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Specified Procedures on the Departmental Financial Statements for 2011-2012

Foreign Affairs and International Trade Canada
Office of the Chief Audit Executive

July 2012

Executive Summary
1.0 Observations
2.0 Recommendations
3.0 Conclusion
Appendix A: Status of Actions to Address Audit Recommendations Related to Previous Financial Statements Reports
Appendix B: Management Action Plan

Executive Summary

Each year, the Office of the Chief Audit Executive (CAE) undertakes detailed audit work on certain areas of the Departmental Financial Statements. Last year, specified audit procedures were carried out on three particular areas: Canada Based Staff (CBS) Payroll, Transfer Payments and Tangible Capital Assets.

This year, specified audit procedures were carried out on the following Locally Engaged Staff (LES) accounts:

Accounts	Expenses
Payroll Expenses	$227,461,987
Severance Payments	$6,897,626
Severance Liabilities	$91,723,000
Pension Payments	$47,870,993

Responsibility for the management, processing and reporting of these funds is shared among: the Assistant Deputy Minister of the International Platform; the Heads of Missions responsible for LES payroll and the Chief Financial Officer. Effective January 1, 2012, there was a significant change in responsibilities for management of the LES Pension Program. The Treasury Board transferred this responsibility and the pension program funds to DFAIT. This required DFAIT to report full year expenses in their Departmental Financial Statements.

Why is this important?

Departmental Financial Statements are a principal tool for accountability to Parliament. They demonstrate, in a transparent fashion, the use of public funds aligned with priorities. Ensuring the reliability of the information contained within the statements supports sound stewardship.

There are some 5,518 LES working in over 110 different countries at 160 missions. LES:

are compensated in different local currencies using different stand-alone systems;
participate in a combination of plans developed and administered based on local law and practice, or in a worldwide pension scheme administered by the Department.

The complexity of assessing, recording and reporting payments and liabilities, and consequently the level of risk to the Departmental Financial Statements, is elevated as a result of these factors.

What did we examine?

The auditors carried out specified procedures to:

Gain a high level understanding of the roles and responsibilities, policies, procedures and controls in place;
Analyze the reasonableness of the account balances reported;
Test details of transactions; and,
Assess the calculation used to determine the LES Severance Liability.

As well, progress in implementing management actions to address recommendations from previous audit work was assessed.

What did we find?

With very few and minor exceptions, the auditors were satisfied that payment transactions were appropriately recorded in DFAIT’s financial records. In the auditors’ opinion, those minor exceptions had no material impact on the overall financial statements.

There is some concern noted with respect to the methodology used to calculate the LES Severance Liability. The auditors were unable to accurately assess the full impact on the total liability due to the fact that the $92M is based on information reported for the period 2007-2008 to 2010-2011 as well as the 2011-2012 data currently being examined. This issue is addressed in further detail in Section 1.2.4 and Table 1.

While no material misstatements were noted, recommendations are made in the following areas to ensure consistency in the process across missions.

The processes and control activities over financial reporting of LES payroll expenditures have not been documented. This creates a challenge for the Department in meeting the Treasury Board Policy on Internal Controls requirement for documentation and could lead to inconsistent practices. The auditors noted significant differences in the handling of LES pay by the different missions abroad.
The Department's accounting policy for Accrued Salary and Benefits for both Canada Based and Locally Engaged Staff is out-of-date. As well, the year-end instructions are not complete. This could lead to inconsistent treatment, by missions, of amounts owing at year-end.

All recommendations from previous audit work on the Departmental Financial Statements had been addressed appropriately. Section 1.4 of the report provides an overview of results and the full explanation on progress is contained in Appendix A.

Conclusion

Based on the audit procedures performed, the auditors found no reason to believe that Locally Engaged Staff payroll, pension and severances payments were materially misstated. Moreover, the transactions tested were appropriately recorded in DFAIT’s financial records.

The auditors were however, unable to accurately assess the impact of the calculation used to estimate and report on the total LES severance liability.

Statement of Assurance

In my professional judgment as Chief Audit Executive, sufficient and appropriate audit procedures have been conducted and evidence gathered to support the accuracy of the information in this report. The results are based on a comparison of the conditions, as they existed at the time, against pre-established audit criteria that were agreed upon with management. The results are applicable only to the processes examined. The evidence was gathered in compliance with Treasury Board Policy, Directives, and Standards on internal audit for the Government of Canada.

