HC 653 Defence CommitteeWritten evidence from the Ministry of Defence

MOD ANNUAL REPORT AND ACCOUNTS

In advance of the Committee’s hearing on 10 September, I would like to offer the Committee some background information to the Comptroller and Auditor General of the National Audit Office’s qualifications to the MOD’s Accounts for the financial year 2012/13.

The Committee will be familiar with the two longer-standing qualifications on inventory and the accounting treatment of contracts containing a lease. The Department continues to make progress on these issues, which is recognised by the NAO and I will be able to update you on this at hearing if required. The purpose of this letter is to provide an explanation of the three new qualifications, which we expect to be one-off occurrences.

The Department’s Accounts have been qualified on our accounting treatment of the valuation of the Germany Estate. This is the first time we have been qualified on this topic, which follows the announcement by the Defence Secretary in March 2013 that we would proceed with the withdrawal of British forces from Germany such that drawdown would be complete by 2019.

We record the Germany Estate as an asset and give it a representative current value on our Statement of Financial Position. That value gradually reduces (depreciates) over time, at a rate which previously reflected our expectation that the presence of UK forces in Germany would continue in the long term. However, since we have now put in place a firm outline plan to withdraw, with a clear date for the drawdown process to be completed, our accounts need to reflect the revised value this implies for the estate we hold in Germany.

We therefore reduced our assessment of the representative current value to MOD of the Germany Estate by around £1.5bn in 2012/13, so that the overall value reduces in line with our drawdown plans. We have not spent or lost this sum, which we have never held in cash—it simply represents the consequent change in the value of one of our assets. The Department’s spending power is entirely unaffected.

The reason that the NAO have qualified our Accounts on this is because of a difference of opinion over the technical accounting treatment of this revaluation. Our view was that it should be reflected by a reduction in the ‘revaluation reserve’ which was created when the value of the Germany estate was previously revised upwards. This is because theDepartment does not believe that these impairments are due to clear consumption of economic value nor loss of service potential. This is also consistent with the position that the Germany Estate was given a value as an “in-use” asset for book-keeping purposes, the Department was not free to dispose of it as it wished and the return of the estate to the Germans does not represent a financial loss that should be crystallised as an expense to the Department. Officials here consulted HM Treasury experts on the accounting treatment for this situation, and confirmed it at the very highest level of HM Treasury. The NAO disagreed with the HM Treasury view and the treatment on the basis that they felt there was a loss of service potential, the revaluation reserve should not be used and the reduction in value treated as a genuine financial loss. The second qualification reflects the NAO’s opinion that if the revaluation reserve had not been used the Department would have breached its AME limit.

I have discussed this situation at length with the Secretary of State and with the Comptroller & Auditor General and consider that following the advice of HM Treasury, who set the accounting rules and Managing Public Money, is a reasonable judgement for me to make as the Accounting Officer. I found myself in the situation that the NAO and HM Treasury do not agree on the accounting treatment with the result that we have two new qualifications which I considered I should alert you to before the hearing of the Committee.

Finally, as the Committee will be aware, Parliament annually sets limits on the number of personnel retained for service in the Armed Forces. These limits are sub-divided by regular and reserve and by a number of special categories. It has now become clear that the limit on Special Members of the Reserve Naval Forces was breached during 2012/13. On 1 April 2012 the Department employed 1,950 against a limit of 1,940. By 1 May 2012 that number had fallen back below 1,940, where it remained for the rest of the year.

As the NAO have acknowledged, the Department has made good progress this year on the resolution of the long-standing issues. The IFRIC 4 issue is inherently complicated and will take more time to resolve, including careful negotiations with our contractors and the NAO on the value of the assets under consideration, if indeed it can ever sensibly be resolved. We intend to resolve the inventory issue in time for next year’s ARAC.

I hope this letter is appropriate and helpful before my appearance at the Committee.

Jon Thompson
Permanent Under-Secretary Of State

August 2013