Ministry of Defence Annual Report and Accounts 2010-11 - Defence Committee Contents


2  MoD Resource Accounts 2010-11

Qualification of the 2010-11 Accounts

4. The Comptroller and Auditor General (C&AG) qualified his audit opinion (for the fifth successive year) on the Department's 2010-11 Resource Accounts due to material error arising from adopting accounting policies which did not fully comply with the required auditing standard. 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.

5. The C&AG also limited the scope[3] of his audit opinion due to weaknesses in accounting for non-current and inventory assets. The MoD was unable to provide sufficient appropriate audit evidence, that is, adequate documentation to support the accounting treatment for:

  • Bowman radios (£0.1 billion);
  • certain inventory and capital spares (£5.2 billion);
  • the valuation of a further unquantifiable amount of inventory and capital spares.[4]

ACCOUNTING FOR CONTRACTS THAT MAY CONTAIN LEASES

6. The C&AG qualified the MoD Resource Accounts in 2009-10 and 2010-11 because of non-compliance with international reporting requirements which are now required practice for Government Accounts. The C&AG reported that :

The MoD did not comply with the International Financial Reporting Issues Committee Interpretation 4 (IFRIC 4) determining whether an arrangement contains a lease and International Accounting Standard (IAS) 17 on leases. This led to the omission of a material value of assets and liabilities from its Statement of financial position.[5]

7. The extent of this 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:

While these considerations have not had a material impact in many other areas of the public sector they are of particular relevance to the Ministry of Defence. It necessarily enters into strategic arrangements with key 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 exclusive, or near exclusive use of industrial assets and capability which have only limited utility to other customers.[6]

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.[7]

8. In response to the C&AG's criticisms in 2009-10, the MoD agreed to apply the new requirements to all contracts entered into from 2010-11.[8] Following the announcements in the Strategic Defence and Security Review (SDSR) and the potential impact on existing contracts and the supplier base, the MoD has now put on hold further work to achieve compliance until contract re-negotiations have been completed.[9] In effect, the MoD reneged on its earlier agreement with the NAO. The C&AG recommended further action:

I continue to recommend that the Department carries out further work to identify contracts where the risk of inappropriate accounting treatment is highest and targets further efforts on higher value, higher risk contracts. This work should be undertaken as contract renegotiations complete.[10]

9. In our report on the Annual Report and Accounts 2009-10, we recommended that the MoD carry out further work to identify those contracts where the risk of inappropriate treatment is highest. In response to our report, the MoD stated that it would not commence the necessary work to identify such leases until at the earliest 2012-13 and could not estimate a completion date.[11] On 12 October 2011, we wrote to the Chancellor of the Exchequer inquiring as to what his policy was in respect of Government Departments breaching the requirements of the Treasury Financial Reporting Manual in this regard. We have yet to have a reply to that letter.

10. In its response to our written questions prior to the evidence session with the PUS, the MoD told us that it was unlikely that the qualification would be removed before 2014-15 at the earliest.[12]

11. We asked Ms Brennan, the Permanent Under Secretary, if it was satisfactory that the MoD accounts would be qualified indefinitely. She replied:

[...] The Government decided that they would sign up to those international financial accounting standards. I think there is a real difficulty in that no one else has to face the scale or the complexity of trying to deal with IFRIC 4 in relation to the kinds of contracts that we have. [...] this standard just does not fit very easily or sensibly with the kind of business that we do. We decided to take what we thought was a pragmatic approach and say, "We will focus on the big areas, and when we are renegotiating contracts we will do this," but it is going to cost us quite a lot of money to comply with this standard. To be brutally frank, we don't actually think it brings us value in terms of the information that we will get as a result of us—and our suppliers—having to spend money.[13]

12. We also asked if there were other aspects of accounting standards which did not provide the MoD with cost-effective management information. Mr Thompson, MoD Director General of Finance, told us:

This is the only case where we think there is a major difference of opinion between ourselves and the Treasury about the application of this standard, and whether or not an arrangement between the Department and its various contractors contains a lease or not. That is simply because of the practicalities of implementing the standard. I think I was clear with the Committee last year that the impact of implementing this standard is really significant [...].

13. While we recognise that compliance with the International Financial Reporting Issues Committee Interpretation 4 (IFRIC 4) and International Accounting Standard 17 on leases will be 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. In October 2011, we wrote to the Chancellor of the Exchequer to ask for his policy on Government Departments who fail to meet Treasury financial reporting requirements; we have still not received a reply despite reminders. We deplore this. The Treasury should either explain why it is not enforcing the standards which it has imposed and to which the MoD has, in common with all other departments, agreed or explain what it is going to do to change these standards for the MoD.

