Quarterly Financial Report (QFR) for the Quarter Ended June 30, 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. This report should be read in conjunction with the Main Estimates and Supplementary Estimates A. 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 Forces (CF) and the Department of National Defence (DND) 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 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 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 fiscal year. Budget 2012 was tabled in Parliament on March 29, after the tabling of the Main Estimates on February 28, 2012. As a result the measures announced in the Budget 2012 could not be reflected in the 2012-2013 Main Estimates.

In FY 2012-2013, frozen allotments will be established by Treasury Board 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 Treasury Board, 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 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 $1,508 million (7%). This net decrease is the result of decreases in Vote 1 spending authority of $908 million, a decrease in Vote 5 spending authority of $570 million, an increase in Vote 10 spending authority of $24 million, and, a decrease of spending authority for Statutory Payments of $53 million.

The change in budgetary spending authority is summarized below:

The $255.7 million decrease for the Canada First Defence Strategy 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 the Supplementary Estimates.

The change in Vote 10 spending authority is due to a net increase in transfer payment programs 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

Overall expenditures for the first quarter of FY 2012-13 have increased by 3.9% ($139.6M) compared to the first quarter of the previous year. Canada’s participation in the Wideband Global Satellite Communications System accounts for the overall expenditure increase under the professional, special and other services standard object (SO). Most of the other variances by SO are attributable to items in the spending authorities for FY 2011-12 and not in the spending authorities for FY 2012-13, such as the establishment of SSC and the launch of CSE as a stand-alone agency. Additional factors contributing to variances by SO are changes to capital project activity and decreases in support to deployed operations.

Total personnel expenditures decreased 1.7% ($38.4M) over the previous year. Expenditure increases resulting from approved military and civilian pay raises of approximately 1.5%, were offset by the transfer of personnel for the stand-up of SSC and CSE as stand-alone agencies. The overall result is a net decrease to personnel expenditures.

Transportation and communications expenditures decreased 11.4% ($22.4M) largely due to a decrease in support to deployed operations, specifically the CF participation in the North Atlantic Treaty Organization (NATO) led effort in Libya, and to a lesser extent due to the transfer and stand-up of SSC.

Professional, special and other services expenditures increased 55% ($192.1M) from the previous year. The increase is directly related to Canada’s participation with our allies in the Wideband Global Satellite Communications System.

Repair and maintenance decreased 23% ($44M) over the previous year’s first quarter primarily due to the transfer of e-mail, network and data centre services to SSC effective 15 November 2011.

A decrease of 19% ($36.8M) in utilities, materials and supplies from the previous year is principally due to a decrease in support to deployed operations.

Acquisition of land, buildings and works increased 45% ($21.5M) compared to the first quarter of the previous year. This is directly related to increased spending on infrastructure projects.

Expenditures for the acquisition of machinery and equipment increased 22% ($62.2M) from the previous year primarily due to higher expenditures by capital equipment investment projects such as the Medium-to-Heavy Lift Helicopter Project.

Transfer payments in the first quarter of FY 2012-13 increased by 215% ($14.3M) compared to the first quarter of the previous year. This was due mostly to the timing of transfer payments under the $231M NATO Contribution Program.

Planned re-spendable revenues to be netted against planned expenditures increased 12.8% ($7.9M) primarily due to the timing on the recovery of aviation fuel costs from foreign militaries.

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 and uncertainty exist with the planning and implementation of various change initiatives identified under government-wide spending reviews.

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

The Order in Council 2011 - 1297 dated 15 November 2011 transferred funds and personnel from DND to SSC. This has had little effect on service delivery in DND in the near term and with close coordination with SSC the transition should not significantly disrupt DND activities and programs.

The Order in Council 2011 - 1305 dated 16 November 2011 transferred the personnel and resources from DND to CSE with little disruption to either organization. DND continues to work closely with CSE to support the establishment of their organization.

On-going planning and implementation of various change initiatives identified under the government-wide spending review, Strategic Review and CF Transformation was a major focus of activities this quarter.

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 resulting in the following reductions in spending authority for DND as follows:

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

The Department of National Defence and the Canadian Forces (DND/CF) reviewed their spending and programs to ensure they are effective and efficient, as well as respond to the priorities of Canadians.

This allowed the DND/CF 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.

Most of the savings for FY 2012-13 will be achieved by maintaining the regular and reserve force strength of the Canadian Forces at 68,000 and 27,000 respectively, deferring anticipated growth, over the medium term. A reduction in total contracted services will also contribute to achieving FY 2012-13 savings.

There are no significant variances in current fiscal year expenditures directly related to the implementation of Budget 2012 initiatives because the majority of savings in the current fiscal year are associated with deferring additional investments to grow the regular and reserve force strength of the Canadian Forces. At the end of the first quarter, the reduction to expenditures for contracted services has not generated a significant in-year expenditure variance.

The risks and uncertainties associated with implementation of savings initiatives are to maintain the operational effectiveness and readiness of the CF. The mitigation strategy has been to phase-in the reductions and to balance the savings across the Department, with a focus on increased efficiencies rather than on reducing operational capability.

Approved by:

Dated: 29 AUGUST 2012

Ottawa, Canada

6. Financial Tables

• Statement of Authorities
• Departmental Budgetary Expenditures by Standard Object