Portfolio Departments and Associated Entities: Results of the 2013–14 Audits

Conclusions

Financial reports prepared by portfolio departments, and their associated entities, are generally timely and accurate. Their contents can be relied on by Parliament and the community, with the exception of the former Department of Education and Early Childhood Development (DEECD) which received a qualified audit report.

A number of self-funded agencies continue to have high financial sustainability risks, which, if not addressed, may affect the service potential of their assets and the services they offer to the community.

Internal audit functions across the portfolio departments were generally sound. However, improvements can be made to strengthen these functions. Portfolio departments' expenditure on internal audit has reduced since 2011–12, despite significant operational changes impacting their risk profiles over the same period.

The Prudential insurance standards for Victorian Government insurance agencies provide a framework for the management and supervision of the state's insurers. The framework could be improved with the appointment of an independent prudential auditor to review the attestations made by the insurance agencies.

The debt management practices over unpaid fines can be improved. In the categories reviewed in this report, the state wrote off fines where a warrant had been issued, predominantly traffic fines, totalling $58.2 million in 2013–14, as compared with $60.4 million in 2012–13.

Findings

Quality of financial reporting

A clear audit opinion confirms that an entity's financial report has been prepared according to the requirements of relevant accounting standards and legislation, and fairly presents the financial results of the entity's operations and its assets and liabilities, in all material respects.

Clear opinions were issued for each of the 204 entities that had finalised their financial reports at the time of preparing this report—five financial reports are still to be finalised. The former DEECD's financial report for the year ended 30 June 2014 was issued with a qualified opinion. This matter is commented upon in the Auditor-General's Report on the Annual Financial Report of the State of Victoria, 2013–14.

The financial statements of 22 entities were not finalised within the statutory time frames.

Portfolio departments had not resolved 47 control weaknesses, rated as high or medium risk, identified during the 2012–13 audits, or earlier. This lack of action means that the control frameworks in place at the portfolio departments are not as effective as they could be.

The State of Victoria's Annual Financial Report

The State of Victoria's Annual Financial Report (AFR) acquits the government's stewardship of the state's finances to Parliament, and is a consolidated financial report of 279 state-controlled entities.

The preparation of the AFR is a requirement of the Financial Management Act 1994 (FMA), however, we have noted that the AFR is not subject to the same governance and oversight arrangements as other financial reports prepared under the FMA. In particular, an audit committee has not been given responsibility for overseeing the preparation and fair presentation of the AFR.

The former Treasurer of Victoria did not sign the certification of the financial report and delegated this responsibility to specified officers of the Department of Treasury and Finance. However, the Treasurer is responsible for the preparation of the AFR under the FMA.

Audits by invitation

The Auditor-General conducted financial audits of three entities by invitation in 2013–14, as compared with four in 2012–13. This includes the annual financial audit of the Parliament of Victoria's financial statements.

When conducting financial audits by invitation under the Audit Act 1994, the Auditor-General cannot consider issues of waste, probity and the lack of financial prudence. These issues are all required considerations for all other financial audits conducted by the Auditor-General under the Audit Act 1994 and are generally expected aspects of public sector audits.

This limitation on scope means that there are lower standards of accountability for entities audited by invitation than for the rest of the public sector. We are seeking amendments to the Audit Act 1994 to address these anomalies, and to allow an audit of these entities' expenditure of public funds.

Financial sustainability risks of self-funded public sector entities

Of the 210 portfolio departments and associated entities, 45 are classified as self‑funded, because the majority of their revenue is generated from their operations. As a broad rule, self-funded entities should aim to generate sufficient revenue to meet their financial obligations, and to fund asset replacement and new asset acquisitions, if they are to be financially sustainable over the long term.

Fifteen of these entities received a high-risk rating for financial sustainability at 30 June 2014. Across the past five years, eight of these entities have been assessed as having a high sustainability risk every year. The entities are:

• Docklands Studios Melbourne Pty Ltd
• Fed Square Pty Ltd
• Melbourne Convention and Exhibition Trust
• State Sport Centres Trust
• Victorian Arts Centre Trust
• Geelong Performing Arts Centre Trust
• Melton Entertainment Trust
• Port of Melbourne Corporation.

For these entities, there are significant financial challenges, that if not addressed, may lead to a reduction in the services they provide to the community. If these entities are to be financially sustainable over the long term, the underlying pricing model used to generate revenue may need amendment, another funding source may need to be found or additional government support may be required.

