Defence Audit Committee (DAC)
Although the Defence Audit Committee did not present any formal reports to the Board in the reporting period, it issued its annual performance report in June 2012. As a member of the Defence Board, the Committee Chair has given regular oral updates to the Board, including the issues that caused the National Audit Office to qualify their opinion of the Accounts. The DAC has provided extensive advice to the previous Accounting Officer on this Governance Statement, particularly about the section on major risks and
weaknesses in control. The DAC also spent a considerable amount of time working with Defence Equipment and Support on the way forward in improving financial discipline.
The Committee reviewed a number of items in the course of the year in order to assure itself of the adequacy of the Department’s internal control arrangements. There had been a series of issues raised in the previous year’s Statement on Internal Control that the Committee had to consider, including:
● The effect of continuing Manpower reductions on: the Department’s ability to retain the right skills;
morale in the Civil Service and Armed Forces; and the safety risk of a shortage of suitably qualified and experienced personnel within specific safety environments;
● Progress in addressing Stock, Assets and Inventory Control issues;
● The unauthorised disclosure of information from within the Department which had reached new levels during the SDSR;
● The environment and safety risk posed by aging infrastructure in the fuels and explosives estates.
In addition, the Committee carried out its annual stewardship of the Process Owner assurance reports to assure itself of the adequacy of internal control arrangements and the conclusions it reached.
Investment Approvals Committee (IAC)
The chair of the IAC has provided regular oral updates to the Board on its work. There have been no individual investment decisions that have had to be escalated to the main Defence Board this year. The Defence
Board made strategic balance of investment decisions as part of the Planning Round 2012 process, which culminated in the Secretary of State announcing that the Defence Budget was in balance on 14 May 2012.
The IAC considered a wide range of projects, including the Queen Elizabeth Class aircraft carrier programme, the Type 26 (Global Combat Ship), the Chinook New Buy, the Complex Weapons Programme and Defence Core Network Services (DCNS). In total, the IAC considered 88 submissions on projects worth over £400M, including 20 Main or Initial Gate Business Cases. Of those Business Cases, 10 were approved, 6 were approved with caveats and 4 were rejected. Where the IAC does not give approval it directs the project to undertake specific actions before they seek approval again. Examples of projects where the IAC directed further work before endorsement was given are the Type 26 Global Combat Ship, Military Flying Training Service, Project Vanguard (a training estate contract), and Logistics Commodity Services (Transformation).
People Committee
During 2011-12, the ground work was laid for the new People Committee, as recommended by Lord Levene’s report of June 2011. At the same time, work has also been done to put in place the new Joint Assured Model for military appointments and work on civilian workforce planning; both of which will feature heavily on the agenda of the People Committee in the coming year.
6. Compliance with Corporate Governance Code
I reviewed the Department’s compliance with the Corporate Code issued by the Cabinet Office in July 2011.
The Department complies with all of the requirements except:
● Section 2.8 of the Code requires us to collectively affirm and document the Board’s understanding of the Department’s purpose and document the Board’s role and responsibilities in a Board operating framework. The Defence Board’s operating framework is still in draft, and will be published later this year.
Until this is done, the requirements in section 2.8 are not met in full;
● The Department only has three non-executive Board members, in contravention of section 3.3 of the Code, which requires four. We will not be appointing a fourth;
● Section 5.9 of the Code requires at least one non-executive Defence Board member to sit on the Defence Audit Committee apart from the Chair. The Department does not currently meet this requirement.
7. The risk and control framework
The Department’s system of internal control is designed to manage risk to a reasonable level. Internal control is based on processes designed to identify and prioritise the risks to the achievement of Departmental aims, to evaluate the likelihood of those risks being realised and the impact this would have, and to manage them efficiently, effectively and economically. The system of internal control has been in place in the MOD for the year ended 31 March 2012 and up to the date of approval of the Annual Report and Accounts, and accords with HM Treasury guidance.
Active management of risk is fundamental to the effective achievement of Defence objectives, and is central to the way business is conducted within the Department. It informs operational decision making, contingency planning, investment decisions and the financial planning process. Guidance on the Department’s approach to risk is detailed in a Joint Service Publication. This guidance is cascaded down through Top Level Budget Holders and is available to all staff on the MOD’s intranet. Individual training is available to all staff via the Department’s in-house training provider.
The Defence Board has identified 8 Risks to Strategic Aims and 6 Major Failure Risks. These are monitored and reviewed by the Board during the quarterly and annual performance and risk reviews. These strategic risks are not published for reasons of national security.
The Department’s tolerance of risk varies between the different areas of Defence business. Military operations are inherently risky. The level of risk that Ministers agree to accept is based on advice from senior military and civilian officials. Every effort is made to provide personnel and assets with proper protection through planning, equipment and training, but we ultimately rely on the judgment of Force Commanders to manage the risks on a day to day basis. On the non-operational side, the Defence Board receives regular Security, Business Continuity and Health & Safety reports. This year has seen a fall in the number of non-operational fatalities from sixteen to eleven. There is no common factor that explains the fall. Because the absolute number of fatalities is small, the fall may not be statistically significant.
Defence Internal Audit, supported by Price Waterhouse Coopers, conducted a review of risk management that concluded in April 2011. The main workstreams included: establishing a Risk Group, chaired by me in my role as DG Finance to identify the Department’s key risks and drive a risk focussed culture into the business; a review of the Defence Board’s set of Strategic Risks, to drive top down risk management, and; defining the department’s tolerance of risk. These workstreams continue to be implemented. KPMG also produced a major piece of work for the Department on improving the way that the risk of fraud is managed. As a result of this work, I approved the creation of a Counter Fraud and Loss Team (CFLT). This will be led by a senior civil servant who will support and take direction from an Anti Fraud Group, which will meet quarterly. The CLFT will own and maintain a comprehensive analysis of Defence’s fraud vulnerability and use this to prioritise and deliver an integrated service of crime and fraud reporting, intelligence, analysis, prevention, education, enforcement and asset recovery through a multi-disciplinary and mixed police/civilian team.
