House of Commons - Ministry of Defence Annual Report and Accounts 2011-12

Ministry of Defence Annual Report and Accounts 2011-12 - Defence Committee Contents

2 MoD Resource Accounts 2011-12

Production of the 2011-12 Annual Report and Accounts

Late production of the Accounts

4. The MoD laid its Annual Report and Accounts 2011-12 before Parliament on Thursday 6 December 2012.[4] HM Treasury guidance for 2011-12 states that:

The statutory deadline for submitting signed resource and other accounts is 30 November 2012. It is best practice for departments to aim to lay resources accounts and the accounts of agencies and trading funds in parliament by 30 June 2012 and by no later than the parliamentary summer recess.[5]

5. In the Governance Statement in the Annual Report and Accounts, Jon Thompson said:

[...] The NAO's audit of the value of accruals recorded in the draft accounts found evidence of potentially material errors. As part of my strenuous efforts to improve financial discipline in the MoD, I decided to delay the laying of the Accounts until we had greater confidence that the accruals figure was correct. We retained KPMG to conduct an independent review of accruals balances reported by Defence Equipment and Support. This is now complete, and the relevant journal entries have been adjusted in the light of its findings. The NAO have confirmed that the revised figure for accruals is true and fair.[6]

6. We pressed Jon Thompson as to why the MoD was some five months late in submitting its audited accounts to Parliament. He told us that, as part of its audit of the MoD accounts, the National Audit Office (NAO) had found errors in its sample examination of accruals and had brought them to the attention of the MoD in June 2012. In his former capacity as Director General Finance, he had recommended to the Secretary of State that they resolve the problem fully rather than meet the deadline for the Annual Report and Accounts:

We traded time for [...] having a further improvement in the quality of the accounts.[7]

7. The MoD had brought in external help to do a full review of all accruals in the MoD's accounts and to provide the necessary assurance to the Accounting Officer (Permanent Under Secretary). This review had taken some considerable time. After the review, the MoD had made the necessary adjustments to the accounts and returned them to the NAO for further audit work.[8] The review had found that the MoD had "under-accrued by some £425 million and over-accrued by a similar amount, netting out to almost zero".[9]

8. When asked why it had taken the NAO to identify the problem with the accruals, Jon Thompson said that this was a regrettable matter.[10] He also acknowledged that "the issue had come out of the blue to the MoD".[11]

9. It is unsatisfactory that the MoD was some five months late in laying its Annual Report and Accounts for 2011-12 before Parliament. While it may have been appropriate to delay the laying of the Accounts to ensure that the accruals were correct, it is worrying that the problems with the accruals in the MoD accounts "came out of the blue".

Shortages of skills and expertise

10. The Governance Statement of the Annual Report and Accounts 2011-12 highlighted how the errors in the draft Accounts revealed weaknesses in the quality and capacity of finance staff. In the Governance Statement, Jon Thompson said:

Errors in the draft Accounts of this scale raises questions about the effectiveness of the control framework and revealed weaknesses in the quality and capacity of finance staff. Subsequent analysis suggests there has been an accumulation of errors over time which were in themselves not material, but whose cumulative effect now needed to be addressed. The accounting consequences of changes made in the SDSR [Strategic Defence and Security Review] and subsequent planning rounds may have diverted attention away from the accurate reporting of accruals and compounded acknowledged issues arising from skills shortages in the finance area. We will be expending additional effort in ensuring that all financial transactions are correctly accounted for throughout this financial year and ensuring that staff receive training. We will also be reviewing the internal processes in Defence Equipment and Support [DE&S] to ensure that any underlying issues which may result in accruals and other financial information being mis-reported are addressed. In the longer term, the Materiel Strategy is expected to result in a step change in financial discipline in DE&S. I expect to be able to lay next year's Accounts before the summer parliamentary recess in 2013.[12]

11. When questioned about the skills shortage and lack of necessary expertise, Jon Thompson said that the financial challenge in the MoD was complex and that implementing the Strategic Defence and Security Review had "added further layers of complexity to the financial challenge".[13] He also acknowledged that the MoD did not have the necessary expertise and had had to bring in external assistance from some of the large accountancy firms.[14]