Original signed by:
Yves Vaillancourt
Chief Audit Executive

1.0 Observations

1.1. LES Payroll Expenditures

High-level understanding of processes and controls

The auditors interviewed Corporate Accounting (SMOQ) and International Platform HR Operations (ALDS) staff in order to determine the roles and responsibilities, as well as the processes and controls followed in Locally Engaged Staff (LES) personnel administration and LES payroll processing.

As at March 31, 2012, there were a total of 5,518 LES working in over 110 different countries at 160 missions. These employees are compensated in different local currencies. Client Relations and Missions Operations Bureau (AFD) has LES position funding authorization. ALDS performs the LES compensation review. All LES payroll is locally processed by individual missions using standalone systems or applications. As such, missions are responsible for managing its LES personnel function and payroll, including:

LES hiring and termination authorization;
Personnel file establishment and maintenance;
Payroll file preparation and maintenance;
Payroll processing and approval; and,
Preparing and posting the payroll Journal to the appropriate General Ledger (GL) accounts in the Integrated Management System (IMS).

DFAIT has not documented processes and control activities over financial reporting of LES payroll expenditures. Based on information received from 17 missions’ high-level description of the process to record and approve LES payroll, the auditors noted significant differences in how LES pay is handled. This challenges the Department’s ability to address documentation requirements of the Treasury Board Policy on Internal Controls.

The auditors were advised that Corporate Finance (SMD) is working with ALD to develop an LES payroll system. This initiative has now received full funding and is expected to be piloted in 2013-2014. There are opportunities to increase the effectiveness and efficiency of the LES payroll process through:

Determination and documentation of a consistent process; and
Continued system development to support this process.

To assess the adequacy of the year-end account closing procedures over LES salary and benefits, the auditors reviewed DFAIT’s Accounting Policy for Accrued Salary and Benefits for Canada Based and Locally Engaged Staff, and the DFAIT 2011-2012 Year-end Procedures for Missions.

The auditors noted that DFAIT’s accounting policy for Accrued Salary and Benefits for Canada Based and Locally Engaged Staff is out-of-date. It did not reflect DFAIT’s reporting requirement with respect to the severance liabilities according to Treasury Board Accounting Standard 1.2. With the new Departmental responsibility for management of the LES pension program effective January 1, 2012, this policy should be updated to reflect DFAIT’s new accounting and reporting requirement related to LES pensions.

Overall, 2011-12 Year-end Procedures for Missions provides detailed year-end instructions to missions for calculation and set-up of “Payables at Year End” (PAYE). With respect to the LES accrued salary and benefits, the 2011-12 year-end procedures only stated that missions must calculate and set up PAYEs for overtime, compensatory time, mandatory and non-mandatory leave credits. It didn’t address other items such as, due but unpaid severance payments, due but unpaid lump sum payments (e.g. LES salary revision), or due but unpaid items related to LES pension payments. This could lead to inconsistent treatment, by missions, of amounts owing at year-end.

1.1.2 Analytical Procedures of LES Payroll Expenses Reported

The LES payroll expense reported by management totalled $227 million. Management provided the listing of all transactions in the LES Salary & Wages General Ledgers for fiscal year 2011-12.

The auditors conducted expenditure sub-category analysis and performed two forms of analytical procedures to assess the reasonableness of the total amount reported.

Comparison of the LES payroll expenses to prior year LES payroll expenses by sub-category of the expenses (i.e. regular pay, acting pay, and overtime pay, etc.)
Comparison of LES salary expenses to LES salary budget and forecast information reported in year-end FINSTAT (as at April 20, 2012) by the Financial Resource Planning and Management Bureau.

The LES salary and wages reported in 2011-2012 totalled $227 million. The total expenses in 2010-2011 were $215 million for the same type of payroll expenses. This represents an increase of $12 million or 5.7%. The bulk of this increase ($11 million) is an increase in the regular pay category. The $11 million regular pay increase can be partially explained by the LES salary revision in 2011-2012 ($7M). The remaining $4M is attributable to: incremental pay increases; and, an increase of 95 LES (indeterminate, full-time equivalent).

To assess the completeness of total payroll expense reported by management, the auditors also performed a comparison of the total $227 million LES payroll expenses to the LES salary budget (N012) and actual expenditure information reported in the year-end FINSTAT by Financial Resource Planning and Management Bureau. According to 2011-2012 Year-End FINSTAT, LES actual salary expenditures (N012) were $235M; an $8M difference.