14. The MoD should comply with the C&AG's recommendation that the MoD should identify contracts where the risk of inappropriate accounting treatment is highest and should target further efforts on higher value, higher risk contracts as soon as contract renegotiations resulting from the Strategic Defence and Security Review are completed. It should ensure that it applies IFRIC 4 to all new contracts immediately. In response to this Report, the MoD should provide a timetable for completion of this work and a reliable estimate for when it expects the C&AG to give the MoD a clear audit opinion.

BOWMAN RADIOS

15. Bowman is a tactical communications system providing secure radio, intercom and internet services in a modular and fully integrated system with an overall net book value of £1.52 billion. In his report on the limitation on the scope of his opinion, the C&AG recognised the challenges faced by the MoD in locating Bowman communication equipment given the number of different tracking systems used at different locations and the difficulty of tracking data relying on manual input and processes.[14]

16. At 31 March 2011, the MoD had 50,893 radio sets recorded on the system but the NAO could only find evidence for the whereabouts of 37,645. The MoD provided information from other sources on a further 9,155 radios leaving 4,093 radios valued at some £125 million with inadequate evidence.[15] This amount compares with Bowman radios valued at £184 million in 2009-10 and Bowman radios valued at £155 million in 2008-09 with no suitable evidence.[16]

17. We raised concerns about the MoD's inability to track Bowman radios adequately in both 2010[17] and 2011[18] and, in 2011, we recommended:

We share the concern of our predecessors that it is unacceptable, despite the difficulty of tracking assets in theatre, that the MoD cannot, at a given time, account for the whereabouts of radios worth £184 million. There are security as well as financial, implications associated with losing equipment such as radios; having an effective audit trail is the only way to ensure that all radios are accounted for.[19]

18. In the Government response to our report on the MoD Annual Report and Accounts 2009-10, the MoD stated that it was continuing to improve the audit trail using current systems to track Bowman radios and a further improvement was due in 2012 which would result in serial numbers for all radios being recorded.[20] In our predecessor Committee's Report on the Annual Report and Accounts 2008-09, we expressed concern about the security implications of losing Bowman radios. In the Government response to this Report, the MoD stated that it had satisfied itself that "the current security risk is as low as reasonably practical".[21]

19. We asked the MoD when it would be able to provide the NAO with suitable audit evidence on the existence of all Bowman radios, Ms Brennan and Mr Thompson told us:

Ms Brennan [...] Bowman is a particularly difficult issue, because you think of it as a radio as if it was a single piece. It gets used in different ways. It gets dismantled and taken into parts and stuck in a vehicle, where part of it is in the vehicle and another part of it is not used, so actually our ability to track it in that respect has proved troublesome. We are continuing on a programme of narrowing down the number of Bowman radios that we cannot identify.

Mr Thompson [...] We are down from 5,961 a year before [to 4,093]. The plan to capture the individual serial numbers, which is the gap in the data, is due to finish in December 2011. At that point, we think we should have all the serial numbers. We then have to match that up with the number that we should have in order to draw a conclusion for the 2011-12 Accounts.[22]

20. Mr Thompson further told us that he could not say if the limitation on scope of the C&AG's opinion because of Bowman radios would be removed next year as there might still be gaps in the evidence which would lead to the need to write down some assets.[23] The C&AG recommended that the MoD should ensure that sufficient focused effort was given to addressing the underlying problem, in particular the MoD should:

  • improve the robustness of the quarterly Bowman reconciliations, focusing on the quality of the data input to inventory management systems by users; and
  • ensure that any future IT solutions are matched with appropriate processes to accurately record all radios by serial number.[24]

21. We remain concerned that, despite improvements in the audit trail for Bowman radios, the MoD cannot guarantee that it will be able to provide the NAO with adequate audit evidence about the radios for the 2011-12 Resource Accounts. This situation is unsatisfactory and is evidence of weaknesses in the MoD's financial management. We intend to pursue the issue of appropriate bar coding or other asset tracking technology in a future inquiry into defence procurement. The MoD should ensure that it complies with the C&AG's recommendations on improving the robustness of quarterly reconciliations and the quality of data input and on ensuring the accurate recording of all radios by serial number in future IT systems.