12. When asked to quantify the level of skills that the MoD needed. Jon Thompson said:

It is my belief that there is an appropriate balance to be struck between what is the permanent civil service and what is the necessary higher-level skill that you need to supplement that with from the best of the private sector. To give you some sense of scale, in relation to the finance function, there are approximately 1,000 qualified accountants [...] and we have around 100 KPMG colleagues; that number will reduce over time. Does that give you a sense of the scale of the injection that we require? It is about a 10% supplement; we would expect that, over three years with KPMG, there would be enough skills transfer and we would grow enough of our own people that we would reduce that to the minimum necessary.

13. Jon Thompson estimated that the MoD would have the necessary in-house expertise by 2014.[15] He pointed out that the MoD was a complicated Department and "equivalent to a FTSE top five company in terms of annualised spend and balance sheet size".[16] He said that the MoD had not yet reached a satisfactory level of financial control.[17]

14. The delays in producing the Annual Report and Accounts 2011-12 reveal a worrying lack of financial expertise within the MoD. While bringing in external accountants may have been the only way to sort out the problems with the accruals, the MoD should ensure that the employment of such an expensive resource is for the shortest period possible. In response to this Report, the MoD should set out, in some detail, its plans to ensure that it gets the expected transfer of skills to internal MoD staff from its employment of external accountancy staff including. These plans should include the methodology for judging that this has occurred.

Annual Report and Accounts 2012-13

15. We asked Jon Thompson if next year's accounts would be similarly delayed. He said:

[...] We have all the necessary systems and processes agreed with the NAO, within the MoD and so on to deliver them in June. If the action that we have been able to take on stock and accruals and the general increase in terms of the performance of the finance function of Defence Equipment and Support continues along the route that we have mapped out, one would expect that we could lay the accounts in June.[18]

16. Despite the assurances from the Permanent Under Secretary, our experience of the MoD's Report and Accounts leads us to be sceptical about the prospect of the MoD delivering its Annual Report and Accounts 2012-13 before the Parliamentary summer recess.

Qualification of the 2011-12 Accounts

17. The Comptroller and Auditor General (C&AG) qualified his audit opinion (for the sixth successive year) on the Department's 2011-12 Resource Accounts due to material error arising from adopting accounting policies which did not fully comply with the required auditing standards. A material error is one which results in a significant misstatement in the accounts; materiality depends on the context of the error but is of a level which could affect the understanding of, or decisions taken by, users of the accounts. The C&AG qualified the financial statements:

Firstly, the Ministry of Defence has not complied with the Financial Reporting Framework as it has not accounted for the expenditure, assets and liabilities arising from certain contracts in accordance with International Financial Reporting Standards (IAS 17), Consequently, the Ministry of Defence has omitted a material value of assets and liabilities from its Statement of Financial Position as at 1 April 2010, 31 March 2011 and 31 March 2012. This has also led to a material misstatement of the Statement of Comprehensive Net Expenditure for 2010-11 and 2011-12 and Statement of Parliamentary Supply for 2011-12. I am unable to quantify the impact on the financial statements because the Ministry of Defence has not maintained the records or obtained the information required to comply with International Financial Reporting Standards in this respect.

Secondly, in respect of the valuation of inventory (£3 billion) and certain non-current assets in the form of capital spares (£7 billion) recorded in the financial statements, the evidence available to me was limited due to the Department having failed to perform an adequate impairment review on a systematic basis. Consequently I was unable to obtain sufficient, appropriate audit evidence to support the valuation of £10 billion in the Statement of Financial Position and assess the completeness and accuracy of the associated transactions in the Statement of Comprehensive Net Expenditure. I have also been unable to obtain sufficient, appropriate audit evidence for the corresponding figures for 2010-11, which were also subject to this qualification.[19]

18. The C&AG also gave a qualified opinion on the regularity of the 2011-12 Accounts as the MoD had not obtained the requisite approvals from Cabinet Office and HM Treasury in respect of the remuneration package of the Chief of Defence Materiel.[20]

