Quarterly Financial Report (QFR) for the Quarter Ended June 30, 2016

1. Introduction

This quarterly report has been prepared by management as required by section 65.1 of the Financial Administration Act (FAA) 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). 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 (hereafter “Department”) 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 renewing Canada’s proud tradition of international leadership.

The Defence mission is delivered through six 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 2016-17. 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.

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 June 30, 2016 as compared to the same period last year, exceeding a materiality threshold of $20.0M or for those items with an unusual percentage increase/decrease.

Statement of Authorities

Total budgetary authorities available for use decreased in 2016-17 from those of 2015-16 by $532.7M (2.8%). This net decrease is the result of increases in Vote 1 spending authority of $169.8M, decreases in Vote 5 spending authority of $733.1M, decreases in Vote 10 spending authority of $4.2M, and an increase in spending authority for Statutory Payments of $34.8M.

The change in budgetary authority is summarized below:

The change in Vote 1 budgetary authority is primarily due to an increase in the annual escalator on defence spending. The increase in Vote 1 is partially offset by decreases to the funding in support of the ongoing implementation of Defence Priorities and other miscellaneous departmental requirements.

The change in Vote 5 budgetary authority is primarily due to a decrease in the net adjustments to the spending profile of major capital equipment and infrastructure projects to align financial resources with project acquisition timelines. Specifically, cash requirements for the Family of Land Combat Vehicles and the Maritime Helicopter project are lower in 2016-17 than in 2015-16. The decrease in Vote 5 is partially offset by an increase in funding related to Federal Infrastructure projects.

The change in Vote 10 budgetary authority is primarily due to a decrease relating to the transfer of the National Search and Rescue Secretariat from the Department to the Public Safety and Emergency Preparedness.

The increase in statutory budgetary authority is primarily due to higher rate in the employer’s portion of the Employee Benefit Plan contributions.

Statement of Departmental Budgetary Expenditures by Standard Object

YTD "net budgetary expenditures" increased by $117.2M (3.4%) compared to the first quarter of the last year.

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

• Professional, Special and Other Services ($128.2M) – primarily due to increased professional services requirements for major capital projects;
• Transportation and Communications ($36.0M) – primarily due to increased costs for military relocations and milestone payments made for Mercury Global Military Wideband Satellite Communications project; and
• Repair and Maintenance ($31.1M) – primarily due to an increase in repair and maintenance of real property.

The standard object with the most significant decrease in the first quarter, as compared to the same quarter last year, was:

• Acquisition of Machinery and Equipment ($89.6M) – primarily due to decreased procurement for Maritime Helicopter project.

3. Risks and Uncertainties

To fulfill its mission, the Department 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, the Department’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 increased spending.

The Department’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 the Department 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 the Department.

Additionally, significant unforecasted operational demands can occur at any time, requiring the Department 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

In the past few years, the Department has faced a changing fiscal environment. In response, the Department has launched a number of initiatives, including Defence Renewal, aimed at improving business processes and practices. The implementation of these initiatives continues to be a priority for 2016-17. Defence Renewal is focused on re-evaluating requirements, finding efficiencies and generating savings for reinvestment in military capabilities and readiness, including the internal reinvestment of personnel to higher priority tasks.

To prepare for the future, the CAF will continue to develop capabilities in intelligence, surveillance, reconnaissance, the cyber and space realms, and targeting processes. However, in addition to addressing capacity, the Department needs to ensure proper alignment of the Defence Team to support these emerging capabilities. In 2016-17, a detailed strategy will be developed to better meet the future requirements of the security environment, and this initiative will be incorporated into the Defence Policy Review.

Despite the challenging economic times, the Department will continue to deliver a combat-effective, multi-role military for Canada and Canadians by enhancing operational capabilities and reducing corporate and institutional overhead.

Approved By:

Dated: 29 August 2016

Ottawa, Canada

5. Financial Tables

• Statement of Authorities
• Departmental Budgetary Expenditures by Standard Object