Audit of Payables at Year End (PAYE) Management Control Framework 2006-2007
Project # 07/08 01-02
prepared by the Audit and Evaluation Directorate
1.0 Description of Assignment
The Agency is required to apply Canadian generally accepted accounting principles for the public sector. In addition, it must annually produce a complete set of financial statements that can withstand audit testing. It must account for all of its own transactions and, in particular, record its liabilities at year end in its accounts and financial statements.
During a recent audit project, we observed that payables at year end were a very large part of the expenses of the entity being audited and could constitute an administrative burden, particularly at year end, in view of the associated accounting and administrative requirements. Finance Directorate representatives also told us of their concerns with certain common practices for the establishment of accrued expenses.
The liabilities in the Agency's financial statements amounted to $110 million as of March 31, 2006, and $117 million as of March 31, 2007.
1.2 Purpose of Audit
Agency management is responsible for the integrity of the information in these financial statements. Accordingly, it must implement a financial management and internal control system designed to provide reasonable assurance that the financial information is reliable. The purpose of the audit is to verify the control framework that management has established to account for payables at year end (PAYE), which is designed to attest that the amounts are faithfully represented in the Agency's accounts and books.
Appendix A presents the audit criteria used in detail.
The audit project is concerned with the financial and administrative controls as well as the systems and processes instituted by management to ascertain and account for liabilities at year end.
1.4 Approach and Methodology
Various audit processes were employed, including staff interviews and reviews and analyses of documents and records.
A review of accounting standards and certain relevant policies was done in order to develop audit criteria. In particular, the approach included a review of controls and practices in effect as well as corroboration procedures applied to a sample.
Liabilities are Agency obligations arising from its operations and events that occurred no later than March 31. The time period principle requires each transaction to be assigned to a given fiscal year and the expenses be charged to the credits for that year.
The following table presents the liabilities as of March 31 of each of the last two fiscal years in terms of balance sheet items and according to the classification of the financial reporting accounts (FRAs) to which they correspond.
2.0 Audit Results
2.1 Overall Findings
Our audit showed that the measures in place intended to provide reasonable assurance of the reliability and integrity of the financial information are inadequate.
In the course of our review procedures we observed:
The Accounting, Financial Reporting and Policies Division is responsible for the Agency's accounting and the production of its financial statements. It also relies on the co operation of the staff of the Sector Financial Operations Division, which is very involved in the recording of financial operations.
The Finance Directorate shall:
design and implement the necessary control measures to provide reasonable assurance that the financial information is reliable;
2.2 Detailed Findings
2.2.1 Accounts Payable Ongoing (FRA 21111)
The financial reporting account "Accounts payable ongoing" is used to group together debts related to the purchase of merchandise, materials, supplies and services. These accounts payable are customarily recorded on the basis of the invoices received and processed. The account balance was $37,610,424 as of March 31, 2007.
Our audit revealed that there was no work file to back up the balance on the books, in particular by explaining its composition in terms of the accounts in the general ledger used by the Agency to record its transactions. Such a work file should also have included the list of individual accounts detailing the Agency' liabilities.
Our discussions also brought out the fact that no analysis had been done to validate the reliability and integrity of the year-end balance. We had expected such an analysis to be done in view of the importance of this balance and its sizeable change from the previous year.
Our summary review consisted of a reconciliation of the financial reporting account with the general ledger accounts in which individual accounts were recorded. We also checked that the amount of $37,610,424 was justified by obtaining the list of individual accounts. A review of the individual accounts revealed, in particular, that the balance on the books is made up of 1,296 individual accounts, of which 368 are related to Agency employees, and that 60% of the amount, or $22.7 million, is attributable to only five suppliers.
2.2.2 Accrued Salaries and Wages (FRA 21112)
This item is used to record salary expenses payable for working days between the last pay period paid and March 31.
There, too, our audit revealed a lack of any work file or analysis to explain and document the balance on the books of $1,365,329.
In addition to reconciling the financial reporting account appearing in the trial balance with the general ledger accounts, our summary review consisted of reconstituting the amount recorded from the Salary Management System (SMS) and ensuring that individual accounts did exist.
2.2.3 Accrued Liabilities (FRA 21113)
This item represents the expenses chargeable to the period that are established on the basis of elapsed time or as a service is rendered, which give rise to a debt that will only become legally due and payable at a later date. They constitute debts at the end of the period even if no invoice has yet been sent. Accrued expenses are customarily recorded at the end of the fiscal year by adjusting entries to comply with the time period principle, which involves the matching of goods and expenses. As of March 31, 2007, accrued expenses amounted to $45,066,885.