Internal audit

The Standing Directions of the Minister for Finance require public sector agencies to establish, maintain and resource an internal audit function. Internal audit is a key governance and oversight mechanism.

The internal audit functions at the portfolio departments were generally sound. All portfolio departments had an internal audit function in place, with an appropriate charter and regular reporting to the audit committee and senior management.

The value of fees paid to internal audit service providers for services outside the scope of internal audit, such as the provision of consulting services, exceeded the actual internal audit fee at five portfolio departments. Portfolio departments should take due care before engaging an existing internal audit service provider to perform additional work, outside the agreed scope of internal audit to ensure there are no conflicts of interest, there is adequate scrutiny of contract scope, and that there is an appropriate segregation of duties.

The average annual expenditure on internal audit in 2013–14 has reduced by approximately 8 per cent since 2011–12 across the nine portfolio departments. At the same time, operating expenditure has increased by approximately 2 per cent, and the operational and risk profiles of departments have changed significantly.

Prudential supervision

The Prudential insurance standards for Victorian Government insurance agencies (the Standard)—being the Transport Accident Commission, the Victorian WorkCover Authority and the Victorian Managed Insurance Authority (the insurance agencies)—require those agencies to submit an annual attestation to the Department of Treasury and Finance (DTF) stating that they have appropriate governance, risk management and prudential management arrangements in place. DTF, as the prudential supervisor, has the power to investigate compliance with the Standard as it considers appropriate.

The supervision approach adopted by DTF is relatively 'light touch'. DTF relies primarily on the annual compliance certifications of the insurance agencies and does not verify the accuracy of those certifications.

The state's insurance agencies managed assets totalling $27.6 billion and liabilities totalling $25.2 billion at 30 June 2014.

DTF's prudential supervision of the insurance agencies would be strengthened if it exercised its authority under the Standard to appoint an independent prudential auditor to provide independent assurance about the reliability of the insurance agencies' annual attestations of compliance with the Standard. DTF adopts this approach for other state prudential supervision regimes and it would be similar to the requirement of having an annual independent financial audit of agency financial statements.

The insurance agency boards nevertheless take reasonable steps to satisfy themselves that the Standard has been properly implemented. However, the Victorian WorkCover Authority's approach is not consistent with that of the other insurance agencies as it does not seek annual internal audit assurance regarding its compliance with the Standard.

Infringements

In 2013–14 over 3 million infringement notices were issued by the state in relation to mobile and fixed camera traffic offences, tollway offences, 'on-the-spot' offences and public transport offences. The state recognised revenue from these fines totalling $608 million in 2013–14, compared with $649 million in 2012–13.

The state wrote off $58.2 million of these fines under warrants in 2013–14, compared with $60.4 million in 2012–13, as they were deemed uncollectable. The Department of Justice and Regulation's (DJR) debt management practices over unpaid fines can be improved through the development of improved management reporting, information gathering and analysis. Currently DJR does not analyse the write-off of fines by category, or type, to assist in improving the collection and enforcement of unpaid fines.

Alpine resorts

Over the five years to 31 October 2013, the state's alpine resorts have generally reported a collective operating surplus. This is largely due to ongoing funding provided by the state government.

However, the Mount Baw Baw and Lake Mountain resorts have regularly been rated a high financial sustainability risk—indicating there may be short-term financial risks that need to be managed.

Significant projects

A number of significant projects were underway at 30 June 2014 including the Port Capacity Project, Regional Rail Link and Western Highway upgrades. In the majority of cases, the significant projects reviewed are progressing on time and within budget.

However, the Regional Rail Link was originally expected to be completed by December 2014—following a 2011 review, the project completion time frame was changed to 2016.

The Western Highway upgrades include the duplication of the Western Highway between Ballarat and Stawell. Funding approvals currently in place are only sufficient to complete the duplication to Ararat, which is 30 kilometres short of Stawell. Completion of the upgrades is dependent on further funding negotiations with the Commonwealth Government.

Public private partnerships

At 30 June 2014, 21 facilities were operating, or were being built in Victoria, under a public private partnership (PPP) arrangement. The total nominal cost of these PPPs over the remaining life of the contracts is $36.6 billion. It is important these arrangements are subject to the same scrutiny by the Auditor-General as other public spending.

While the state has increasingly sought such partnerships, alliances or other service delivery models involving the private sector, the provisions of the Audit Act 1994 have failed to keep pace with these developments. Consequently, the Auditor-General's mandate to review public expenditure on large projects has been eroded. Simultaneously there has been continued, if not increased, expectations from the community about transparency and accountability.

