Quarterly Financial Report (QFR) for the Quarter Ended December 31, 2012

1. Introduction

This quarterly report has been prepared by management as required by section 65.1 of the Financial Administration Act and in the form and manner prescribed by the Treasury Board (TB). This report should be read in conjunction with the Main Estimates and Supplementary Estimates A and B. This report has not been subject to an external audit or review.

The Defence mission is to defend Canada and Canadian interests and values, while contributing to international peace and security. On behalf of the people of Canada, the Canadian Armed Forces (CAF) and the Department of National Defence (DND) stand ready to perform three key roles:

• Defend Canada - by delivering excellence at home;
• Defend North America - by being a strong and reliable partner with the United States in the defence of the continent; and
• Contribute to International Peace and Security - by projecting leadership abroad.

The Defence mission is delivered through seventeen program activities. A summary description of these program activities can be found in Section II- Report on Plans and Priorities.

Basis of Presentation

This quarterly report has been prepared by management using an expenditure basis of accounting. The accompanying Statement of Authorities includes the Department's spending authorities granted by Parliament and those used by the Department consistent with the Main Estimates and Supplementary Estimates A and B for fiscal year (FY) 2012-13. This quarterly report has been prepared using a special purpose financial reporting framework designed to meet financial information needs with respect to the use of spending authorities.

The authority of Parliament is required before moneys can be spent by the Government. Approvals are given in the form of annually approved limits through appropriation acts or through legislation in the form of statutory spending authority for specific purposes.

When Parliament is dissolved for the purposes of a general election, section 30 of the Financial Administration Act authorizes the Governor General, under certain conditions, to issue a special warrant authorizing the Government to withdraw funds from the Consolidated Revenue Fund. A special warrant is deemed to be an appropriation for the fiscal year in which it is issued.

As part of the Parliamentary business of supply, the Main Estimates must be tabled in Parliament on or before March 1 preceding the new FY. Budget 2012 was tabled in Parliament on March 29, 2012 after the tabling of the Main Estimates on February 28, 2012. As a result the measures announced in Budget 2012 could not be reflected in the 2012-2013 Main Estimates.

In FY 2012-13, frozen allotments were established by TB authority in departmental votes to prohibit the spending of funds already identified as savings measures in Budget 2012. In future years, the changes to departmental authorities will be implemented through the Annual Reference Level Update, as approved by TB, and reflected in the subsequent Main Estimates tabled in Parliament.

The Department uses the full accrual method of accounting to prepare and present its annual departmental financial statements that are part of the departmental performance reporting process. However, the spending authorities voted by Parliament remain on an expenditure basis.

2. Highlights of fiscal quarter and fiscal year to date (YTD) results

In the following section on financial highlights the Department is providing explanations for differences, for the fiscal quarter and fiscal YTD, at December 31, 2012 as compared to the same period last year, exceeding a materiality threshold of $20M or for those items with an unusual percentage increase/decrease.

Statement of Authorities

Total budgetary authorities available for use decreased in FY 2012-13 from that of FY 2011-12 by $1.67B (8%). This net decrease is the result of decreases in Vote 1 spending authority of $1.00B, a decrease in Vote 5 spending authority of $640M, an increase in Vote 10 spending authority of $24M, and a decrease in spending authority for Statutory Payments of $53M.

The change in budgetary spending authority is summarized below:

*The numbers may not add to the totals due to rounding.

The $255.7M decrease for the Canada First Defence Strategy (CFDS) relates to the portion of funding that was received for the past several FYs, but has not yet been received for FY 2012-13. Additional authorities for FY 2012-13 will be sought through Supplementary Estimates C. The CFDS outlines what is required to develop and maintain a first-class, modern military that is well-trained, well-equipped and ready to take on the challenges of the 21st century. To accomplish this, the CFDS provides a 20-year roadmap, which is periodically reviewed, to modernize the CAF with stable and predictable funding.

The $196.9M decrease in Vote 1 and $39.5M increase in Vote 5 are the result of variances in the amount of the Budget Carry Forward of funding from previous FY. This routine Budget Carry Forward is subject to TB policy and approval that provides departments and agencies with additional financial flexibility and encourages good financial management and planning.

The change in Vote 10 spending authority is due to a net increase in transfer payments, and the decrease in Statutory Payments is due to lower employee benefit contributions resulting from the establishment of CSE and SSC as stand-alone agencies.

Statement of Departmental Budgetary Expenditures by Standard Object

Compared to last year, overall expenditures decreased $174.7M (3.4%) in the third quarter of FY 2012-13. This decrease brings the YTD expenditures to $423.1M (3.1%) lower than last year.

The standard objects with the most significant decreases in Q3, as compared to the same quarter last year were:

• Professional, Special and Other Services ($202.1M) - primarily due to a coding discrepancy ($159.2M) in which expenditures normally recorded as Acquisition of Machinery and Equipment, were recorded as Professional, Special and Other Services in Q3 FY11/12. A further reduction was a result of lower Professional Service expenditures ($32.3M) for the Frigate Life Extension Project;
• Rentals ($81.3M) - primarily due to reductions related to deployed operations; and
• Acquisition of Machinery and Equipment ($57.7M) – primarily due to timing differences in the acquisition of equipment in several major projects.