The Defence Audit Committee, chaired by an external independent member of the Defence Board, reviews the Department’s approach to internal control and provides independent advice both to the Defence Board and the Accounting Officer. The Committee adopts a strategic approach, challenging the overall risk identification and assessment processes and pulling together all the strands of independent assurance. It co-ordinates the activities of internal audit, and draws on annual reports from the eleven pan-Departmental Process Owners and specialist assurance sources, such as Defence Internal Audit. Most Top Level Budget Holders are supported by an Audit Committee, which is chaired by a non-executive member and at which representatives from the internal and external auditors are present. Like the Defence Audit Committee, these committees focus their activities to provide advice on wider-business risk and assurance processes. The Defence Audit Committee has a meeting with the Chairs of the TLB audit committees once a year to seek their perspective on potential issues to be raised in this Governance statement.
The Department has a major programme in place to transform the way finance is managed. As part of this work, the Defence Audit Committee reviewed how assurance should be provided and the executive is undertaking further work, which the Defence Audit Committee are currently considering.
An annual risk-based programme of internal audit is provided by Defence Internal Audit, who are the primary source of independent assurance. The overall opinion provided by the Group Head of Internal Audit is that of Limited Assurance, based upon the audit and consultancy tasks undertaken throughout 2011-12. In particular DIA found:
● Further work was required to develop and fully embed risk management;
● Fraud risk management arrangements required improvement in the areas of risk assessment, prevention and detection, which stimulated the KPMG review;
● Governance and accountability arrangements needed strengthening together with the quality and use of management information;
● Further work was required to address fundamental Inventory control system weaknesses;
● Evidence indicated a need to improve the Department’s contract monitoring processes across a range of activities, in particular the management of the Framework Agreement for technical Support was found to have significant weaknesses.
The Department’s external audit function is provided on behalf of Parliament by the Comptroller and Auditor General, supported by staff from the National Audit Office (NAO). As part of the assurance process, the NAO see all Defence Audit Committee and TLB Audit Committee papers and attend their meetings.
8. Significant Risks
As set out above, we do not publish all of our major risks for security reasons. I identified the following risks that affect the control framework:
Accounting for Accruals
Following the application of Clear Line of Sight the budgeting regime has come within the scope of the external Audit for the first time. The NAOs 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 is 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.
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 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 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.
Unauthorised Disclosures
My predecessor reported last year that leaks from within the Department remained damaging and resource intensive to manage. Leaks have remained a problem this year, particularly those surrounding the Joint Strike Fighter variant. Leaking damages trust between Ministers, civil servants and the Military, undermines the Chain of Command and can have a material effect on the quality and timeliness of decision making. They have also made internal communications more difficult, which raises the risk to morale. We continue to take vigorous steps to ensure that the rules are rigorously enforced and there is work being taken forward as part of Transforming Defence to tackle the behaviours that cause leaking.
Fuel Estate
My predecessor also reported last year concerns about the fuels estate. Resource constraints have led to a lack of investment in fuels infrastructure, posing a risk to both the environment and safety. The single greatest challenge remains the age of the infrastructure, which continues to operate through a mix of stop-gap maintenance, careful risk management and reactive funding. This risk has been mitigated to an extent by an improved reporting and assurance regime, and I expect this to improve with the unification of key responsibilities within the Defence Infrastructure Organisation. Meanwhile, the overall level of non-compliance with Regulations at some level at 151 out of 238 sites remains a concern.
Staff Reductions
The Department has made significant progress in making the reductions in both civilian and military staffing levels set out in the SDSR. The effect that this has had on morale remains a concern. A further concern is that many areas report shortages of Suitably Qualified and Experienced Personnel for example, finance and commercial staff, despite systems in place designed to ensure that these people cannot apply for paid exits, and that recruitment is permitted for business critical skills. The shortage of finance skills has contributed to the accounting for accruals issue referred to above. On the civilian side, work is in hand to ensure that all Top Level Budget holders have comprehensive Workforce Management Plans, which should mitigate this risk to a degree. The Armed Forces already have a clearer view of where their shortages lie, and have targeted measures in place.
Inventory and Stock Control
The National Audit Office has acknowledged the Department continues to make progress in accurately accounting for inventory, which my predecessor raised in last year’s Statement on Internal Control. We have now completed the reconciliation between the inventory and accounting systems for inventory and capital spares balances, and the Accounts are no longer qualified on these grounds. The NAO has also confirmed that adequate processes and systems are in place to account for Bowman radios.
Nevertheless, the NAO opinion is that the Department needs to do more to ensure that the value of the inventory and capital spares balances better reflects their material condition. This is particularly the case where there is a lack of evidence to show that holdings have been reviewed by management in light of reducing fleet sizes. Work is underway to dispose of surplus items, but until this is complete we are holding items that are no longer required and which may consequently be of less value to the MOD than is stated in the Accounts.
Summary
We continue to work hard to improve the mechanisms the Department has for controlling its resources and managing risk. Except in those areas outlined above I am, however, satisfied that our current control mechanisms are fit for purpose. I am also satisfied that adequate progress is being made on outstanding issues.
Jon Thompson 30 November 2012
Accounting Officer