Further analysis identified that this $8M expenditure was recorded in the “General Ledger (GL) Account 40095 - Other Benefits/Gratuities”. The auditors used IMS Business Warehouse to extract data and confirm how this GL Account was reported in the prior year’s Departmental Financial Statements. In the 2010-2011 Financial Statements GL Account 40095 was grouped under “LES Salaries and Wages”. The variance, therefore, is explained.

Based on the above analytical procedures, the auditors found no reason to believe that the LES payroll expenses reported are materially misstated.

1.1.3 Tests of Details

We performed tests of details on LES payroll expenditures, the purpose of which was to assess whether payroll expenditures were valid, recorded at the proper amount and recorded in the proper period (i.e. cut-off testing).

The Deloitte methodology suggested a sample of 15 transactions for this area, based on an assessment of significant risk and not relying on controls. The auditors selected an additional 4 transactions for a total of 19 transactions in order to obtain additional assurance that LES payroll expenses were properly recorded.

We assessed that hiring/rehiring and terminations represented a higher degree of risk than normal, recurring pay. As such, the auditors selected 6 tests for individuals that were hired during the year, and 5 tests for individuals who had a pay termination during the year. Therefore, there were 11 transactions out of 19 (or 58%, consistent with the prior year’s work for Canada-Based Staff) for this specific area. In addition, we also selected 3 employees that did not have a position number in the Human Resource Management System (HRMS). The remaining 5 transactions represent employees who were employed by DFAIT throughout 2011-2012. Employees were selected based on lists provided by management. These lists identified all hires and terminations in the year, as well as employees who were employed throughout the year. The auditors did not validate the lists provided by management for completeness.

For the samples tested, auditors noted the following:

In one case, the letter of offer was not signed by the employee and the manager had signed some three months after the employee started working; and,
There was no Section 33 approval in the documentation provided for one pay period for one employee tested.

Except as noted above, the auditors were satisfied that the transactions tested were appropriately recorded in DFAIT’s financial records. In the auditors’ opinion, there is no material impact on the overall financial statements.

1.2 LES Severance Payment and Severance Liabilities

1.2.1 High-level understanding of processes and controls

The auditors met with DFAIT’s Corporate Accounting group and Locally Engaged Staff Services Bureau - LES Pension and Insurance Sector (ALDP) to gain an understanding of the roles and responsibilities, as well as the processes and controls used by management to process LES severance payments and set up LES severance benefits liabilities.

The auditors were advised that all LES severance payments are required to be calculated and authorized by ALDP. Once ALDP receives the request for a severance determination from missions, ALDP will:

Request detailed information such as the reason for termination, information used in the mission for initial calculation;
Review employee HR file and reconfirm country specific terms and conditions of employment;
Calculate the severance amount;
Perform a peer review and approve the severance amount;
Authorize the mission to make payment and provide instructions on how to code transactions in IMS; and
Request the mission to provide required proof of payment for closing the severance file.

ALDP tracks all approved severance payments in ALDP’s Severance and Pension Approval Tracking System (WIP).

According to Treasury Board Accounting Standard 1.2, departments are required to record the obligation related to the severance benefits earned by employees of a department. Unlike CBS severance liabilities, which are calculated, based on a whole of government actuarial valuation and distributed across departments on a percentage basis, LES severance liabilities are calculated based on a methodology developed by ALDP. ALDP also determines the source of data used and performs the calculation. Corporate Accounting sets up the LES severance benefits accruals in the financial records and the financial statements.

1.2.2 Analysis of Severance Payments Reported

LES Severance Payments reported in IMS for the year ended March 31, 2012 were $6.9M. To assess the accuracy and completeness of the total amount of severance payments, the auditors performed analytical procedures by comparing this amount with the total authorized amount in ALDP’s WIP.

In ALDP’s WIP, there were a total of $5.6 million authorized severance payments for 239 individuals during the fiscal year 2011/12. This is $1.3 million less than the amount reported in the IMS records.
The auditors performed further analysis of IMS LES severance payment transactions and inquired with ALDP management and the specific mission in order to determine the nature of the $1.3 million discrepancy and whether this $1.3 million should be reported as LES severance payments. The $1.3 million discrepancy was identified as follows.