Accounting for contracts that may contain leases

19. The C&AG qualified the MoD Resource Accounts in 2009-10, 2010-11 and 2011-12 because of non-compliance with international reporting requirements which are now required practice for Government Accounts. In preparing its accounts, the MoD must comply with the requirements of the Government Financial Reporting Manual. Since 2009-10, the Manual has required the adoption of International Financial Reporting Standards by UK central Government bodies. These Standards[21] require preparers of the accounts to establish whether lease-type contracts are in substance a finance or operating lease. These decisions have a significant impact on the Accounts because if the contract is classified as a finance lease then the valuation of the assets used to deliver the service would need to be recognised in the financial statements alongside a liability for the minimum lease payments due under the contract.[22]

20. The extent of this issue is significant for the MoD Accounts as the MoD has strategic non-competitive arrangements with key contractors for specialist defence platforms which often provide for the exclusive use of industrial assets—effectively meaning that the MoD has entered into a lease type agreement. The C&AG reported that:

The accounting requirements for lease type arrangements are particularly relevant to the Department. It necessarily enters into strategic arrangements with certain contractors to procure specialist defence platforms on a non-competitive basis, for example in relation to surface ships, submarines and aircraft. These arrangements may provide for the exclusive, or near exclusive use of industrial assets which have only limited utility to other customers. Consequently, the contractual terms, which are covered by the Government Profit Formula [...], may give rise to the Department controlling the significant majority of the outputs of the supplier's assets involved in the arrangement. For example, where shipyards are used exclusively on defence contracts and the pricing of the contract recognises this by allowing recovery of fixed costs other than through market rate or unit cost pricing. As such, these arrangements may be considered to contain a lease under IFRS, and may have the characteristics of a finance lease.[23]

The C&AG could not quantify the impact of this non-compliance on the financial statements as the MoD had not maintained appropriate records, but, given the number and size of contracts involved, there is likely to be material understatement of the assets and liabilities.[24]

21. In response to the C&AG's qualification, the MoD "has now committed to completing an initial review by September 2013, by supplier and contract, of the industrial facilities to which IFRIC 4 [International Financial Reporting Issues Committee] is likely to apply. This review will consider the potential resources and timescales required to achieve compliance".[25] Jon Thompson told us that he would expect to complete the review in the second half of 2013 and that the qualification of the Accounts would remain until at least 2012-13.[26] He also told us that this is "complicated territory to work your way through".[27] David Williams, Acting Director General Finance, said that:

But I think [...] even if we conclude in that example that we should recognise part of the value of Barrow on our books, is it whole or part, and how do we value it? The company will use different accounting standards from ours. There must be a material prospect that what we will do is to trade a qualification for not having it on our books for a qualification for having it on our books but being unable to satisfy the NAO about the quality of the valuation of the asset. We should not assume, therefore, that this will be a simple transition to a clean set of accounts. Clearly, we need to see where the review comes out next year. It seems to me that that opens up a new set of complexities.[28]

22. In the Government Response to our Report on its Annual Report and Accounts 201011, the MoD said that:

Work undertaken during the implementation of International Financial Reporting Standards in 2009-10 highlighted that those contracts most at risk of containing a lease (IFRIC 4), for accounting purposes, are the single source strategic procurement arrangements with the UK's main defence contractors. These are also the highest value contracts managed by the Department. Once contract re-negotiations resulting from the Strategic Defence and Security Review (SDSR) are complete, effort will be concentrated on reviewing these single source arrangements.

SDSR negotiations will continue into 2012-13 after which MoD will need to agree with the various contractors a mechanism for identifying and valuing, on an ongoing basis, any assets deemed to be leases and therefore recorded on the MoD Statement of Financial Position (SoFP) and the costs of doing so. The contractors will expect to be recompensed for the considerable work this will involve. Therefore, it is estimated that C&AG will not be able to provide MoD with a clear audit opinion on IFRIC 4 until 2014-15 at the earliest.

In the meantime MoD has been reviewing all new competitive contracts in accordance with the requirements of IFRIC 4 since the start of 2011-12. To date none of these arrangements have been identified as requiring MoD to include the contractor's assets on the Department's SoFP.

