Quarterly Financial Report (QFR) for the Quarter Ended September 30, 2014

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. 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 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 for fiscal year (FY) 2014-2015. 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 September 30, 2014 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 increased in 2014-2015 from those of 2013-2014 by $936.9 million (5%). This net increase is the result of decreases in Vote 1 spending authority of $157.5 million, increases in Vote 5 spending authority of $1,219.5 million, decreases in Vote 10 spending authority of $6.5 million, and a decrease of spending authority for Statutory Payments of $118.6 million.

The change in spending authority is summarized below:

The change in Vote 1 spending authority is primarily due to decreases in funding related to the Budget 2012 Spending Review; for Canada’s Mission in Afghanistan; for severance; and for travel savings. A timing difference related to funding for the Federal Contaminated Sites Action Plan (FSCAP), as well as the transfer of funding to Shared Services Canada related to their responsibility for the acquisition and provision of hardware and software also contributed to the decrease. These Vote 1 decreases were offset by an increase in the annual escalator on defence spending as announced in Budget 2008 and by funding authorized to be carried forward from 2013-14 to 2014-15.

The net increase of $1.21B in Vote 5 spending authority is due to increases of $1.17B in the net adjustments to the spending profile of major capital equipment and infrastructure projects to align financial resources with current project acquisition timelines and $113M in funding authorized to be carried forward between fiscal years, with offsetting decreases of $27M as a result of transfer of funding to Shared Services Canada for the Carling Campus Project and $37M in other miscellaneous departmental requirements. The adjustments to the spending profile of major capital equipment relate specifically to requirements for the Family of Land Combat Vehicles, the Arctic Offshore Patrol Ships, and Maritime Helicopter Project that are higher in 2014-15 than 2013-14.

The change in Vote 10 spending authority is due to a decrease in transfer payments. The decrease in Statutory Payments is largely due to a reduction in employee benefit plan contributions as a result of the Budget 2012 Spending Review.

Statement of Departmental Budgetary Expenditures by Standard Object

YTD "net budgetary expenditures" decreased $698.3M (8.3%) compared to the second quarter of the last year.

In Q2, “net budgetary expenditures” decreased $241.7M (5.5%) as compared to the same quarter last year.

The standard objects with the most significant decreases were:

• Other Subsidies and Payments ($91.6M) – primarily due to a large payment made in Q2 FY 2013-2014 related to the Manuge class-action lawsuit.
• Professional and Special Services ($88.4M) – primarily due to schedule changes in the timings of submarine refits;
• Acquisition of Machinery and Equipment ($48.0M) – primarily due to reduced procurement of spare parts for aircraft, ships and auxiliary vessels;
• Transportation and Telecommunications ($42.2M) – primarily due to delays in the processing of Military Cost Move claims in Q2 FY 2014-15;
• Repair and Maintenance ($40.8M) – primarily due to the realignment of some of the Construction/Betterment general ledger accounts from the standard object Repair and Maintenance to the standard object Acquisition of Land, Buildings and Works.

The only standard object with a significant increase in Q2, as compared to the same quarter last year was:

• Personnel ($77.9M) – primarily due to higher disability insurance costs in Q2 FY 2014-2015 resulting from the court’s decision in the Manuge class-action lawsuit.

Revenue increased by $37.0M primarily due to a timing difference in payments received from the United Kingdom related to the provision of service to the British Army units training in Canada.

3. Risks and Uncertainties:

To fulfill 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.

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

Impacts related to change initiatives such as Budget 2012 will continue to shape DND/CAF operations, personnel and programs throughout FY 2014-2015. Activities to find better, more effective and efficient ways for DND/CAF to do its work, and move into a new era of renewal will be ongoing. Despite the challenging economic times, DND/CAF will continue to deliver a combat-effective, multi role military for Canada and Canadians by enhancing operational capabilities and reducing corporate and institutional overhead. Details related to Budget 2012 initiatives are provided in the next section.

5. Budget 2012 Implementation

This section provides an overview of the savings measures announced in Budget 2012 that are being 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.

The departmental reductions as a result of Budget 2012 are $1,106.1M in FY 2014-2015 and ongoing.

DND/CAF reviewed spending and programs to ensure they are effective and efficient, as well as responding to the priorities of Canadians. DND/CAF Budget 2012 initiatives focus on process reform, administrative efficiencies, reducing reliance on contracted services, and rebalancing the workforce. This allowed the DND/CAF to ensure the right people with the right experience were in place to realize the important missions for which they are responsible on behalf of all Canadians.

Savings for FY 2014-2015 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, rationalizing corporate accounts, centralizing service delivery for real property and civilian human resources (HR) management and reducing total contracted services and grants and contributions.

The implementation strategy has been to phase-in the reductions and to balance the savings across the Department, with a focus on increased efficiencies. Budget 2012 cost savings measures started in FY 2012-2013.

As of September 30, 2014, DND/CAF has achieved $865.3M (78.2%) of the $1,106.1M in proposed savings for FY 2014-2015, which are related to:

• Deferring CAF growth – resulted in savings of approximately $278M in previously planned expenditures;
• Contracting initiatives – resulted in a reduction of $341.3M in previously planned expenditures;
• Rationalization of corporate accounts and reducing National Procurement expenditures – $139.2M;
• Civilian workforce reduction initiatives – $81.0M;
• Centralized service delivery for real property and civilian HR – $19.6M;
• Reductions in personnel costs for full-time Reservists – $5.8M; and
• Reductions in grants and contributions – $0.4M.

Approved By:

Dated: 26 November 2014

Ottawa, Canada

6. Financial Tables

• Statement of Authorities
• Departmental Budgetary Expenditures by Standard Object