$0.75 million related to Brazilian severance payments. ALDP confirmed that the severance payments are mandatory according to the local statutory systems, which do not require ALDP authorization. Therefore, it is not included in ALDP’s WIP;
$0.15 million are payments recorded by the Bogota mission. The auditors followed up with Bogota and confirmed that these payments are paid to various private funds selected by employees according to local statutes. These are severance benefits earned by employees paid-out, no later than February 14 each year, for the previous calendar year worked;
$0.16 million were recorded as monthly severance advances in the Caracas mission;
$0.24 million remaining, which can be attributed to possible coding errors, and/or timing differences between ALDP authorization and mission payment date, etc. The auditors did not follow up on these miscellaneous items as the amount was not significant.

Based on the above analysis, the discrepancy between IMS and ALDP’s WIP is reconcilable.

1.2.3 Tests of Details on LES Severance Payments

Combined with our analytical procedures, the auditors also performed limited sample testing. The auditors first randomly selected 5 severance payments from IMS records, and then selected another 4 samples from the $1.3 million discrepancy identified by the analytical procedures.

The auditors traced these payments to ALDP’s authorization emails to assess whether these payments were properly authorized, paid to eligible employees and recorded at the proper amount and in the proper period.

On the 9 samples tested, auditors noted that there were two transactions not recorded in the proper period. A total of $0.01 million severance payments were recorded as 2011-2012 expenses instead of being accrued in 2010-2011. This amount has minimal impact on the overall financial statements. It did, however, support the recommendation (See Recommendation No. 2) to provide missions with clear instructions for year-end procedures to ensure that all severance amounts owing but not yet paid to LES employees who have been stuck of strength by March 31st are properly accrued.

The auditors were satisfied that, with the exception of those noted above, the transactions tested were appropriately recorded in DFAIT’s financial records. The auditors found no reason to believe that the LES Severance Payments were materially misstated.

1.2.4 Assessment of LES Severance Benefits Liability Calculation

DFAIT officials estimated total LES severance benefits liabilities at March 31, 2012 to be $92 million. As noted above, the estimate of LES severance liabilities is calculated based on a formula developed by ALDP. ALDP determines the source of data used and performs the severance liability calculation.

The formula for calculating LES severance benefits is as follows: the average severance cost per employee, multiplied by the total number of eligible employees at year end, then multiplied by a layoff /payout rate. The average severance cost per LES (individual) is the average cost of severance based on historical data (contained in IMS, ALDP WIP and HRMS) from the past 5 fiscal years; the layoff /payout rate is calculated by dividing the average number of approved severances by the average number of indeterminate terminations.

ALDP has stated that this formula is not intended to reproduce the true accounting liability or annual expense determined on an accrual basis pursuant to Public Sector Accounting Standards. It represents the total expected amount payable based on the average severance benefits paid over recent years and on past termination experience. It does not include any provisions for salary increase, membership numbers and changes in severance provisions. Corporate accounting indicated that this represents management’s best estimate and judgment.
In the notes to the Financial Statements, Canada-Based Staff Severance Liability and Locally Engaged Staff Severance Liability are reported together. In the case of CBS, the note clearly states that it is based on an actuarial evaluation of the future liability for the Government as a whole. The explanation for calculating the LES Severance does not disclose whether it is actuarially based.

The auditors further reviewed ALDP’s calculation and the source of data used to assess the reasonableness of the calculation. The auditors are concerned about the source of data used in calculating the average cost per LES severance.

To obtain the average cost per LES severance, ALDP used the average number of approved severances derived from ALDP’s WIP while the average severance payment data is taken from IMS actuals, with the assumption that all severance payments in IMS are actual severance payments. As noted in the analysis of the current year severance payments in IMS, $1.3M are not severance payments made upon termination, but are related to severance payouts for current year severance benefits earned by local law and severance advances. Using two different sources of data for calculating the average cost per LES severance (total payments from IMS combined with the number of approved cases in ALDP’s WIP), might not give a correct picture of the average cost per severance.

To assess the impact of the $1.3M noted above, the auditors calculated the average cost per LES severance by using two different sets of 2011-2012 data. We compared the results of:

using ALDP’s cost and number of approved severance cases; and alternatively,
using the ALDP methodology (of taking ALDP’s number of approved case and IMS data).

The variance in these two methods is illustrated in Table1 below that shows that the calculated difference on LES severance liabilities, based on 2011-2012 data, is $17 million.

The auditors were unable to accurately assess the impact on the total LES severance liability estimated and reported. This is due to the fact that the $92 million is based on information reported for the period 2007-2008 to 2010-2011, in addition to the 2011-2012 data currently being examined. This audit work did not include a detailed examination of financial statements of previous years.