23. While we recognise that compliance with the International Financial Reporting Issues Committee Interpretation 4 (IFRIC 4) and International Accounting Standard 17 on leases is more onerous for the MoD than other departments, it is important for public transparency and proper conduct of Government business that all departments comply with Government accounting policy. Compliance is particularly relevant for the MoD because it enters into many contracts for defence equipment on a non-competitive basis. We recommend that the MoD put in place the necessary work to ensure that the C&AG is able to give an unqualified audit opinion in respect of IFRIC 4 by 2014-15 at the latest. In response to this Report, the MoD should provide a plan and timetable for completion of this work.

Assets and stock balances

24. The Armed Forces require a wide range of supplies and spares for immediate and potential use. These supplies and spares are described collectively as 'inventory'.[29] For the 2011-12 Accounts, the MoD was unable to provide the NAO with appropriate audit evidence in support of inventory of some £3 billion and capital spares of some £7 billion. The MoD failed to perform an adequate impairment review on a systematic basis in respect of the inventory items and capital spares.[30] An impairment review is an assessment of the wear and tear on inventory items and the consequent adjustments to the valuation of these items. The C&AG said:

I have limited the scope of my opinion in relation to certain non-current assets recorded within the SoFP [Statement of Financial Position], in the form of capital spares (£7 billion) and inventory (£3 billion). The limitation arises as a result of the Department having inadequate processes to assess the impact of impairment of non-current asset capital spares and the valuation of current asset inventories in the form of raw materials and consumables. Due to the lack of a systematic assessment the Department has been unable to provide me with sufficient evidence to support the valuation of these balances.[31]

25. He also said:

A systematic impairment assessment will also enable the Department to identify spares and inventory for disposal or repair; this will serve to reduce stock holding costs and critically to help to better inform operational decision making in respect of items available for immediate use.[32]

26. The C&AG continues to recommend that " the Department delivers against its planned approach to undertake a systematic review of inventory and capital spares against the requirements of IAS [International Accounting Standard] 36 and IAS 2, in order to assess the impact of impairment".[33]

27. Jon Thompson acknowledged that many of the problems with inventory management had been long standing and deep-rooted:

I have been very transparent with the Committee over the past three years, and there are some deep and systemic issues in some of these areas that will take a long time to resolve. As I said to the Public Accounts Committee two weeks ago, there is evidence that the stock issues have been there for several decades. In fact, if you dig back far enough, there is an NAO Report on that issue from 1991, which was, to be open with you, not particularly actioned until 2008. So I am not underestimating the challenge; I am trying to be as open with you as I possibly can be. There remain some deep-rooted issues that we are trying to resolve by adding to capacity through appropriate third parties.[34]

28. He also explained that they had had some success in removing areas of qualification:

[...] if you go back two years, the qualifications included: there was no reconciliation between the stock on a shelf to the stock systems, and between the stock systems and the finance systems, and then between the finance systems and the accounts. You have to start from being able to reconcile the stock that you have got against the stock systems and then the finance systems, and then you clear down those qualifications, which we have done, and which is reflected in the National Audit Office Report.

Then you are left with the fundamental of what is essentially the last question. By the time you have done all of that, are capital spares and stock worth £16.8 billion net, because that is the number that is in the balance sheet? And the answer to that question is that at the moment we cannot give the National Audit Office the necessary assurance that they are, and that leaves us with the remaining qualification.[35]

29. In its further evidence to the Committee, the MoD told us:

[...] It is possible that remaining qualification may be removed in 2012-13, but it is more likely in 2013-14 given the remaining work to be carried out to value total stock and inventory to the standards needed to meet appropriate accounting standards.[36]

30. The MoD should complete its impairment review as quickly as possible. It should ensure that the remaining qualification on inventory and capital spares does not extend beyond 2013-14.

