirements. 8.2 No issues arose that we need to draw to the Committee s attention.

17 Part B: Advice to the Committee 17 9 Defence White Paper and long-term plans (background) Defence White Paper 9.1 The Defence White Paper was released in December It sets out the overall direction for Defence over the next 25 years. 9.2 The 2011 Briefing for the Incoming Minister of Defence (BIM) said that the first priority of the NZDF is operations, at home and abroad. The second priority is to implement the White Paper, including the Cabinet-directed savings and redistribution target of $350 - $400 million per annum by 2014/15. It stated that the implementation of the White Paper extends out to 2035, with the main areas of focus for the next five years being: Future force structure introducing an amphibious task force. Defence capabilities introducing into service significant new capabilities (including the upgraded Hercules, the upgraded Orions, and new helicopters). NZDF reorganisation operating as a strategy-led organisation, with an improved teeth to tail ratio. This involves updated ICT, shared services and logistics, improved governance and management, improved co-operation with defence partners, and more effective use of commercial partners. The NZDF is also rebalancing its workforce and civilianising some positions. 9.3 The next White Paper is planned for Decisions on future capability requirements will affect financial projections beyond that date. Defence Capability Plan 9.4 The Defence White Paper introduces a new approach for managing defence capability. 11 The Defence Capability Plan (published September 2011) is designed to give shape to the first 10 years of capability development under the policy framework provided by the Defence White Paper. 12 The Plan is intended to be the primary guide for NZDF capability development out to Although the Defence Capability Plan is aligned to the White Paper, it has been prioritised to reflect fiscal constraints and to manage within NZDF funding baselines. Consequently, the Plan represents a significantly lower capability investment than that envisaged by the White Paper The Defence Capability Plan can be funded until 2020 from available funding, with no capital injections. Beyond that date, capital requirements will be substantially driven by capability decisions in the 2015 White Paper. If existing policy settings are maintained, then significant capital would be required as several key assets will need replacing (including the Hercules and B757 transport aircraft, the naval combat capability, and the Orion maritime surveillance aircraft) New Zealand Government, Defence White Paper 2010, page 7. New Zealand Government, Defence Capability Plan, page 8. New Zealand Defence Force, The Statement of Intent, page 44.

18 The BIM has a graph that shows the capital bulge that would occur after 2021 if existing policy settings are maintained 14. The graph shows capital expenditure running at about $400 million per annum in the years 2011/12 to 2020/21. It then increases substantially with expenditure in each of the next five years being between $800 million and $1 billion. 9.8 There are two foci in the Defence Capability Plan: The establishment of a Joint Amphibious Task Force by 2015 and the transition to a network-enabled Defence Force by 2020 ( Total Defence Capability 2020 ). 15 The intentions for, and nature of, the Joint Amphibious Task Force are also referenced in both the Ministry s and the NZDF s latest SOIs. 16 Future The Chief of Defence Force (CDF), Lieutenant General Rhys Jones, has formulated the Future 35 strategy to prepare the NZDF for challenges out to A chart depicting the three periods within Future 35 is presented on page 18 of the NZDF s SOI The Future 35 plan to 2015 focuses on two areas: Capability renewal; and Organisational reform Capability renewal essentially involves the development of the Joint Amphibious Task Force (JATF), an integrated and coherent work force at the front end of NZDF Organisational reform deals with joined up working of the middle and back of the Defence Force. The Organisational Reform area contains two broad programmes: Efficiency Programme (EP), which aims to deliver savings of $350-$400 million per annum for reinvestment in the frontline; and Reform programme, which looks to add value These two programmes also include the development of strategies for the Total Defence Workforce, which will optimise the employment of full-time service personnel, reserves, and civilians The Committee may wish to receive an update on progress with developing the JATF and other aspects relating to organisational reform. The Committee may wish to ask: Please provide an update on progress with forming of the Joint Amphibious Task Force (JATF). Is the initiative currently on track? To what extent, if any, does the current attrition and shortfall in Regular Force numbers pose difficulties with achieving the development of the JATF by 2015? Please provide an update on other organisation reform and restructuring initiatives, including progress on future workforce planning and any further progress with the civilianisation of positions Ministry of Defence/New Zealand Defence Force, Briefing for the Incoming Minister of Defence (Key Points), 2011, page 8. New Zealand Government, Defence Capability Plan, page 4. New Zealand Government, Defence Capability Plan, page12; Ministry of Defence, Statement of Intent 1 July June 2015, pages 3 and 10; and New Zealand Defence Force, The Statement of Intent, pages 4, 6, 7, 22, 28-9, 44-5, 55. New Zealand Defence Force, The Statement of Intent, pages 5-7. New Zealand Defence Force, The Statement of Intent, pages