There is currently no Australian accounting standard, or other whole-of-Victorian-government guidance, which prescribes how PPP transactions should be accounted for.

Recommendations

1. That the State of Victoria's Annual Financial Report be subject to review by an independent audit committee.

2. That the Financial Reporting Directions and Standing Directions under the Financial Management Act 1994 be applicable to the State of Victoria's Annual Financial Report.

3. That the Treasurer of Victoria signs the certification of the State of Victoria's Annual Financial Report.

That portfolio departments and associated entities:

4. review their financial reporting processes to address the better practice financial reporting elements identified in this report, including the preparation of shell financial statements

5. address identified internal control issues in a timely manner

6. through audit committees, implement appropriate monitoring mechanisms to ensure audit findings are resolved by management on a timely basis.

That the Department of Treasury and Finance:

7. works with self-funded entities to review their underlying pricing model and sources of funding, in order to improve their long-term financial sustainability.

That portfolio departments:

8. improve and document processes for the assessment and mitigation of the potential conflicts of interest of internal auditors, and ensure that this is not compromised when engaging internal audit service providers to perform additional services

9. improve the key performance measures used to review the internal audit function, and utilise these to conduct regular assessments of the function

10. review expenditure on, and coverage of, the internal audit function to ensure that adequate and appropriate assurance is being obtained over the functions and processes within the portfolio department.

That the Department of Treasury and Finance:

11. strengthens its supervision of the insurance agencies by appointing a prudential auditor to provide independent assurance about the reliability of the insurance agencies' annual attestation of compliance with the Prudential insurance standards for Victorian Government insurance agencies
12. provides additional guidance to insurers regarding the level and frequency of internal audits to be conducted at all insurers, to ensure a consistent and comprehensive approach.

That the Victorian WorkCover Authority:

13. engages its internal auditors to conduct an annual assessment of its compliance with the Prudential insurance standards for Victorian Government insurance agencies, to bring its practices in line with the better practice undertaken by the other insurers.

That the Department of Justice and Regulation:

14. obtains assurance over the operating effectiveness of internal controls at third-party service providers
15. routinely reports on, and undertakes an analysis of, the categories and types of fines written off in order to improve the collection of unpaid fines.

That the alpine resorts:

16. develop strategies to improve their long-term financial sustainability.

That the Department of Treasury and Finance:

17. finalises accounting and reporting guidance for public private partnership projects, and makes it available to Victorian public sector agencies.

Submissions and comments received

In addition to progressive engagement during the course of the audit, in accordance with section 16(3) of the Audit Act 1994 a copy of this report, or relevant extracts from the report, was provided to all portfolio departments and named agencies with a request for submissions or comments.

Agency views have been considered in reaching our audit conclusions and are represented to the extent relevant and warranted in preparing this report. Their full section 16(3) submissions and comments are included in Appendix F.

1.1 Introduction

This report covers the nine portfolio departments and 201 associated entities with 30 June 2014 balance dates. Included in these associated entities are the five alpine resort management boards (alpine resorts) which have an annual balance date of 31 October. The most common reporting frameworks for these entities are the Financial Management Act 1994 (FMA), the Corporations Act 2001 and the Australian Accounting Standards. Details of the entities covered in this report are set out in Appendix C.

This is the first time the alpine resorts have been included in our parliamentary report covering the portfolio departments and associated entities. Previously the alpine resorts have been included in our annual parliamentary report on the education sector.

1.2 Structure of this report

The structure of this report is set out in Figure 1A.

Figure 1A

Report structure

Source: Victorian Auditor-General's Office.

1.3 Audit of financial reports

An annual financial audit has two aims:

• to give an opinion consistent with section 9 of the Audit Act 1994, on whether the financial statements are presented fairly, and in accordance with the relevant financial reporting framework
• to consider whether there has been any wastage of public resources or a lack of probity or financial prudence in the management or application of public resources, consistent with section 3A(2) of the Audit Act 1994.

1.3.1 Audit of internal controls relevant to the preparation of the financial report

Integral to the annual financial audit is an assessment of the adequacy of the internal control framework and governance processes related to an entity's financial reporting. In making this assessment, consideration is given to the internal controls relevant to the entity's preparation and fair presentation of the financial report, but this assessment is not used for the purpose of expressing an opinion on the effectiveness of the entity's internal controls.