ASSETS AND STOCK BALANCES

22. For the 2010-11 Accounts, the MoD was unable to provide the NAO with sufficient appropriate audit evidence and adequate documentation to support the accounting treatment for certain inventory and capital spares valued at some £5.2 billion (£5.5 billion in 2009-10 and £6.6 billion in 2008-09). The C&AG reported that while some progress had been made, significant issues would remain until the introduction of new major new systems—the Management of the Joint Deployed Inventory (MJDI) and the Joint Asset Management Engineering Solution (JAMES)—is fully implemented. He noted that the main areas of weakness were:

  • discrepancies between inventory counts and warehouse management records;
  • inadequate impairment of inventory and capital spares; and
  • unreconciled differences between the warehouse system records and the accounting system.[25]

23. The C&AG also reported that he considered the processes by which the MoD assesses the impairment of inventory and capital spares not to be systematically or routinely undertaken. Following earlier NAO recommendations, the MoD conducted a sample review of slow moving inventory, that is stocks which are not called upon often, representing some 25 per cent of non-explosive inventory. The review found obsolete items resulting in a net write-off of £325 million.[26]

24. We asked the MoD if it was on track to introduce the major new stock systems, MJDI and JAMES, and what might the likely size of write-downs in the accounts be. Mr Thompson told us:

We are definitely on track for March 2014. The project in the MoD is regarded as a tier 2 change programme. That means that it has a regular quarterly review by the Vice-Chief of the Defence Staff, the second Permanent Secretary and I, as well as regular reviews of all of all those projects on a regular cycle. It has the potential that if you do a review of slow-moving inventory and so on, it may identify some of the things to be written off either for obsolescence or loss reasons.

One of the gaps in the Accounts is in relation to [...] stock. It is not transparent about the amount of provision that already exists. [...] we have a current provision for potential write-off in the future of £2.2 billion, which has been built up over a significant amount of time. The number in the Accounts is—net—around £7.7 billion. The gross stock is £9.9 billion. Until we work through this over the next three years, it is difficult to answer your question about whether £2.2 billion is a sufficient provision or not. On the basis of the information we have, we believe that it is, but only time will tell.[27]

25. Being able to identify and record the condition of inventory is critical for operational reasons to enable the repair, replenishment and disposal of items. It is also essential to provide reliable information to Parliament and the public in the form of the annual accounts. Problems with stock control are likely to continue until the introduction of new stock systems in March 2014 leaving the MoD with inadequate information for a further three years. We look forward to hearing further evidence of tangible progress in identifying and recording missing inventory between now and March 2014. As a minimum, the MoD should make strenuous efforts to ensure that the agreed timetable is met and does not slip further.

Underspend in 2010-11 Accounts

26. The MoD underspent its budget for 2010-11 by some £7,971 million against its gross resource estimate of £58,320 million—the Spring Supplementary Estimate having increased the resource estimate by £18,000 million. The MoD told us that the reason for the underspend was as follows:

The Department was required to produce accounting estimates of SDSR-related costs in February 2011. At that time the detailed work required to produce these estimates to an auditable standard had not been completed. The Department deliberately decided to bid for the maximum likely costs required, because failure to request sufficient resources in the Supply Estimate process to cover SDSR costs would have risked an excess vote. As a result, not all of the costs originally requested in 2010-11 were incurred by year end.

A further £1BN of underspend was a result of accounting changes, including predicted movements in indexation and foreign currency derivatives that did not materialise and an overestimation of the likely impact of the change in accounting policy for leased land.[28]

27. The bulk of the underspend was caused by the MoD's over-estimate of the costs of SDSR decisions for 2010-11(£6,456 million) and the non-use of some accounting provisions for write offs (£1,083 million). The MoD explained the underspend in more detail as follows:

  • £7,539M for RfR1[request for resources] in respect of the main costs of the MoD and the Armed Forces, the vast majority of which was non-cash. £6,456M related to SDSR
  • £394M in respect of the additional costs of military operations (RfR2), an area of the Department's activity that can vary significantly depending on conditions on the ground.
  • A further £38M against RfR3 war pensions which is consistent with the reducing number of pensioners.[29]

28. The MoD told us that the SDSR changes (£6,456 million) were broken down as follows:

  • £3,200M was included in the Estimate for inventory writes-off following withdrawal of equipment. Detailed work is ongoing to identify the total inventory write off. Only £800M in respect of Nimrod, Harrier and Tornado, was included in the 2010-11 accounts;
  • £400M was an underspend relating to the write-off of vehicles. Funding was included for the write off of tanks and artillery (AS90) but the identification of specific vehicles has not progressed sufficiently for inclusion of actual costs in the 2010-11 accounts.
  • £1,200M included in the Estimate for additional writes-off of assets and assets under construction. The Estimate assumed sufficient progress would have been made to enable accounting action to be taken in the 2010-11 accounts. This was not the case;
  • a £265M surplus after the write off of ships (four Type 22 frigates, HMS Ark Royal, RFAs Fort George and Largs Bay) and aircraft (Harrier and Nimrod MRA4) being the difference between the estimate and the actual costs incurred in 2010-11;
  • a further surplus of £1,391M arose against the Estimate for write off of other assets and provision for the future costs of staff reductions (£857M) which was a provision to cover the cost of redundancies over the comprehensive spending review period—the NAO would not allow this provision as the number was not sufficiently certain.[30]