31. In June 2012, the NAO reported on how the MoD managed its inventory. The NAO reached a number of conclusions including:

The Department [MoD] is continuing its work to improve the quality of its data and has committed significant funds to improving its IT systems. These limitations, however, further highlight that the Department's ability to manage its inventory is compromised by its current information systems and the data those systems hold.[37]

On value for money, the NAO concluded that:

The Department recognises there are problems with its inventory management, and has introduced projects to improve its practices. However, the root cause of the excess stock is that management and accountability structures fail to provide the incentives to drive cost-effective inventory management. The Department will need to address these weaknesses comprehensively to deliver value for money.[38]

The NAO made the recommendations set out in Table 1 below.:

Table 1: NAO recommendations from Managing the defence inventory Report[39]

a The Department should develop a coherent and comprehensive strategy for the size, value and composition of the inventory that it needs to retain, and use this as a basis for setting coherent targets and management approaches.
The Department has made improvements to better manage inventory, but does not yet have a coherent and comprehensive view of the size and value of the inventory it needs to retain. Consequently the Department cannot manage its inventory as a strategic asset or set coherent targets and management approaches. Its strategy should embed good inventory management behaviours as standard business practices, for example ensuring that project teams do regularly review their inventory to identify items for disposal.

b The Department should expand its financial information and use it to improve cost-effective decision-making.
The Department does not collect all the information needed to understand the full cost of managing inventory, nor does it centrally collate and report its cost information. The Department cannot, therefore, make informed decisions and evaluate whether it is achieving value for money from these decisions. The information should be collated in a manner that allows the full cost to be estimated for individual types of stock. Costs should include that of holding and managing stock by the armed forces.

c The Department should reduce the amount it spends each year on inventory where it already holds sufficient stocks.
The Department holds £4.2 billion of inventory that has not moved in over two years and a further £2.4 billion of holdings sufficient to cover five years of use. However it spent £1.5 billion in 2009-10 and 2010-11 on consumable inventory that it has not used.

d The Department should set up management and accountability structures that incentivise good inventory management.
The Department will be introducing a number of significant reforms over the next few years, including new operating models for the Department overall, and for Defence Equipment and Support. The Department should use the opportunity presented by these reforms to set up management and accountability structures that encourage teams to manage inventory efficiently as well as effectively.

e The Department should address its problems in managing inventory before it outsources some of its warehousing, distribution and commodity procurement functions.
The Department is exploring options for outsourcing but there are risks to achieving value for money owing to a lack of a comprehensive top-down strategy, robust information and skilled staff. The Department will need to successfully address these to avoid paying a premium for outsourcing.

32. We asked the MoD why it was holding £4.2 billion worth of inventory which had not moved in over two years and a further £2.4 billion sufficient to cover five years. Jon Thompson replied:

[...] We have to stop buying more than we are consuming. We introduced a series of controls from 1 April 2012 that have already reduced the current year's expenditure in this area by half a billion pounds—we are half a billion pounds down on the year before, on an annual spend of roughly £2 billion.[40]

33. We also asked what would be the likely level of savings from the better management of the inventory. Jon Thompson said that the MoD could save money:

The savings will come from not needing so much warehousing and stock management. We spend around £275 million or thereabouts on warehousing, distribution and so on. That is the number where you can make an annual recurring saving because you are not buying so much stock, you are not storing so much stock and then you are not ultimately disposing of it. That is where you can save money for the taxpayer.[41]

We would expect that to reduce fairly significantly. It can never be zero, because we will always have to manage some stock, but I would expect it to be in the high tens.[42]

34. We welcome the Permanent Under Secretary's frankness in acknowledging that the problems with stock management are of long-standing but it is now time to sort out these problems. We recommend that the MoD implements the recommendations laid out in the NAO Report: Managing the defence inventory. In response to this Report, the MoD should set out how it plans to implement the NAO's recommendations and provide us with its inventory management plan and strategy.

Implementation of IT systems

35. Jon Thompson told us that the MoD was improving its management of the defence inventory:

We have an inventory management plan and strategy. There is a group that oversees it at the three-star level at DE&S. There is a specific full-time two-star military officer who runs this, who appeared in front of the Public Accounts Committee. There is a significant amount of work going on in terms of people, time, investment, training, IT systems and so on in order to improve the situation.[43]

He also said that the MoD was rationalising the IT systems dealing with stock and inventory control with an aim of reducing the 78 IT systems to four by 2015.[44] The MoD later told us that the four IT systems being implemented were:

JAMES (Joint Asset Management Engineering Solutions): This new capability is primarily designed to manage and track all assets across the Land Domain, including vehicles, ground equipment, and radios. Implementation of JAMES will enable the retirement of 5 legacy systems. JAMES implementation is due to be completed (for all major units) by 31 March 2014.