Internal controls are systems, policies and procedures that help an entity to reliably and cost-effectively meet its objectives. Sound internal controls enable the delivery of reliable, accurate and timely external and internal reports. An entity's governing body is responsible for developing and maintaining its internal control framework.

Internal control weaknesses we identify during an audit do not usually result in a modified audit opinion because often an entity will have compensating controls that mitigate the risk of a material error in the financial report, or we can undertake alternative audit procedures to gain sufficient assurance. A modification is warranted only if weaknesses cause significant uncertainty about the accuracy, completeness and reliability of the financial information.

Weaknesses in internal control found during the audit of an individual entity are reported to its governing body, management and audit committee in a management letter.

Our reports to Parliament raise systemic or common weaknesses identified during our assessments of internal controls over financial reporting and selected focus areas. This report includes the results of our review of the internal audit function at portfolio departments, compliance with prudential insurance supervision standards by the state's insurers, and comments on certain infringements. This report also considers the financial results and sustainability risks of alpine resorts and provides an update on significant projects and public private partnerships within Victoria.

1.3.2 Financial audits of portfolio departments and associated entities

A breakdown of the entities covered by this report is set out in Figure 1B.

Figure 1B

Entities by portfolio and legislative reporting framework

Note: The alpine resort management boards are included in the Department of Environment and Primary Industries total for 2013–14.

Source: Victorian Auditor-General's Office.

The overall number of entities audited and covered in this report increased by two since 2012–13. A list of changes is provided in Figure 1C.

Figure 1C

Changes to audited entities in 2013–14

Source: Victorian Auditor-General's Office.

1.4 Machinery of government changes

Machinery of government changes amend the administrative structure of government agencies. These can be small changes, such as the transfer of a function from one portfolio department to another, or significant changes, such as the merging of portfolio departments, or the creation or discontinuation of an entity or portfolio department.

On 9 April 2013, the then Premier announced machinery of government changes that affected some of the portfolio departments and included:

• changes to the number and scope of portfolio departments
• new departmental secretaries
• changes to ministerial allocations.

An Order in Council was issued under the Public Administration Act 2004. It renamed three existing departments with immediate effect:

• the Department of Transport was renamed to the Department of Transport, Planning and Local Infrastructure
• the Department of Sustainability and Environment was renamed to the Department of Environment and Primary Industries
• the Department of Business and Innovation was renamed to the Department of State Development, Business and Innovation.

The Department of Planning and Community Development and the Department of Primary Industries, ceased to exist for financial reporting purposes effective from 1 July 2013. The operations of these departments were mainly amalgamated into the new Department of Transport, Planning and Local Infrastructure and the Department of Environment and Primary Industries respectively; although some functions were moved to the Department of Premier and Cabinet, including Veterans Affairs, and to the Department of State Development and Business Innovation, including CenITex and EnergySafe Victoria.

On 3 June 2013, the Premier made a declaration under section 30 of the Public Administration Act 2004 that transferred staff and functions between portfolio departments on that day, to affect the machinery of government changes.

The financial impacts of the machinery of government changes have been recognised in the 2013–14 financial statements for the relevant portfolio departments, with the assets, liabilities, income and expenditure transferring to the new portfolio department on 1 July 2013.

During December 2014, the new government initiated machinery of government changes which will impact the 2014–15 financial year.

1.5 Reporting framework

Financial statements are required to be prepared in accordance with Australian Accounting Standards, and the applicable legislated reporting frameworks. Under the FMA, the Minister for Finance has the authority to issue directions in relation to financial administration and reporting issues.

The FMA requires annual reports to be submitted to the relevant minister and tabled in Parliament within four months of the end of the financial year. These reports should include financial reports for the entity and any controlled entities, and are required to be prepared and audited within 12 weeks of the financial year end.

Entities reporting under the Corporations Act 2001 are required to report to their members within four months of the end of the financial year. A summary of the FMA and Corporations Act 2001 reporting time frames is provided in Figure 1D.

Figure 1D

Legislated financial reporting time frames

Source: Victorian Auditor-General's Office.

1.6 Audit content

The audits of the portfolio departments and associated entities were undertaken in accordance with Australian Auditing Standards.

Pursuant to section 20(3) of the Audit Act 1994, unless otherwise indicated any persons named in this report are not the subject of adverse comment or opinion.

The total cost of preparing and printing this report was $275 000.

2.1 Introduction

This part covers the results of the 2013–14 audits of nine portfolio departments and 201 associated entities. It also compares the financial reporting practices in 2013–14 against better practice, legislated time lines and 2012–13 performance.

