House of Commons - Ministry of Defence Annual Report and Accounts 2013-14

Ministry of Defence Annual Report and Accounts 2013-14 - Defence Contents

1 MoD Resource Accounts 2013-14

1. Government Departments are expected, under Treasury guidance, to publish annual reports and audited accounts at the end of each financial year and before the Parliamentary summer recess.[1] In addition to the accounts, the Annual Report contains data on the department's performance against the input and impact indicators in its business plan and a description of its activities. The MoD laid its Annual Report and Accounts for 2013-14 before Parliament on Thursday 27 November 2014.[2]

2. We took oral evidence from Jon Thompson, Permanent Under-Secretary at the MoD, and Mr David Williams, Director General Finance, on the MoD's Report and Accounts for 2013-14 on 7 January. The MoD also provided us with supplementary written evidence in response to further questions that we subsequently sent to them in writing.

3. The MoD delayed publication of the 2013-14 accounts to avoid qualification of the accounts on the grounds of an incorrect balance being reported for assets under construction within the Defence Infrastructure Organisation (DIO).[3] In his Governance Statement in the Report and Accounts, Jon Thompson reported that the National Audit Office (NAO) had identified concerns around the "substantiation" of the £2.7 billion balance previously disclosed by DIO as Assets Under Construction (AuC). DIO had worked to resolve these concerns but this work had not been completed in time for the original publication date for the Report and Accounts. He reported that

4. In our Report on the Armed Forces Covenant: Accommodation we expressed concern about the management of the DIO, given the major transformation that it was undergoing, including the reduction of staff from 7,000 to 2,000, and the significant programmes it was undertaking, including the return of the Army from Germany, rebasing and the renegotiation of major contracts. The Government reassured us in its response to that Report that the Transformation Programme was subject to internal review and would be held properly to account within MoD.[5]

5. In his Governance Statement on the Annual Report and Accounts, Jon Thompson noted the MoD's Internal Audit conclusion that it could only give limited assurance on the management of strategic and operational risks, and that, given the transformation that DIO was undergoing, "the reduction of resources has led to a weakening of the control environment."[6] However, he added that steps were being taken "to improve the quality of the control environment." [7] We questioned Jon Thompson about the problems in the DIO. He told us that a NAO report on the DIO had raised significant concerns about the management of the estate, including the operation of 76 different information systems to record land and property. These systems had now been consolidated into one system which went live in December 2014.[8]

6. We sought reassurance that the delays in publication of the accounts would not be repeated and asked about future financial and accounting challenges for the MoD. Jon Thompson told us that the new challenges would arise from the next Strategic Defence and Security Review in respect of its impact on the annual finances of the MoD and the management of balances in terms of writing off assets or shortening the lives of equipment.[9]

7. The MoD also provided us with further details on future accounting challenges, including the sales of the Defence Support Group (DSG), the Government Pipeline Storage System and Marchwood military port, future estate rationalisation and the hand-back of the German estate.[10] The MoD also told us that the move to the new Defence Operating Model, with greater authority, responsibility and accountability for budget holders, had inevitably increased complexity and the consequential risk of inconsistent identification and treatment in the financial accounts.[11]

8. It is disappointing that, once again, the MoD was some five months late in laying its Annual Report and Accounts before Parliament. While it may have been appropriate to delay the laying of the Accounts to ensure the balance sheet figure for assets under construction was accurate, it was concerning that this problem was identified by the National Audit Office rather than by the MoD itself. We were also concerned that the resolution of the problem required a write-off of £267 million, some ten per cent of the total valuation of assets under construction. However, we are satisfied that steps are being taken to reduce the risk of such problems arising again.

9. In response to this Report, the MoD should tell us what planning it is doing to ensure that it appropriately manages the impact of the likely changes to asset balances, such as write-offs of assets or shortening the effective operational lives of equipment, that will arise from the forthcoming Strategic Defence and Security Review. It should also tell how it intends to manage the impact of the continuing management reform of Service Commands.