Table 1 - LES Severance Liability Calculation Analysis

**ALDP's Calculation: Estimated Total LES Severance Liability (FY 2011/12) - Detailed Calculations**
Fiscal Year	Number of Approved Severances	Total Terminations	Indeterminate Terminations	Number of LES at March 31	Number of indeterminate at March 31	Total Cost	Average Cost
Layoff factor: 65% LES Severance Liability: $91,723,000
2007/08	238	530	403	5,161	4,888	$5,522,000
2008/09	241	476	378	5,177	4,943	$6,071,000
2009/10	161	553	238	5,355	5,129	$5,009,000
2010/11	218	943	378	5,450	5,230	$5,658,000
2011/12	244	847	308	5,518	5,325	$6,887,000
Average	220	670	341	5,332	5,103	$5,829,000	$26,500

Analysis of Different Results by Applying Different Sources of Data to Calculate Average Cost Per LES Severance

Formula: Number of Indeterminate LES as at March 31, 2012 X Layoff Factor X Average Cost Per LES Severance.

To calculate average cost per LES severance, ALDP used average severance payments from IMS and the average number of approved severance cases derived from ALDP’s WIP.

Comparison by using different sets of FY2011/12 data

Formula

ALDP's calculation based on 5 year historical data:

Layoff factor : 65%
Number of LES at March 31: 5,325
Average cost per case: 26,500 ($5,829,000/220)
Apply formula to calculate LES severance liability: 91,723,125

If average cost per LES severance case is calculated by using ALDP's cost data and Number of approved severance case:

Layoff factor: 65%
Number of LES at March 31: 5,325
Average cost per case: 23,331 ($5,576,000/239)
Apply formula to calculate LES severance liability: 80,752,845

If average cost per LES severance case is calculated by using ALDP methodology: #of approved severance case from ALDP WIP and cost data from IMS :

Layoff factor: 65%
Number of LES at March 31: 5,325
Average cost per case: 28, 225 ($6,887,000/244)
Apply formula to calculate LES severance liability: 97,695,200

*Comparison: 97,695,200 - 80,752,845 = 16,942,355

Result of Analysis

To assess the possible impact of the $1.3 million on the year-end LES severance liability estimation, the auditors calculated the average cost per approved LES severance case by using two different sets of 2011-2012 data, then applied formula. The difference is roughly $17 million.

Therefore, using different source data resulted in a significant difference in the estimation of the total LES severance liability.

The auditors, however, were unable to accurately assess the impact on the $91.7 million of LES severance liabilities reported because the information of 2007-2008 to 2010-2011 (which is used in part to calculate the liability at March 31, 2012) was outside the scope of this audit work.

1.3 LES Pension Payments

1.3.1 High-level understanding of processes and controls

The auditors met with DFAIT’s Corporate Accounting group and LES Pension and Insurance Division (ALDP) to gain an understanding of the requirements (including recent changes) on reporting LES pension payments, roles and responsibilities, as well as the processes and controls used by management to process LES pension premium and benefits payments.

During 2011-2012, DFAIT received from the Treasury Board a new vote for Locally Engaged Staff (LES) pension, insurance and social security programs. LES pensions, insurance and social security coverage are now funded by this new vote. Effective January 1, 2012, responsibility for management of the LES pension program was transferred by the Treasury Board from the Treasury Board Secretariat (TBS) to DFAIT. Accordingly, there is a significant change for 2011-2012 in accounting and reporting LES pension payments. All LES pension payments are reported under DFAIT’s authorities (Vote 17) as well as specific departmental expenses. In 2011-2012, Treasury Board Secretariat was responsible up to the point where the new arrangement was in place. Therefore, the expenses from April 1st to December 31st were transferred to DFAIT through an Interdepartmental Settlement. DFAIT is now required to report full year expenses incurred by the Government of Canada for these benefits. In addition, the auditors were advised that actuarial surpluses or deficiencies of the LES pension plan will be recognized in the financial statements of the Government of Canada, and not in DFAIT’s as the Treasury Board Secretariat was the plan sponsor (and thus responsible for any actuarial surpluses or deficits).

In general, the cost of LES pension payments consists of two types of payments:

Contributions or premiums (employer contribution) paid to the Local Social Security System and Employer Sponsored Separate Pension Plans; and
Pension benefit payments at the termination of employment for eligible retirements/ terminations, including annuity payments and lump-sum pension payments.