29. The MoD told us that it had incorrectly predicted movements in indexation factors and foreign currency derivatives and that it had overestimated the likely impact of the change in accounting policy for leased land as follows:

  • a surplus of £840M relating to movements in indexation factors and movements in foreign exchange derivatives both of which did not materialise;
  • a £243M underspend related to the £1,923M estimate for the effect of a change in accounting policy for leased land.[31]

30. We asked the MoD how it got its estimate of expenditure so wrong. Mr Thompson told us that it was mainly a problem of timing as to when the provisions would fall and he could not be certain that they had got it right for next year.[32] We are concerned that, in having such a large underspend in 2010-11, MoD has demonstrated that it is poor at accounting for and estimating the size and timing of write-offs.

Thefts and frauds

31. We were surprised to find that a number of high value and, in some cases bulky, items had been stolen from the MoD: for example, night vision goggles worth £45,000; helicopter rotary blades worth some £50,000 in one month; and an inflatable boat, an outboard motor and a trailer in another.[33]

32. When asked about how the MoD was tackling thefts, Ms Brennan told us:

Our strategy in relation to theft covers a variety of things. One is that, yes, we do have guards and a different variety of guarding arrangements. Another goes back to the inventory system, in terms of being able to track where things are. We pay particular attention to controls over ammunition and dangerous stores, if you like, so that we try to minimise the risk of that.

In the kind of environment we work in, we are perpetually balancing the need to have controls over the movement of equipment and the need for military equipment to be moved rapidly to where it is needed, and the level of theft. What I do not know [...] is the extent to which we think our level of theft is moving in the wrong direction. [...]

One thing about the MoD is, because it is so big, the crude numbers are always bigger, in that we have more things that are of interest for people to steal.[34]

33. We were also concerned as to whether the MoD had control of its stores and pursued theft vigorously enough. Ms Brennan told us:

[...] We have both the Military Police and the MoD Police and they do pursue theft and fraud within defence, and there is a fraud cell that looks at pursuing fraudulent activity. However, I could not say whether that volume of theft is disproportionate compared with where it has been before.[35]

34. As part of the follow up to the evidence session with the Permanent Under Secretary, we asked for details of the reported thefts and fraud over the last five years and what the MoD was doing in respect of theft and fraud. The MoD provided us with the following summary of thefts and fraud reported to the Defence Irregularity Reporting Cell as shown in table 1.Table 1: Summary of thefts and frauds in the MoD 2006-07 to 2010-11[36]

YearNumber of

reported thefts

Value of reported thefts (£)1 Number of reported frauds2
2006-07
167
376,000
254
2007-08
338
1,149,000
326
2008-09
398
1,609,000
657
2009-10
491
1,068,000
463
2010-11
433
1,911,000
592

Data source: MoD

Notes:   1. The monetary values of thefts are the estimate given when initially reported.

2. The MoD could not provide estimates of the value of the reported frauds.

3. The increase in thefts from 2006-07 to 2007-08 is due to the introduction of the Defence Irregularity Reporting Cell and the associated improvement in general awareness of the Department's reporting requirements.

35. The MoD also told us that it took fraud and theft very seriously and was taking actions as follows:

We have set up the Defence Crime Board, chaired by DG Finance, to bring together senior staff from the MDP [Ministry of Defence Police], the Service police authorities, internal audit, and main business units to provide strategic direction and policy to drive initiatives aimed at combating and reducing crime.

The Permanent Secretary and the Chief of the Defence Staff have written to the heads of our main business units with our updated fraud policy and fraud response plan. They have made it clear to these senior staff that they expect them to ensure their organisation adheres to the Department's zero tolerance approach to fraud.

Fraud awareness presentations are delivered to engage staff in taking action where they suspect fraud or theft. Regular bulletins are also produced to raise awareness. The MDP provides a health check service to units whereby they analyse the implementation of policy and process to identify areas where there is a potential risk of fraud or corruption.

