Quarterly Financial Report (QFR) for the Quarter Ended June 30, 2011

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. This report should be read in conjunction with the Main Estimates and Supplementary Estimates and 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, Defence stands 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 Part II of the Main Estimates.

Basis of Presentation

This quarterly report has been prepared by management using an expenditure basis of accounting using a special purpose financial reporting framework designed to meet financial information needs with respect to the use of spending authorities. 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 (as applicable) for the 2011-12 fiscal year.

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.

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

Statement of Authorities

Total authorities available for use decreased in the first quarter of FY 2011-12 from that of FY 2010-11 by $214.0M (1.0%). Major factors contributing to the net decrease include:

• Budget 2008 commitment to change the automatic annual increase on defence spending to 2% from the previous 1.5%, beginning in 2011-12;
• Adjustments in the spending profile for Infrastructure and Major Capital Projects;
• Canada First Defence Strategy and support for Canada's domestic and international security operations and challenges;
• Cost containment measures to reduce the rate of growth in operating expenditures announced in Budget 2010.

Due to the election, TBS restricted the content of funding requests for 2011-12 Supplementary Estimates (A) to specific items. Therefore additional funding requests that would normally have been included in 2011-12 Supplementary Estimates (A) will be included in 2011-12 Supplementary Estimates (B).

Statement of Departmental Budgetary Expenditures by Standard Object

Personnel expenditures for civilians increased by $31.3M (1.4%) from the previous year due to the implementation of revised collective agreements, as well as successful staffing of essential vacant positions.

Transportation and communications expenditures increased $17M (9.6%) from the previous year. This increase is mainly attributable to rising relocation contract costs associated with fuel price volatility and other variables related to relocation moves for the regular Canadian Forces (CF) members. These relocation moves regularly occur during the first and second quarters.

Expenditures for professional, special and other services increased by $30.6M (9.7%) in this quarter largely due to deployed operation expenditures in the Mediterranean and south-east Asia relating to new and changing military roles.

Rentals increased overall from the previous year by $8.5M (10.2%), mainly in support of Readiness training.

Repair and maintenance expenses increased by $30.2M (18.6 %) primarily due to real property maintenance on naval and army buildings and works.

The increase of $10.4M (5.7%) for utilities, materials and supplies is largely related to increased aviation fuel costs.

Expenditures for the acquisition of machinery and equipment decreased by $241.3M (45.5%) compared to the same quarter last year. The decrease is due to reduced contracting activity for capital projects, which frequently occurs during an election period, and realignment of cash profiles.

Transfer payments to the North Atlantic Treaty Organization (NATO) and other recipients of grants and contributions decreased by $35.6M (84.3%) compared to this period last year due to favourable exchange rates and approval delays experienced during the election period.

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 funding lapses or shortages. For example, an appreciation of the Canadian dollar or deterioration of commodity prices, oil in particular, could result in a funding lapse. 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 funding lapses.

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.

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 a budget adjustment from Parliament.

This Departmental Quarterly Financial Report (QFR) reflects the results of the current fiscal period in relation to the 2011-12 Main Estimates and Supplementary Estimates A.

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

In 2011-12 a major focus of activities will be planning for and implementing the transition of the CF from a combat to a training role in Afghanistan, in support of the Government of Canada's commitment to the NATO Training Mission Afghanistan (NTM-A), where the CF will advance security, promote the rule of law and human rights and support the delivery of humanitarian assistance to the Afghan people.

Operation MOBILE, the CF participation in Operation UNIFIED PROTECTOR, the NATO-led effort in Libya began in late March 2011. During this quarter the House of Commons adopted a motion to extend Canada's participation in the mission to the end of September 2011. As such, it will continue to have an impact on operations, personnel and programs throughout the next quarter.

Approved by:

5. Financial Tables

• Statement of Authorities
• Departmental Budgetary Expenditures by Standard Object