MJDI (Management of the Joint Deployed Inventory): This new capability will provide a single system for managing the Defence Inventory in the Deployed Environment, and is currently being rolled-out to support Op HERRICK [operations in Afghanistan]. Implementation of MJDI will enable the retirement of 6 legacy systems, with implementation due to be completed in March 2014.

BIWMS (Base Inventory and Warehouse Management Services): This is a new capability to replace 40 legacy systems (some of which are over 40 years old) to provide unified inventory management processes across Defence. It is scheduled to be delivered in a number of phases between 2013 and the end of 2015/2016. Current planning assumptions have 10 legacy systems being retired in March 2014, and a further 30 systems due retirement by March 2015.

Logical Data Model: This is a new capability, which builds on Data Warehousing capabilities, to bring together, for the first time, information relating to base inventory, deployed inventory and consignment tracking to improve the quality of management information in support of operational decision making. Implementation is due to commence in January 2013, with full roll-out completed by March 2014. It does not replace any legacy systems.[45]

36. Being able to identify and record the condition of inventory and assess its value is important for operational reasons as it enables the repair and replenishment of items needed and the disposal of those items no longer required. It is also critical in making value for money decisions about the amount of inventory to be purchased and held. Problems with stock control are likely to continue until the introduction of new stock systems in March 2014 leaving the MoD with inadequate information. We look forward to hearing further evidence of tangible progress in identifying, recording and assessing inventory between now and March 2014. The MoD should also make strenuous efforts to ensure that the agreed timetables for the required systems are met.

Qualification of the regularity opinion

37. Since May 2010, the Cabinet Office has required approval of all pay packages for newly appointed civil servants who receive remuneration packages in excess of £142,500. The Chief of Defence Materiel (CDM) has a full year equivalent salary in the range £240,000 - £245,000. In July 2010, the MoD obtained outline approval for the basic salary package of the new Chief of Defence Materiel. However, it failed to obtain the required approval for CDM's overall remuneration and benefits package. As a consequence, the C&AG was unable to give an opinion on whether the remuneration of the CDM had exceeded the MoD's delegated authorities. He, therefore, qualified his opinion on regularity in respect of these payments which he considered to be material in the context of the Remuneration Report.[46]

38. Jon Thompson explained why the situation with the Chief of Defence Materiel arose:

The approval is in relation to one aspect of the overall package, which is that of contribution towards a London flat. The salary was approved by the necessary authorities on appointment. The aspect of the use of a current driver, which was inherited from the CDM's predecessor, was also agreed at that particular point. But the question of switching from the use of hotels to a contribution towards housing allowance, when that was agreed with the then Second Permanent Under Secretary at the end of 2010, was not brought to the attention of the necessary decision makers, and it was not regularised. The National Audit Office has brought that to our attention. That is the aspect that was highlighted in its Report and which we are currently trying to regularise. It is a regrettable situation that happened in 2010. The salary is fine and the car is fine. The issue is about the contribution towards housing. I understand that the second PUS at the time made the decision that it was better value for money for the taxpayer to switch and that is what led to this situation.[47]

The MoD subsequently told us that its contribution to the cost of the rented flat was some £2,000 a month.[48]

39. We asked Jon Thompson whether the Chief of Defence Materiel or any other senior official is classed as self-employed for tax purposes. He said that after the issue with the Student Loans Company, the MoD had done a full review and no one was classed as self-employed but he would wish to check.[49] The MoD subsequently confirmed that all senior MoD staff were paid through the MoD payroll and paid PAYE (pay as you earn) tax.[50]

40. The failure to obtain approval for the full remuneration package of the Chief of Defence Materiel is regrettable and the situation should be remedied as soon as possible. The MoD should ensure that the MoD Accounts are not qualified for this reason in 2012-13.