Qualification of the Accounts 2013-14

10. The Comptroller and Auditor General (C&AG) qualified his audit opinion on the Department's 2013-14 Resource Accounts for the eighth successive year. The principal reason for qualification is the accounting treatment of single source contracts that may contain leases (under International Accounting Standard 17), but a qualification was also recorded in respect of the impairment (write-off) of the valuation of the estate in Germany and inventory and non-current items.[12]

ACCOUNTING FOR CONTRACTS THAT MAY CONTAIN LEASES

11. The C&AG again qualified the MoD Accounts on the grounds that the MoD is likely to have omitted a material value of leased assets and associated liabilities from its Statement of Financial Position.[13] The C&AG explained that the accounting requirements for lease type arrangements were particularly relevant to the MoD as, by necessity, it enters into a number of strategic arrangements with particular contractors to procure specialist defence platforms on a non-competitive basis. These arrangements could entail exclusive, or near exclusive, use of industrial assets making it reasonable to allow recovery of fixed costs other than through market rate or unit cost pricing.[14] The C&AG could not quantify the impact on the financial statements because, as a result of its accounting policies, the MoD had not maintained appropriate records or obtained the information to do so.[15]

12. In 2013-14, the MoD agreed with HM Treasury not to gather the further management information required to understand the impact on these contracts as it would not represent value for money. [16] In written evidence, the MoD told us that it planned to undertake further work with the support of a commercial accounting firm to "assess the implications of determining whether an arrangement contains a lease (IFRIC 4) and the subsequent accounting under IAS 17".[17]

13. The MoD Annual Report and Accounts 2013-14 have again been qualified on the balances for contracts likely to contain a lease. The MoD should report to us on the results of its latest review of contracts.

INVENTORY

14. For the 2013-14 Accounts, the C&AG was satisfied that the MoD had provided sufficient evidence that the closing balances of non-current assets, capital spares and inventory items were correct but there was not sufficient evidence on the opening balances or to which periods the impairment of £860 million belongs.[18] The C&AG said that challenges remained in respect of systems, inventory checking procedures, inventories held off system, changes to the business and embedding good practice. In particular, he drew attention to the fact that investment in the new Base Inventory Warehouse Management System (BIWMS) had been suspended while the MoD re-assessed its user requirement. He also said that "the full implementation of BIWMS was to be a significant step in enhancing the Department's ability to efficiently manage and control its inventory".[19] David Williams told us that the suspension of the BIWMS had been reversed by the investment committee in early January.[20]

15. In response to our written questions, the MoD told us that a detailed review of inventory items had resulted in the £860 million impairment for events which had not been properly accounted for in previous years and should be seen as a one-off correction. Many of these events had resulted from the outcome of the last Strategic Defence and Security Review.[21] The MoD also told us:

16. We are pleased to see that the MoD is finally managing to get to grips with the management and control of its inventory and capital spares and welcome the PUS's assertion that the MoD Accounts will no longer be qualified on this basis. We also welcome the commitment by the PUS to a detailed item by item impairment review following the outcome of the next Strategic Defence and Security Review. The Comptroller and Auditor General (C&AG) does, however, point to ongoing challenges in respect of systems and embedding good practice. The MoD should tell us how it will address these challenges.

Costing information for the next Strategic Defence and Security Review

17. Given its problems with financial and management information, we asked how well the MoD would be able to cost defence outputs for the next Strategic Defence and Security Review. David Williams explained that the strategic cost model was a high level cost model which would answer two questions:

18. The strategic cost model is a crucial tool for preparation of the next Strategic Defence and Security Review. Decisions about which capabilities the UK can afford have to be taken on the basis of the most robust information and a clear understanding of the cost drivers behind capabilities. The MoD should provide us with a description of the strategic cost model, its accuracy and any limitations that it has identified in its utility.

1 HM Treasury DAO(GEN) 03/13 Back

2 Ministry of Defence Annual Report and Accounts 2013-14 HC 764 Back

3 Q 1 Back

4 Ministry of Defence Annual Report and Accounts 2013-14 HC 764 Certificate of the C&AG page 97 Back

5 The Armed Forces Covenant in Action? Part 2: Accommodation Government Response Third Special Report 2012-13 HC 578 Back

6 Ibid page 96 Back

7 Ministry of Defence Annual Report and Accounts 2013-14 HC 764 Certificate of the C&AG page 97 Back

8 Q 3 Back

9 Q 11 Back

10 Ministry of Defence Memorandum: Response to follow-up questions Back

11 Ministry of Defence Memorandum: Response to follow-up questions Back

12 Ministry of Defence Annual Report and Accounts 2013-14 HC 764 Certificate of the C&AG page 97 Back