2.2 Conclusion

The financial reports of portfolio departments and their associated entities for 2013–14 were of a high standard, with the exception of one department. At the date of preparing this report, 204 unqualified audit opinions had been issued. The former Department of Education and Early Childhood Development (DEECD) received a qualified opinion and the financial reports of five entities had not been finalised at the time this report was prepared—including three of the alpine resorts. The financial statements of 22 entities were not finalised within the statutory time frames.

2.3 Audit opinions issued

Independent audit opinions add credibility to financial reports by providing reasonable assurance that the information reported is reliable and accurate. An unqualified audit opinion confirms that the financial statements fairly present the transactions and balances for the reporting period, in accordance with the requirements of relevant accounting standards and applicable legislation.

Unqualified audit opinions were issued on 204 financial reports, compared with 203 in 2012–13, although a number of these opinions were issued with an emphasis of matter. One qualified opinion was issued.

Qualified opinion

DEECD received a qualified audit opinion for its 2013–14 financial report. The reasons for the qualification of the opinion issued in respect of the DEECD financial statements were set out in detail in the Auditor-General's Report on the Annual Financial Report of the State of Victoria, 2013–14. A summary of these findings is presented below.

The audit opinion on DEECD's 2013–14 financial report was qualified with respect to a $1.58 billion economic obsolescence adjustment to the carrying value of school buildings at 30 June 2014, and the reclassification of the prior period's school building impairment of $2.15 billion as a fair value adjustment.

The audit opinion was qualified because:

• the accounting policy adopted to fair value school building assets, specifically including an economic obsolescence adjustment, was not appropriate
• the key valuation assumptions and judgements were not be supported by sufficient appropriate evidence
• the reclassification of previously reported 30 June 2013 balances did not accord with Australian Accounting Standards
• DEECD included comments in the accountable officer's and chief finance officer's declaration on the 2013–14 financial report that were inappropriate.

DEECD's accounting policy for economic obsolescence resulted in a significant write down of taxpayer investments in school buildings which continue to deliver educational outcomes. Further, in our review of the practices applied across other Australian jurisdictions we found that Victoria is alone in its approach to this matter.

Emphasis of matter

An auditor can draw a reader's attention to a matter or disclosure in the financial report to provide important context, including where the financial report has been prepared using a special purpose financial framework. Financial reports that include an emphasis of matter (EoM) paragraph in the audit opinion still present the entity's financial information fairly and can be relied upon by the user.

In 2013–14, 26 entities covered by this report prepared special purpose financial reports. These entities received an EoM paragraph in their opinion to draw attention to this basis of preparation. In addition, four entities received an audit opinion containing an EoM for other reasons, as detailed in Figure 2A.

Figure 2A

30 June 2014 opinions with an emphasis of matter paragraph

Source: Victorian Auditor-General's Office.

2.4 Quality of reporting

The quality of an entity's financial reporting can be measured in part by the timeliness and accuracy of the preparation and finalisation of its financial report, as well as against better practice criteria.

Appendix C details the legislative and reporting framework for the entities covered by this report.

2.4.1 Accuracy

The frequency and size of errors in the draft financial reports submitted to audit are direct measures of the accuracy of those reports. Ideally, there should be no errors or adjustments required as a result of an audit.

Our expectation is that all entities will adjust any errors identified during an audit, other than those errors that are clearly trivial or clearly inconsequential to the financial report, as defined under the auditing standards. The public is entitled to expect that any financial reports that bear the Auditor-General's opinion are accurate and of the highest possible quality. Therefore, all errors identified during an audit should be adjusted, other than those that are clearly trivial, as defined in the Australian Auditing Standards.

Material adjustments

Material errors need to be corrected before an unqualified audit opinion can be issued. It is noted that 21 material financial adjustments were made across the nine portfolio departments during the 2013–14 audits, compared with 23 in 2012–13. Of these 21 adjustments, four were greater than $100 million—all relating to DEECD—and a further eight were greater than $10 million—relating to DEECD, the Department of Treasury and Finance (DTF) and the former Department of Environment and Primary Industries.

A further 28 material adjustments were made to the disclosures in the notes accompanying the financial statements, compared with 21 in 2012–13.