19 10 Ministry of Defence Overview of performance The Ministry is funded through Vote Defence, which provided 96% of the Ministry s total income in 2011/12. Total income for 2011/12 was $ million, a 3% increase on the previous year (2010/11: $ million) Expenses mainly comprise personnel expenses (61% of total expenses) and operating expenses (33% of total expenses). Total expenses, at $ million, were up 10% on the previous year (2010/11: $ million). Operating expenses increased by 27% in 2011/12 but were nonetheless below budget. The Ministry reported a net surplus in 2011/12 of $52,000 (2010/11: $810,000) The (now former) Secretary of Defence s overview in the Ministry s Annual Report provides a succinct summary of new military capabilities for 2011/12. He states that enhancing policy advice and evaluation capability within the Ministry is a current priority Central agencies released their report on their Performance Improvement Framework (PIF) review of the Ministry in September 2012 (PIF Report). The PIF Report states that stakeholders believe the Ministry should take a more regular and more active leadership role. Of the 24 areas receiving ratings, 19 were deemed needing development or weak. The PIF Report includes an important caveat that the ratings are premised on the assumption that the Ministry should reposition itself in a stronger leadership role The weaker areas include its audit and performance assessment function; vision, strategy and purpose; leadership and workforce development; and information management. Two other areas of service delivery, policy advice and management of equipment procurement, were deemed as needing development In the reviewers opinion, the Ministry does not have an organisational strategy, and it requires changes to its operating model. Specific challenges presented in the PIF Report include leading debate generally, leading discussions about affordability, ensuring processes and systems are in place to successfully take joint accountability (with NZDF) for the management of military capability, deepening the skills and thought leadership in its policy function, modernising and systematising its approach to audit and assessment work, and strengthening its corporate services capability The Committee may wish to question the Ministry about its response to the PIF Report. The Committee notes the September 2012 report of the Ministry s PIF review. Does the Ministry agree with the proposition that it should increase its leadership role in the sector? What specific actions has the Ministry taken since the PIF Report to respond to its findings and recommendations? How will the Ministry achieve the PIF Report s future state aspirations within its existing budget? Ministry of Defence, Annual Report for the year ended 30 June 2012, page 38. Ministry of Defence, Annual Report for the year ended 30 June 2012, pages 2-4. SSC, Treasury, and DPMC, Performance Improvement Framework: Formal Review of the Ministry of Defence (MOD), September 2012, pages 5, 13, and 14. SSC, Treasury, and DPMC, Performance Improvement Framework: Formal Review of the Ministry of Defence (MOD), September 2012, pages 7 and 10.

20 20 11 New Zealand Defence Force Overview of performance Financial performance 11.1 Almost all of NZDF s income (98%) is derived from the Crown, through Vote Defence Force. At $2.194 billion in 2011/12, NZDF s income was 3% lower than in the previous year. There has been a commensurate drop of 3% ($74 million) in total expenses in 2011/12. Total expenses were $2.163 billion, compared with $2.236 billion in 2010/ Figure 1 shows the relative proportions of NZDF expenses. Personnel costs, at $834.5 million, account for 39% of total expenses and are down 2% on the previous year. Operating costs at $557.3 million account for 26% of expenses and are down by 11% NZDF reported a $31 million surplus in 2011/12 (2010/11: $24 million). 23 A chart depicting expenditure by service is provided on page 18 of the Annual Report. Figure 1: NZDF expenses for 2011/12 Capital charge, $453.0 Depreciation & amortisation, $315.1 Finance costs, $0.8 Other operating expenses, $2.0 Personnel, $834.5 Operating costs, $557.3 Non-financial performance 11.4 NZDF s outputs fall into three main categories: 24 sustaining operational missions; performing predictable or routine tasks such as providing policy advice, multi-agency operations and tasks (MAOT), and community support; and maintaining the required level of military capability Approximately 95% of departmental output expenditure relates to maintaining the required level of military capability, that is, the preparation of the Navy, Army, and Air Force for active service. NZDF s primary focus is geared to preparing for, and delivering, the ultimate end product or goal, thus the main output purchased from NZDF is a sufficiently prepared military capability NZDF provides a comprehensive account of its deployment activity on pages of the Annual Report and a useful summary on page New Zealand Defence Force, The Annual Report, page 152. New Zealand Defence Force, The Annual Report, page 41.

21 11.7 Pages of NZDF s Annual Report explain NZDF s approach taken to measuring and reporting on performance against objectives for preparedness. The preparedness measures relate to Output Classes 2-14, with separate approaches taken to measuring and reporting on Output Class 1 (policy advice), Output Class 15 (miscellaneous support activities), Output Class 16 (operationally deployed forces), and services in support of the Government and community (MAOT), which are funded through the other output classes NZDF s performance against its preparedness objectives is presented on pages of its Annual Report. Across all of the many objectives specified, NZDF appears to be generally meeting its targets. There are notable exceptions, and a useful summary of the extent to which NZDF has met its preparedness objectives is provided on pages Military staff capacity and capability 12.1 The efficiency programme (EP) involves changing the composition of the workforce, including the civilianisation of some positions. The effect of the civilianisation process on morale, staff retention, and risks from lost expertise has been well acknowledged. 25 (The Auditor-General s report on NZDF s civilianisation programme is imminent at the time of writing.) 12.2 The White Paper s objective concerning the new approach to the NZDF workforce is to match positions with staff who possess appropriate skills. In the 2012/13 SEQ, the Minister advises that NZDF s workforce strategy is due for completion by November NZDF s future planning and workforce restructuring is taking place against a backdrop of low morale, high attrition rates, and lower-than-targeted activity due to personnel shortages (as highlighted in Figure 2 below see also pages of the NZDF Annual Report). Figure 2: NZDF Regular Force attrition Ministry of Defence/New Zealand Defence Force, Briefing for the Incoming Minister of Defence (Key Points), 2011, page 8. New Zealand Defence Force, The Annual Report, page 14.