Managers are responsible for identifying the accrued expenses and establishing their amount. To determine accrued expenses at the end of the fiscal year, all transactions must be reviewed to establish the value of any debts for services rendered and work done but not yet invoiced. In this task, managers are assisted by staff of the Sector Financial Operations Division and the Accounting, Financial Reporting and Policies Division, which co-ordinates the whole exercise.
Establishing accrued expenses is a demanding exercise because of the large number of contracts active at any given time, some very complex, and the large number of managers with responsibility for them. For the same reasons, the establishment of accrued expenses is an exercise that requires careful management.
Profile of accrued expenses
Beyond reconciling the financial reporting account appearing in the trial balance of March 31, 2007, with the relevant general ledger accounts, one of the first tasks we undertook was to identify the individual accounts making up the amount of $45,066,885, so as at least to demonstrate their existence and be able to extract a sample for thorough review. The balance on the books comprises 425 individual elements from all sectors of the Agency, broken down as follows:
|Profile of Accrued Expenses|
|Expenses as of March 31, 2007, relating to previous years||$8,495,415||17||7||7||3|
|Expenses as of March 31, 2007, relating to the 2006-2007 fiscal year||$36,517,470||408||330||71||7|
Altogether the review sample comprises 55 separate liabilities for a total sum of $29,742,175. It comprises the 17 elements relating to the previous years and 38 accrued expenses for 2006-2007 totalling $21,246,758. We also did a visual check of the unsampled liabilities.
Although there are some measures in place (policies, instructions, attestations, reviews) to manage the establishment of accrued expenses, our discussions with financial services staff and the anomalies observed in reviewing a sample pointed up the inadequacy of the control mechanisms in effect and a certain lack of knowledge of the accounting principles governing accrued expenses. As a result, financial services staffs are unable either to properly advise managers on how to identify and evaluate accrued expenses or to validate those submitted to them before they are recorded.
Following our review of a sample, the main observations of which are shown in the table below, we can conclude that the balance on the books as of March 31, 2007, does not faithfully represent the value of accrued expenses as of that date. The variances can in some cases be quantified, but in other cases, where information on the degree of completion is unavailable, they cannot.
|Summary of Observations|
|80000001||$188,914.20||Accrued expenses are not established based on the degree of completion;
Instead, their value is set based on elements of the basis of payment (milestones) that do not necessarily reflect the degree of completion of the work or services supplied.
|80000001||188,914.20||Accrued expenses are not established based on the degree of completion;
The value of these accrued expenses is established on the basis of qualitative analyses that do not rely on a rigorous evaluation of the work performed, certified by the supplier and validated by the Agency.
|80000008||466,677.85||Selon les renseignements que nous avons obtenus, ces charges courues ne sont pas justifiées.
Le gestionnaire justifie cette dette potentielle par la possibilité que l'Agence ait des sommes à payer suite à la vérification du contrat par TPSGC. Or, sur la base des rapports de vérification intérimaires produits à ce jour, il y a des paiements en trop de l'ordre de 6,5M$.
|80000009||1,306,058.14||According to the information we obtained, these accrued expenses do not correspond to the potential debt.
The manager justifies this potential debt by the possibility that the Agency will have amounts to pay after PWGSC has audited the contract. However, the interim audit reports produced to date indicate that there are underclaimed amounts on the order of $8.5 million.
|80000004||73,646.93||These accrued expenses should be written off.
These accrued expenses (commonly called "Pools") are kept for a current contract despite the fact that the liabilities they related to have ceased to exist.
|80000221||23,681.92||TThese accrued expenses should be written off.
This accrued expense is kept despite the fact that the liability has ceased to exist. Payment has been made, but charged to another expenditure item.
|80000881 to 80000888||166,000.00||The accrued expenses were not established on the basis of an estimate provided and documented by the claimant.
These accrued expenses were established by Agency staff on the basis of the maximum amounts payable annually under the contribution arrangement.
|several||undetermined||Duplicate accrued expenses were recorded.
Financial reporting account 21113 contains salary-related liabilities (salaries for students, maternity leave) that are already taken into account in financial reporting account 21112 – Accrued salaries and wages.
|80001010||499,667.00||According to the information available, this liability does not correspond to the potential debt. It appears the potential debt is understated by $68,147.