As for the pension contribution or premium paid to social security and separate plans, participation in such plans or local social security systems has been historically approved by the Treasury Board Secretariat. Missions will approve and process the payments based on rates determined by the local social security organization or the amount required in accordance with the TBS approved plan and agreement with the pension provider for 2011-12. To establish annual costs for social security and employer-sponsored separate pension plans, ALDP requests missions to perform funding estimations for each fiscal year. The missions are required to provide ALDP the name of the provider, contribution rate, the number of employees enrolled, and the total salary amount as well as the frequency and the amount of each payment.

Lump sum pension payments for eligible retirements/terminations are processed and calculated centrally in ALDP in accordance with the provisions of the Pension Scheme for Employees of the Government of Canada Locally Engaged outside Canada, 1996. As such, ALDP is responsible for:

Reviewing LES HR files;
calculating lump sum benefits according to the provisions and peer review on the calculation;
approving the calculation of benefits;
authorizing payment by email for the mission to make the payment;
requesting a fund transfer to enable payment to be made at the mission; and
tracking proof of payment in ALDP’s WIP and lump sum files.

In addition, for annuity payments, ALDP notifies missions or the Financial Management Support Unit, Foreign Services Directives Services and Policy (SWCR) of the amount to be paid to each annuitant and the frequency of payments following the annual indexation exercise.

1.3.2 Analysis of Overall Pension Payments

The total LES pension contribution (expense) reported by Corporate Accounting for the year ended March 31, 2012 was $47.87 million, which consists primarily of $38.43 million premium payments to separate pension plans and Local Social Security; $7.68 million lump sum payments to eligible retirements/terminations; and $1.62 million annuity payments to annuitants.

The auditors performed the following analysis to assess the reasonableness of the $47.87 million LES pension contribution reported:

Reconciliation of the $7.68 million lump sum LES pension benefit payments with the total authorized amount tracked in ALDP’s WIP records; and
Comparison of the total LES premium payments to the budget and forecast information reported in ALDP’s 2011-2012 funding spreadsheet.

According to ALDP’s WIP, a total of $7.44 million in payments were authorized for 114 eligible individuals. The remaining amount of $0.24 million was recorded in IMS as a year-end accrual, based on ALDP’s estimation for the pension benefits that have been calculated but not authorized prior to March 31, 2012.

To assess the reasonableness of the contributions or premiums paid to social security and separate plans, the auditors compared the actual premium payments to the budget and forecast information reported in ALDP’s 2011-2012 funding spreadsheet. Total actual premium payments to local social security system and separate pension plans amounted to $38.43 million. The total budget for social security system and separate pension plans (annual estimated costs) was $37.46 million. This represents an underestimation of $0.97 million, or 2.5%. Further analysis identified that funding underestimation is mainly due to one transaction - a $3.26 million special contribution payment to the London defined benefit plan on the deficit amortization for 2012-2020. The auditors made further enquiries of the mission on this transaction and were advised that the UK LES Pension Scheme was under funded. A recovery plan and a set schedule of payments for the period of 2010-2020 was established and approved by the Treasury Board. This $3.26 million is the scheduled payment for the period 2010-2020.

Based on our analytical procedures, the auditors found no reason to believe that the LES pension expense reported is materially misstated.

1.3.3 Tests of Details

Combined with analytical procedures, the auditors performed limited sample testing (test of details). The auditors randomly selected 5 transactions from different types of pension payments as well as one additional judgemental sample from the discrepancy identified in the above analytical procedures. The purpose was to assess whether these expenditures were valid, recorded at the proper amount and recorded in the proper period.

For premium payments, the auditors traced the premium amounts to the supporting documents, (i.e. contract signed between Government of Canada with the separate pension plan provider and local social security organization, the amount of the calculation and receipts for the payments).

For annuity payments and lump sum pension benefits payments, the auditors traced these payments to ALDP’s authorization email and letter to the annuitant for the annual indexation exercise to assess whether these payments were properly authorized, paid to eligible employees and recorded at the proper amount and in the proper period.

The auditors did not identify any discrepancies or errors. Based on the testing performed, the auditors are satisfied that the transactions tested are appropriately recorded in DFAIT’s financial records.

1.4 Actions to Address Previous Report Recommendations

The auditors assessed progress on the management actions related to previous audit work on the Departmental Financial Statements. All actions have been satisfactorily addressed as shown in Appendix A. Particularly noteworthy is the review of capital assets. As a result, the Department now has a consistent policy and procedures in place for the recording and reporting of capital.

2.0 Recommendations

As a result of performing specified procedures, potential areas for improvement were identified. The following summarizes the recommendations in that regard.