The most common areas of material financial and disclosure adjustments identified during the 2013–14 audits were:

• commitment disclosures—adjustments to the financial and narrative information relating to the portfolio departments future commitments, including disclosures regarding public private partnerships
• property, plant and equipment disclosures—the introduction of Australian Accounting Standard AASB13 Fair Value Disclosures required all entities to disclose significantly more information in their 2013–14 financial statements than in prior years regarding the nature of assets held, and the factors used in determining their valuations
• recognition of and/or transfer of assets—adjustments arose following the transfer of assets from one portfolio department to another as a result of the machinery of government changes and from the incorrect recognition of the valuation of fixed assets held by an entity.

Other than two adjustments relating to the DEECD qualified audit opinion, all material errors were adjusted prior to the completion of the financial reports.

Adjustment of other misstatements

Other errors should also be corrected before the audit opinion is issued. While some errors may appear quantitatively immaterial in isolation, in aggregate, a series of small errors may have a significant impact on an entity's financial statements or an entity's operating result.

During the 2013–14 audits, a number of misstatements above clearly trivial thresholds, but below materiality levels, were identified. Most were subsequently adjusted in entities' financial statements, however, some were not adjusted either because they were identified too late in the financial statement preparation process, or could not be processed in a timely manner without raising an unacceptable risk of creating further errors. In these instances the misstatement was raised with management and will be rectified during 2014–15.

Given their nature, these items do not affect the fair presentation of the entity's financial information, meaning the financial reports can still be relied upon by the user.

2.4.2 Timeliness

Timely financial reporting is key to providing accountability to stakeholders and enables informed decision-making. The later reports are produced and published after year end, the less useful they are.

Financial statements prepared pursuant to the Financial Management Act 1994 (FMA) are required to be finalised within 12 weeks of the end of financial year—while the relevant annual reports should be tabled in Parliament within four months of the end of the financial year.

In 2013–14, 183, or 87 per cent, of the 210 entities covered by this report completed their financial reports within the required legislated time frame, compared with 97 per cent, in 2012–13.

Twenty-two entities failed to finalise their financial reports within the relevant time frame, compared with 9 in 2012–13. Five entities, including three alpine resorts, had not finalised their financial statements as at 14 January 2015.

These delays are partially attributable to the entities' failure to prepare for the new Australian Accounting Standard AASB13 Fair Value Disclosures, which imposed increased reporting requirements. These entities should review their financial reporting preparation to ensure that they are able to report on any changed or new accounting standards in an accurate and timely manner, without compromising their legislative obligations.

Another common reason for the delays was a lack of timely preparation of draft financial reports for audit. By not providing complete draft statements to the auditors by the date agreed, any issues identified may not be resolved in a timely manner, impacting the entity's ability to meet their reporting time frame. Entities should work with their auditors to agree on appropriate timetables that enable them to meet their legislative obligations.

2.4.3 Portfolio department financial reporting

An assessment of the quality of the financial reporting process of the nine portfolio departments was conducted against better practice criteria, detailed in Figure 2B, using the following scale:

• no existence—process not conducted by the department
• developing—partially encompassed in the entity's financial reporting process
• developed—entity has implemented the process, however, it is not fully effective or efficient
• better practice—entity has implemented efficient and effective processes.

Figure 2B

Financial report preparation better practice

Source: Victorian Auditor-General's Office, and Australian National Audit Office Better Practice Guide Preparation of Financial Statements by Public Sector Entities, June 2009.

The results are summarised in Figure 2C.

Figure 2C

Results of assessment of report preparation processes against better practice elements

Source: Victorian Auditor-General's Office.

While most elements were developing or developed, with some portfolio departments having achieved better practice, the most significant element to be addressed is the need to consider materiality when preparing the financial statements. The need to undertake rigorous analytical review and strong quality control procedures during the financial report preparation process are essential to ensure the accuracy and completeness of the financial statement disclosures. As part of this process, portfolio departments need to build in detailed financial compliance reviews over the financial statements to ensure that all key elements of the Australian Accounting Standards are complied with.

All of these areas are a significant part of the financial statement preparation process and by not having these elements built into the process, portfolio departments could potentially jeopardise the quality of their financial statements as well as their ability to meet legislated time lines.

2.4.4 The State of Victoria's Annual Financial Report

The State of Victoria's Annual Financial Report (AFR) acquits the government's stewardship of the state's finances to Parliament, and is a consolidated financial report of the 279 state-controlled entities.

The preparation of the AFR is a requirement of the FMA, however, we have noted that the AFR is not subject to the same independent governance and oversight arrangements as other financial reports prepared under the FMA. In particular, while DTF has an audit committee, that committee does not have responsibility for overseeing the preparation and fair presentation of the AFR.