Previous areas of qualification

41. We have been concerned about the qualification of the MoD Accounts for a number of years and welcome the evidence that the MoD has improved in some of these areas. The C&AG is no longer qualifying the MoD Accounts on the following issues:

Completeness of inventory and capital spares—the MoD undertook a major exercise to ensure all stock is recorded on the warehouse systems. This reduced error rates and allowed the C&AG to conclude that the inventory systems are materially complete.
During 2011-12, the MoD deployed significant resource to undertake a quarterly reconciliation across its major warehousing systems. This enabled the C&AG to conclude that, though there was further work to be done in reducing the level of discrepancy between the inventory and financial systems, there are no material discrepancies between the inventory systems and the financial systems.
As the result of an upgrade BOWMAN radios, the MoD now has 49,730 functioning and verifiable radio sets at a valuation of £1.343 billion. The MoD took write off action where it was unable to verify radios to the required standard of audit evidence. It wrote-off 1,163 radio sets at a value of £33 million. Some 84 per cent of Bowman radios are now serially tracked and recorded.[51]

42. Jon Thompson told us that his intention was to have 100 per cent of Bowman radios serially numbered and tracked.[52] He was, however, uncertain as to when that would be achieved.[53]

43. Jon Thompson assured us that the MoD would maintain the progress it had made in reducing the areas qualified by the C&AG:

I don't think we'll return to how it was. We made some progress and we can bank that progress. We have a further development plan, and the NAO have had a look at that. That plan involves further investment in information systems, which has begun to be deployed. We introduced the first of the new IT systems in the last financial year, but there are three more coming in the next two financial years, in relation to stock management, for example. We have a project looking at how we more efficiently do logistics, and we have seen the business case for that. So there is a plan; it is owned by the Chief of Defence Materiel. We have transparency. It's banked some gains and it's got some further progress to make. So I don't see us going backwards.[54]

44. We welcome the reduction in the number of qualifications by the C&AG of the MoD Accounts and the assurance from the Permanent Under Secretary that these qualifications will not reappear in subsequent years.

Flexibility in the use of budgetary underspends

Underspend in 2011-12 Accounts

45. The MoD underspent its resource budget for 2011-12 by some £3.6 billion against its net resource estimate of £42.1 billion, the net outturn being £38.5 billion. Nearly a third of the underspend was caused by the MoD's over-estimation of the costs of Strategic Defence and Security Review (SDSR) decisions—£1 billion—because the MoD found it difficult to forecast costs of the associated write-downs. The remainder was due to movement in the value of nuclear provision (£1 billion) and in the market value of the defence estate (£400 million). The MoD underspent its capital budget by £500 million against an estimate of £9.5 billion.[55] In 2010-11, the MoD underspent its budget by some £7.9 billion.[56]

46. The MoD explained the underspend on the resource estimate in its Annual Report and Accounts 2011-12 as:

an underspend of £1.5 billion against the approved limit for Resource DEL [Delegate Expenditure Limit] resulting from lower than expected outturn against the approved increase to the Supplementary Estimate in respect of non-cash Resource DEL impairments depreciation and release of provisions;
an underspend of £1.7 billion against the approved limit for Resource AME [Annually Managed Expenditure] resulting from an unexpected reduction in the value of nuclear provisions (£0.8 billion) and a balance (£0.9 billion) caused by the inclusion in the Estimates of provision for impairments and depreciation which had not materialised at year end; and
an underspend of £0.4 billion against non-budget resulting from a Prior Period Adjustment to correct an error in an impairment; no provision was made for the correction of prior year errors.[57]

Future underspending

47. In response to our questioning about future underspends, Jon Thompson said that:

In relation to 2012-13, the current financial year, we are currently in negotiation to transfer £1.5 billion of the defence budget from the current year into the next two financial years. If we are successful in those conversations with the Treasury, that will be appropriately disclosed to Parliament in supplementary estimates in January.[58]

He told us that it was highly likely that there would still be a small underspend in 2012-13 even if the negotiations were successful:

To be very clear, when we have done that, it is highly likely that you will sit here next year and there will be a small underspend. It will never be zero because we have to make a prediction in January and then you still have two months of the financial year to run.[59]

48. When asked about the risk that the Treasury might reduce the amount of money given to the MoD, Jon Thompson said:

[...] That is exactly the risk that we are in. If we do not commit the budget to 100%—in the past, we have committed it beyond 100%—it opens up the risk that the Treasury will say, "You have underspent. We will return that money to the Exchequer."