The value of the accrued expense was established on the basis of the budget allocation available at year-end—a justification that has nothing to do with the degree of completion and the CSA's share. According to the available information communicated by the supplier, the value of work done before March 31, 2007 but not invoiced was $1,019,416 payable at 55.7%.
We also noted certain practices during the year involving the use of residual balances that are left when invoices are less than the estimated liability. That practice was to group together the residual balances in a new provision (commonly called "Pool") for use in paying accrued expenses that were underestimated or simply forgotten.
That practice is not in accordance with the technical directives contained in the TBS Policy on Payables at Year-End. The Accounting, Financial Reporting and Policies Division should amend its practices and work instruments (policy, instructions, etc) accordingly.
The Accounting, Financial Reporting and Policies Division has already taken steps to end that practice.
2.2.4 Contractors' Holdbacks (FRA 21153 and 24111)
These items are used to present the Agency's obligations to suppliers with respect to amounts temporarily held back to guarantee satisfactory job completion. Contractor's holdbacks for a period of less than one year (FRA 21153) were established at $1,527,959 and those for a period of more than one year (FRA 24111) were established at $7,270,137.
Our summary review consisted of a reconciliation of the financial reporting accounts with the general ledger accounts. We subsequently established that the stated amounts were justified by reconciling them with their individual component accounts. The work file maintained by the Accounting, Financial Reporting and Policies Division contains, essentially, the confirmation certificates sent by the representatives of the Sector Financial Operations Division. At our request, the individual accounts were provided to us and, according to the information obtained, the amounts established are overstated by $63,164.
2.2.5 Allowance for Vacation Pay / Time-Off in Lieu (FRA 21411 and 21414)
These items are used to record accrued expenses referable to employees' annual leave and compensatory leave credits.
The work file comprises the basic documents used to show the composition of the balances of $2,905,224 (for annual leave) and $502,763 (for compensatory leave) payable to employees. This documentation states the accrued expenses per employee as produced by the Salary Management System (SMS). The file does not however contain any analysis.
Our summary review consisted of reconciling each of the financial reporting accounts appearing in the trial balance with the relevant general ledger accounts and ensuring that the amounts established were in accordance with the documentation on file.
2.2.6 Allowance for Severance Benefits (FRA 21415)
This liability is used to present accrued expenses for severance benefits payable to employees, under collective agreements, for example. As of March 31, 2007, the allowance for severance benefits amounted to $9,963,763.
As in the case of the other liabilities reviewed, we had to reconcile the trial balance item with the general ledger accounts. We also verified the correctness of the stated amount on the basis of the documentation in the work file. Our audit showed that the provision for severance benefits was overstated by $117,786.
According to the Receiver General's instructions, this liability must be established on the basis of the Agency's annual payroll subject to the severance benefits provision. We observed that the payroll includes salary expenses, such as the bilingualism bonus, that must be omitted. Hence, the payroll for calculation purposes was overstated by $498,251.
Appendix A – Audit criteria
The objective of this audit project was to verify the control framework and management practices that help provide assurance that liabilities are being faithfully represented in the Agency's accounts and records. More particularly:
Liabilities are established in accordance with generally accepted accounting principles.
The liabilities exist and are referable to the right fiscal year.
All liabilities are taken into account.
The liabilities are correctly valued.
The presentation of liabilities is in accordance with relevant standards.
Appendix B – Management Action Plan
|Ref.||Recommendation||Responsibility identified||Details of Action Plan||Timetable|
|2.0 Audit Results|
|2.1 Overall findings|
|i) Design and implement the necessary control measures to provide reasonable assurance that the financial information is reliable.||Finance Directorate||Chief Financial Officer||1. Analyse the current process and the audit report (Manager, Accounting)
2. Document the establishment and closing of PAYE's – Produce a reference document (Manager, Accounting)
3. Apply the year-end procedures (Manager, Accounting)
|March 15, 2008|
|ii) Ensure that accounting principles and policies are mastered and applied by financial services staff in a compliant and consistent manner.||Finance Directorate||Chief Financial Officer||1. Make the employees of the Division, Sector financial operations aware (Manager, Accounting)
2. During the year-end meeting: Make the CSA's managers aware and train them (Manager, Sector financial operations)
|March 15, 2008|