These decreases in the quarter were offset by increases in expenditures relating to:

• Personnel ($99.2M) - primarily due to the first payment ($205.6 M) in response to the Manuge v. Her Majesty the Queen class-action lawsuit. Without this single item, personnel costs were down $106.4M due primarily to reductions in civilian pay and allowances related to CSE and SSC; and
• Other Subsidies and Payments ($58.4M) – primarily due to changes in the payment schedule of Payments In Lieu of Taxes (PILT) and the settlement of a Major Crown legal liability.

3. Risks and Uncertainties

To fulfil its mission, National Defence purchases the goods and services necessary to train military forces, conduct operations at the request of the Government of Canada and acquire related infrastructure and equipment both domestically and internationally.

As such, National Defence’s financial transactions are exposed to a broad range of external financial and economic risks such as inflation, foreign exchange and commodity price fluctuations. Depending on how these risks unfold, they could lead to surpluses or shortages. For example, an appreciation of the Canadian dollar or deterioration of commodity prices, oil in particular, could result in lower spending. Conversely, a depreciation of the Canadian dollar or increase in commodity prices could result in budget pressures.

National Defence’s capital acquisition program includes a number of large multi-year acquisition projects. Delays in contracting and procurement activities, or delays in deliveries by suppliers for individual projects, can lead to reduced expenditures or budgetary surpluses.

While National Defence considers key economic and financial risk factors including defence specific inflation and foreign exchange in developing expenditure strategies, these risks are outside of the control of National Defence.

Financial risk surrounds forecasting the timing of expenditures outside DND/CAF control. For example:

• Members of the CAF have the option of cashing out their existing accrued severance entitlement immediately or at the end of their career. Funding is available in FY 2012-13 based on a forecast of the number of members that will elect early payment. Should the number of CAF members electing to receive early payment be different from the forecast, there may be reduced expenditures leading to a budgetary surplus or a requirement to seek additional funding.
• The Government of Canada has proposed a settlement of the Manuge class-action lawsuit concerning the Canadian Forces Service Income Security Insurance Plan. This settlement proposal was presented to the courts on February 15, 2013 and a final decision is pending. Funding is available in FY 2012-13. Should the final implementation of the settlement result in payments being made in FY 2013-14, there will be reduced expenditures that will create a budgetary surplus in FY 2012-13.

Financial risk and uncertainty also exists with the implementation of various change initiatives including the 2010 Strategic Review, the savings measures announced in Budget 2012 and the stand up of SSC and CSE as stand-alone agencies.

Additionally, significant unforecasted operational demands can occur at any time, requiring National Defence to respond anywhere on the globe. Depending on the extent of the operational demand, the cost of unforecasted operations would be mitigated either through internal reallocations or by requesting incremental funding from Government.

4. Significant Changes in Relation to Operations, Personnel and Programs

Current change initiatives that affect DND’s Budget include the 2010 Strategic Review, the savings measures announced in Budget 2012, the stand up of SSC and CSE as stand-alone agencies, along with other restraint and efficiency initiatives. A Defence Renewal Team has been stood up to serve as a central coordinating body to ensure that there is coherence and completeness in the implementation of these and future business process transformation initiatives.

5. Budget 2012 Implementation

This section provides an overview of the savings measures announced in Budget 2012 that will be implemented in order to refocus government and programs; make it easier for Canadians and business to deal with their government; and modernize and reduce the back office.

Budget 2012 presents the results of the review of departmental spending, with reductions for DND as follows:

• $318.8M in 2012-13;
• $692.4M in 2013-14; and,
• $1,106.1M in 2014-15 and ongoing.

DND/CAF reviewed spending and programs to ensure they are effective and efficient, as well as responding to the priorities of Canadians. This allowed the DND/CAF to ensure the right people with the right experience are in place to realize the important missions for which they are responsible on behalf of all Canadians.

As of December 31, 2012, DND/CAF has achieved $282M of the $318.8M in proposed savings.

Savings for FY 2012-13 will be achieved by maintaining the Regular and Reserve force strength of the CAF at 68,000 and 27,000 respectively, deferring anticipated growth over the medium term, and reducing total contracted services. Deferring anticipated growth has resulted in savings of approximately $135M in previously planned expenditures. At the end of the third quarter, after considering expenditure reductions associated with Strategic Review and the transfers associated with CSE and SSC, the net reduction to expenditures for contracted services is approximately $104M. Furthermore, a reduction in personnel costs for full-time Reservists and the civilian workforce related to Budget 2012 initiatives of $10M and $33M respectively has also been achieved. The second quarter report identified a $20M reduction in personnel costs related to Reservists. This report reflects a refinement of the methodology used to attribute personnel savings between Strategic Review and Budget 2012.

Approved by:

Dated: 28 FEBRUARY 2013

Ottawa, Canada

6. Financial Tables

• Statement of Authorities
• Departmental Budgetary Expenditures by Standard Object