MOD is undertaking a project to assess our approach to the risk of fraud, which includes reviewing our current fraud risk management arrangements.[37]

The MoD's actions taken in response to theft and fraud are set out in tables 2 and 3 below. Table 2: Actions on thefts[38]

Year Prosecutions CautionsDismissals Resignations Other action
2007-08
0
3
3
0
1
2008-09
13
5
4
6
3
2009-10
11
7
4
0
14
2010-11
11
7
5
0
21

Data source: MoD


Table 3: Actions on frauds[39]

Year Prosecutions CautionsDismissals Resignations Other action
2007-08
1
2
6
8
16
2008-09
6
4
14
13
55
2009-10
10
8
26
25
171
2010-11
43
8
42
26
219

Data source: MoD

Notes:   1."Other action" includes minor disciplinary action, administrative action, recoveries, and management interventions.

2. The figures for the two tables above include cases where a subject may have received more than one penalty, that is prosecution and dismissal.

36. The MoD also gave us details of the value of stolen assets recovered and monies recovered from detected fraud as set out in table 4 below. Table 4: Value of assets and money recovered from thefts and frauds[40]

YearValue recovered

Theft (£)

Value recovered

Fraud (£)

2007-08
11,000
61,000
2008-09
36,000
87,000
2009-10
38,000
906,000
2010-11
19,000
1,093,000

Data source: MoD

37. We are concerned that the level of theft and fraud in the MoD appear generally to be increasing year on year, and that the level of value recovered from theft and fraud is low. We recommend that the MoD clarify the roles of the various police and security forces dealing with fraud and theft and provide further information on how the problems of prevention, detection and recovery are being managed within the MoD. We note that the MoD is reviewing its fraud risk management arrangements, and expect to be informed of the outcome of this review. We also ask for evidence to show the impact of the Defence Crime Board and the Defence Irregularity Reporting Cell. We expect the MoD to tackle this issue with a greater degree of vigour.



3   A limitation on the scope of the audit opinion is given where the auditor has not been able to obtain sufficient and appropriate evidence to support material balances in the accounts. It relates only to the area described, not the entire account.  Back

4   Ministry of Defence, Annual Report and Accounts 2010-11, HC 992, C&AG's opinion pp 94-95 Back

5   Ibid. Back

6   Ministry of Defence, Annual Report and Accounts 2010-11, HC 992, p 97  Back

7   Ibid. Back

8   Ibid. Back

9   Ibid. Back

10   Ibid, p 98 Back

11   Defence Committee, The Performance of the Ministry of Defence 2009-10: Government Response to the Committee's Third Report of Session 2010-12, Sixth Special Report of Session 2010-12, HC 1495, para 2 Back

12   Ev 20 Back

13   Q 3 Back

14   Ministry of Defence, Annual Report and Accounts 2010-11, HC 992, p 98 Back

15   Ibid. Back

16   Defence Committee, Third Report of Session 2010-12, The Performance of the Ministry of Defence 2009-10, HC 760, para 23 and Defence Committee, Fifth Report of Session 2009-10, Ministry of Defence Annual Report and Accounts 2008-09, HC 52, para 22 Back

17   Defence Committee, Fifth Report of Session 2009-10, Ministry of Defence Annual Report and Accounts 2008-09, HC 52, para 22 Back

18   Defence Committee, Third Report of Session 2010-12, The Performance of the Ministry of Defence 2009-10, HC 760, para 25 Back

19   Ibid, para 24  Back

20   Defence Committee, The Performance of the Ministry of Defence 2009-10: Government Response to the Committee's Third Report of Session 2010-12, Sixth Special Report of Session 2010-12, HC 1495, p 3 Back

21   Defence Committee, Ministry of Defence Annual Report and Accounts 2008-09: Government Response to the Committee's Fifth Report of Session 2010-12, Third Special Report of Session 2010-12, HC 353 Back

22   Q 10 Back

23   Q 56 Back

24   Ministry of Defence, Annual Report and Accounts 2010-11, HC 992, pp 98-99 Back

25   Ministry of Defence, Annual Report and Accounts 2010-11, HC 992, p 99 Back

26   Ibid, p100 Back

27   Q 31 Back

28   Ev 24-25 Back

29   Ibid. Back

30   Ev 24-25 Back

31   Ibid. Back

32   Qq 34-43  Back

33   Qq 12-14, a table showing items with a value of over £100 stolen from the Ministry of Defence, between 12 May 2010 and 28 February 2011, was placed in the Library in response to a PQ in March 2011, www.parliament.uk/deposits/depositedpapers/2011/DEP2011-0602.doc Back

34   Q 15 Back

35   Q 18 Back

36   Ev 23 Back

37   Ev 23-24 Back

38   Ev 23 Back

39   Ev 24 Back

40   Ev 24 Back


 
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© Parliamentary copyright 2012
Prepared 25 January 2012