The Chief Financial Officer Branch should continue developing the LES payroll system for completion by December 2013 to provide timely guidance to staff.
The Chief Financial Officer Branch should ensure that key control activities related to the LES payroll, pension and severances are documented so as to minimize the differences in the handling of LES pay by the different missions abroad and to meet the documentation requirements of the Treasury Board Policy on Internal Controls.
The Chief Financial Officer Branch should update the Accounting Policy for Accrued Salary and Benefits for Canada Based and Locally Engaged Staff to reflect DFAIT’s new reporting requirements with respect to the LES severance liabilities and the LES pension program.
The Chief Financial Officer Branch should provide clear instructions in the Mission’s Year-End Procedures to ensure all items related to LES payroll and benefit expenses incurred but not paid at the end of the accounting period are properly and consistently accounted.
The Chief Financial Officer Branch, in conjunction with the LES Pension and Insurance Division (ALDP), should confirm with the Treasury Board Secretariat the appropriateness of the methodology for calculating and disclosing LES severance liabilities in the Departmental Financial Statements.
International Platform - Locally Engaged Staff Services Bureau (ALDP) should analyze the source data used to calculate the average cost per LES Severance to ensure data integrity when calculating year-end LES severance liability.

The management response and action plan to address these recommendations is contained in Appendix B.

3.0 Conclusion

Based on the audit procedures performed, the auditors found no reason to believe that Locally Engaged Staff payroll, severance payments and pension expenditures were materially misstated. Moreover, the transactions tested were appropriately recorded in DFAIT’s financial records.

The auditors were however, unable to accurately assess the impact on the total LES severance liability estimated and reported. This is due to the fact that the $92 million severance liability estimate is based on information reported for the period 2007-2008 to 2010-2011, in addition to the 2011-2012 data currently being examined. This audit work did not include a detailed examination of financial statements of previous years.

Appendix A: Status of Actions to Address Audit Recommendations Related to Previous Financial Statements Reports

2008-2009 Financial Statements: Note 3 Reconciliation

There were no discrepancies noted; therefore, there were no audit recommendations.

2009-2010 Financial Statements: Note 3 Reconciliation

Audit Recommendation: Should additional Note 3 reconciliations be required in subsequent years, DFAIT should discuss the possibility of finalizing the financial statements only after receiving final documentation from Treasury Board Secretariat.

Audit Recommendation: DFAIT should ensure that the documentation included in the year-end documentation binder is updated following any financial statement adjustments that occur during the financial statement preparation process.

Audit Recommendation: DFAIT should consider reporting the proceeds on disposal affecting appropriations separately in the Note 3 reconciliation. Management should ensure that appropriate reviews and approvals of unreconciled amounts are obtained and documented for audit evidence purposes.

Management Response and Current Status: Management agreed with this recommendation. In the audit work undertaken on the 2010-2011 Note 3 Reconciliation, the auditors verified that these actions had been taken.
NOTE: With respect to ensuring documentation for audit evidence purposes, this problem arose again in the Reconciliation of Note 3 for 2011-2012.

Audit Recommendation: DFAIT should compare Form A vote names and numbers to the financial statement presentation on an annual basis. While vote names and numbers change infrequently, this will ensure the accuracy of Note 3(b).

Audit Recommendation: DFAIT should strengthen its review process and ensure appropriate evidence of the review of the documentation supporting Note 3, such as preparer and reviewer sign-offs in the year-end supporting documentation binder.

2010-2011 Financial Statements: Note 3 Reconciliation

There were no discrepancies noted; therefore, there were no audit recommendations.

2010-2011 Financial Statements: Year End Close Procedures

Audit Recommendation: We recommend that:

DFAIT complete its testing of payroll expenditures as planned; and
Report on the results of the testing to management and the Departmental Audit Committee.

Management Response and Current Status: Design effectiveness testing has already begun. Once any design gaps are addressed, operating effectiveness testing will begin.

As required by the Policy on Internal Control, assessment results are reported to management and the Departmental Audit Committee through the Annex to the Statement of Management Responsibility Including Internal Control over Financial Reporting.

Completed: Design effectiveness testing and a gap analysis were completed during the fiscal year. A report was developed and process owners have been asked to prepare Management Action Plans. Results of design and operating effectiveness are reflected in the Annex to the Statement of Management Responsibility which is reviewed by the Departmental Audit Committee.

The auditors have reviewed the draft Annex B and are satisfied that this recommendation has been implemented.