It is my absolute belief that, in accordance with Mr Micawber, it is better not to be fully committed than it is over-committed. That gives you some room to manoeuvre, because the counter-factual here is, if you have an overheated programme, that leads you to make very poor decisions about individual programmes and the budget overall. It leads you to knee-jerk cancelling of things, stretching them out, laying people off at very short notice and so on, because you do not have any room to manoeuvre. It is worth understanding both those strategies.[60]

Flexibility to carry forward underspent budget

49. Jon Thompson told us that the MoD was in negotiation with the Treasury to transfer underspends from one year to the next:

In relation to annuality, one of the freedoms that we have managed to win through prolonged engagement with the Treasury on the balanced budget is that we have access to budget exchange. That was not available to the Department up to this particular point. If there were underspends in any particular year, we were not able to try to transfer that from one year to another. Given that there is a confidence in the long-term plan, because it adds up to less than the amount of money that would be available under the assumptions, the Treasury is more comfortable to have negotiations with us about budget exchange and moving money from one year to another. I explained what we are currently attempting to do with the underspend in the current year and how that might land in the next two financial years. So that helps us. The equipment programme is a long-term and complicated programme. If that programme moves back, and you have an annual budget, you need to move the funding back. That is exactly what we are currently in negotiation with the Treasury to do.[61]

50. The MoD has now been given access to Budget Exchange which allows Departments to carry forward underspends in resource and capital budgets subject to rules specified in the Consolidated Budgeting Guidance by HM Treasury. Budget Exchange was introduced by the Government in the 2011 Budget and replaces the previous scheme of End Year Flexibility. In the Supplementary Estimates 2012-13, the MoD has requested reductions of £1,240 million in Resource DEL and £350 million in Capital DEL under Budget Exchange to utilise the money in 2013-14 and 2014-15.

51. We note that the Treasury has agreed to the transfer of unspent budget to future years under the Budget Exchange Mechanism. In response to this Report, the Government should inform us how this facility will be delegated to budget holders. The increased flexibility is important for the efficient management of the MoD's expenditure, in particular, of the Equipment Plan budget. The freedom to carry forward its underspends is essential to the maintenance of prudent behaviour by the MoD. It would be shortsighted of the Treasury to claw back any money not spent by the end of the year, or the contingency provisions the MoD has established to protect against unexpected budgetary pressures.

Impact of the Autumn Statement

52. The Chancellor announced in the Autumn Statement in December 2012 that the MoD would have reductions in its Resource Delegated Expenditure Limit (DEL) of one per cent (£245 million) in 2013-14 and two per cent (£490 million) in 2014-15. We asked the MoD what impact these reductions would have on the MoD and the Armed Forces, Jon Thompson said:

[...] as a result of the autumn statement we will not be either cancelling or moving any equipment projects or announcing any additional redundancies on either the military or the civilian side over those two years.[62]

53. He further said:

[...] we have £500 million of departmental unallocated provision in the current year which, if the supplementary estimates agree, we will carry forward into those two years. We also, in those two years, have further unallocated provisions, the combination of what we are carrying forward and what we have already planned for. We should be able to deal with the £250 million and £500 million respectively. That is why I gave you the previous answer: yes, there would be no further reductions necessary.[63]

4 Ministry of Defence Annual Report and Accounts 2011-12, HC 62 Back

5 HM Treasury DAO(GEN) 05/11 Back

6 Ministry of Defence Annual Report and Accounts 2011-12 HC 62 Governance Statement, p 98, section 8 Back

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12 Ministry of Defence Annual Report and Accounts 2011-12 HC 62 Governance Statement,p 98, section 8 Back

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