Additional disparities in the governance structure for the AFR compared to other FMA financial reports were identified:

• The Treasurer of Victoria is responsible for the preparation of the AFR in accordance with applicable Australian Accounting Standards, and determines the manner and form of the financial statements in accordance with the FMA. Consequently, the Treasurer is both responsible for preparing the AFR but also determines the manner and form of the AFR. The form and content of all other financial reports prepared under the FMA are determined by the Minister for Finance. Further, the AFR is not bound to comply with the Financial Reporting Directions or the Standing Directions of the Minister for Finance despite these frameworks applying to other entities prepared under the FMA. This means that the AFR does not disclose some information required by other financial reports, such as related party transactions or executive remuneration.
• The former Treasurer of Victoria did not sign the certification of the financial report and has delegated this responsibility to specified officers of DTF. The AFR does not formally note that the signatories are doing so on behalf of the Treasurer. This is inconsistent with other financial reports prepared under the FMA which are certified by the respective responsible persons.

The objectivity and credibility of financial reporting is diminished when appropriate governance structures are not in place. As the consolidating report to Parliament, the AFR's governance processes should be in line with better practice, and we recommend the above issues are addressed by the Treasurer and DTF.

2.5 Audits by invitation

An entity that does not meet the definition of an authority under the Audit Act 1994 is not required to have the Auditor-General conduct its financial audit. However, under section 16G of the Audit Act 1994, the Auditor-General can accept an invitation to conduct the financial audit of an entity that is not an 'authority'.

Before accepting such an invitation, the Auditor-General must be satisfied that the person or body exists for a public purpose and that it is practicable, and in the public interest, for the Auditor-General to conduct the audit.

The Auditor-General conducted financial audits of three entities by invitation in 2013–14:

• Parliament of Victoria
• Australian Health Practitioner Regulation Agency
• Senior Master of the Supreme Court of Victoria.

When conducting financial audits by invitation under section 16G, the Auditor-General cannot consider issues of waste, probity and the lack of financial prudence. These issues are all required considerations for all other financial audits conducted by the Auditor-General and are generally expected aspects of public sector audits.

This limitation on scope means that there are lower standards of accountability for these entities audited by invitation than for the rest of the public sector. We are seeking amendments to the Audit Act 1994 to address these anomalies, and to allow an audit of these entities' expenditure of public funds.

2.6 Internal controls relevant to the preparation of financial reports

Internal controls at the nine portfolio departments, to the extent that they were reviewed as part of our audit, were adequate for reliable external financial reporting. However, a number of control weaknesses were reported to departmental secretaries and management during the course of the 2013–14 audits.

When issues are identified, the financial audit team will issue a management letter to the secretary of a portfolio department, as the accountable officer, listing details of the issues. Internal control weaknesses reported to the secretary should be actioned and resolved in a timely manner.

There were 65 internal control weaknesses in total that were identified and reported to secretaries at the nine portfolio departments in 2012–13 that remained unresolved at the time of the 2013–14 audits. Forty-seven of these weaknesses were rated as high or medium risk. This lack of timely resolution means that the control frameworks in place at the portfolio departments are not as effective as they should be, and management should seek to address all the issues raised on a timely basis.

During the 2013–14 financial audits, common control weaknesses identified across the nine portfolio departments were related to information technology, account reconciliations and maintaining key policy documents. These were all identified as common weaknesses in the previous year.

2.6.1 Information technology

Information security is important for protecting information technology (IT) applications, infrastructure and information from threats, in order to enable business continuity and minimise risks. Effective IT security controls mitigate the risks that information will be inappropriately released and that information will be incomplete, unreliable or inaccurate.

Six of the nine portfolio departments had common IT issues in 2013–14. These issues related to:

• user access and password management
• system change management procedures
• disaster recovery arrangements
• IT strategic plans
• IT network and system penetration testing.

A lack of monitoring of these issues over an extended period of time may compromise the security of information and expose the portfolio departments to internal and external threats. Resolving these issues can reduce risks to the ongoing operations of the departments.

Our October 2014 report, Information and Communications Technology Controls Report 2013–14, provides further information regarding these IT general controls issues.

2.6.2 Account reconciliations

A financial report is prepared from information captured in an entity's financial system. Balances within the system are supported by various sources of information. Periodic reconciliation of these balances confirms the completeness and accuracy of data.