Audit Recommendation: As DFAIT continues to document its processes and controls, DFAIT should ensure that

Automated controls are clearly identified in the documentation and;
The control matrix identifies the frequency that the control activity occurs and provides sufficient information to properly test these controls.

DFAIT should also ensure that the documentation is sufficiently detailed in order to test only the key controls supporting Canada-Based Staff payroll expenses; this will provide senior management with focused results on whether key controls are operating effectively as well as enhance the accountability of control activities within the Department.

Management Response and Current Status: Process documentation (narratives and flowcharts) is designed to provide an overview of a particular business process and includes more information than just the key controls.
The control matrix is designed to then narrow the list of controls down to those which are considered “key” for testing purposes.
The internal control matrix identifies and documents the risks related to each of the processes, the corresponding control objectives, the control activities designed to address the identified risks, and cross-references key control points to the process flowcharts. The internal control matrix will record the financial statement assertion addressed, the type of control (are controls manual or automated; preventive or detective; segregation of duties, etc.), and the control process owner. All elements are taken together in the determination of which controls are to be considered key for testing purposes. Key controls are then reviewed to ensure they are designed effectively. Once all design gaps are addressed, the key controls (only) will be tested for their operational effectiveness. At this point the frequency with which the key control operates will be factored into the determination of the sample size and reflected in the testing documentation.

No further action is required.

Audit Recommendation: We recommend that management assess the training needs of the transfer payment community and address any training requirements accordingly.

Management Response and Current Status: A DFAIT Focus Group is currently working on a “needs analysis” for the Development of a DFAIT specific course on Financial Management of Grants and Contributions. This initiative is anticipated to be completed this fiscal year.

Completed: The needs assessment was completed and training has been developed; Piloting of three courses is scheduled for the week of July 27 2012:

Introduction to the Financial Dimension of Transfer Payments taking place July 19, 2012
Financial Assessment of Gs & Cs Projects July 24, 2012
Financial Monitoring of Gs & Cs Projects. July 25, 2012.

Audit Recommendation: We recommend that DFAIT develop criteria for capitalization of expenditures to ensure the proper recording of tangible capital asset related transactions.

Management Response and Current Status: There are capitalization criteria currently in place within the Capital Asset Policy and Guidelines which align with PSAB and TBAS. SMO will perform a complete review of the Capital Assets processes this fiscal year. The review will clarify, streamline and standardize guidance on capitalization. A communication and training strategy will be developed to promulgate the new procedures and guidelines.

Completed: A comprehensive capital asset review was completed. As a result, a new policy was developed and issued which outlines the criteria for capitalization of expenditures. The Policy is on the website and a broadcast message will be sent the week of July 27, 2012. Capital Asset Standard Procedures have been completed.
Financial Management Advisors (FMAs) have been extensively consulted on their new roles and responsibilities.
The auditors have reviewed the supporting documentation and are satisfied that this recommendation has been implemented.

Audit Recommendation: We recommend that DFAIT develop criteria related to bundling of tangible capital assets to ensure that transactions are recorded consistently across DFAIT.

Management Response and Current Status: As part of the capital asset review, SMO will revise the capital asset policy and guidelines to include clear policy requirements concerning the consistent recording of pooled purchases of assets individually valued less than $10,000.

Completed: The Capital Asset Policy has been revised to clarify that asset pooling is not permitted.

The auditors have reviewed the supporting documentation and are satisfied that this recommendation has been implemented.

Appendix B: Management Action Plan

Audit Recommendation 1

The Chief Financial Officer Branch should continue developing the LES payroll system for completion by December 2013 to provide timely guidance to staff.

Management Action: The required procurement vehicle for project resources will be awarded by July 31, 2012. Phase I of LES project to deliver Global Template to select pilot missions will begin in August 2012.

Responsible: Corporate Finance, Systems and Business Processes (SMS)

Expected Completion Date: April 2016

Audit Recommendation 2

The Chief Financial Officer Branch should ensure that key control activities related to the LES payroll, pension and severances are documented so as to minimize the differences in the handling of LES pay by the different missions abroad and to meet the documentation requirements of the Treasury Board Policy on Internal Controls.

Management Action: In conjunction with the implementation of the Policy on Internal Control, SMD is creating a generic, inventory of standardized key controls including those for LES payroll. Missions will be required to ensure that these controls are in place, regardless of their individual payroll process. This approach combined with the new standardized payroll system will obviate the need to document 175 different processes.

Responsible: Corporate Accounting, Financial Policy, Controls and Community Development (SMO)