The timely preparation and independent review of reconciliations decreases the risk that errors remain undetected or are not resolved in a timely manner.

Three of the nine portfolio departments had deficiencies in relation to the preparation and review of key reconciliations. While critical departures from expected practices were not identified, their processes surrounding the timely preparation, review and approval of account reconciliations could be improved.

2.6.3 Policies and procedures

Most departments had documented policies and procedures for their key financial processes, however deficiencies identified included:

• the timeliness of policy document reviews
• the establishment of policies regarding ex-gratia payments
• non-compliance with policies
• excessive annual leave balances.

All of the nine portfolio departments have had staff with excessive annual leave balances for a number of years. This is inconsistent with departmental policies and may reduce the effectiveness of key internal controls and is also generally considered to be an increased fraud risk.

Portfolio departments should ensure policy and procedure documents are regularly reviewed and complied with.

Recommendations

1. That the State of Victoria's Annual Financial Report be subject to review by an independent audit committee.
2. That the Financial Reporting Directions and Standing Directions under the Financial Management Act 1994 be applicable to the State of Victoria's Annual Financial Report.
3. That the Treasurer of Victoria signs the certification of the State of Victoria's Annual Financial Report.

That portfolio departments and associated entities:

4. review their financial reporting processes to address the better practice financial reporting elements identified in this report, including the preparation of shell financial statements
5. address identified internal control issues in a timely manner
6. through audit committees, implement appropriate monitoring mechanisms to ensure audit findings are resolved by management on a timely basis.

3.1 Introduction

In this Part we review the financial sustainability of entities that primarily generate revenue from their own operations, rather than depend upon government funding. Forty-five entities have been identified as being self-funded in 2013–14, compared with 47 in 2012–13.

The nine portfolio departments and the other entities predominately funded through government grants have been excluded from this assessment. The financial sustainability of public hospitals, local government, water and tertiary education entities is assessed and reported to Parliament in our sector-specific reports, the details of which can be found in Appendix A.

Self-funded entities should aim to generate sufficient revenue from their operations to meet their financial obligations, and to fund asset replacement and asset acquisitions. Their ability to do this depends largely on their expenditure and revenue management practices, which are reflected in the composition and rate of change of their operating revenue and expenses.

3.2 Conclusion

There has been a deterioration in the financial sustainability of the self-funded entities over the past five years. Fifteen, or 33 per cent, of the 45 entities assessed in 2013–14 were rated as having a high financial sustainability risk, compared with 26 per cent in 2012–13.

A review of state entities that have been rated as high risk for each of the past five years indicates that many may not be able to set their fees and charges at a level that would enable them to generate enough revenue to meet their obligations as they fall due and ensure the long-term maintenance of their assets. In many cases, if these entities were to set their prices at a point that would allow them to do this, the community may not use the services available.

If these entities are to be financially sustainable over the long term, the underlying pricing model used to generate revenue may need amendment, another funding source may need to be found or additional government support may be required. The Department of Treasury and Finance should work with self-funded entities to try to find an appropriate balance between the fee-setting model and their ability to improve their long-term financial sustainability.

3.3 Financial sustainability risks

We analysed the financial trends and patterns of the self-funded entities by examining four core indicators over a five-year period. The indicators used were the underlying operating result, liquidity, self-financing and capital replacement, as they reflect an entity's funding and expenditure policies, and indicate whether the policies are financially sustainable.

Financial sustainability should be viewed from both the short- and long-term perspective. The short-term indicators, in this case, the underlying operating result and liquidity indicators, measure an entity's ability to maintain adequate liquid assets, and to generate an operating surplus over the short term. The long-term indicators, that is, the self-financing and capital replacement indicators, identify whether adequate funding is available and being spent on asset renewal to maintain the quality of service delivery, and to help meet community expectations and the demand for services.

Appendix B describes the financial sustainability indicators, risk assessment criteria and the benchmarks we use in this report. Figure B4 in Appendix B provides the results of our analysis for each of the 45—47 in 2012–13—self-funded entities as at 30 June 2014.

Financial sustainability risks assessments 2009–10 to 2013–14

We have published a financial sustainability analysis for self-funded entities annually since 2008–09 in this report.

Figure 3A provides a summary of the financial sustainability results of self-funded entities in each of the five years since 2009–10.

Figure 3A

Financial sustainability risk assessment, 2009–10 to 2013–14

Source: Victorian Auditor-General's Office.

The number of entities rated as having a high financial sustainability risk has been increasing since 2009–10.

A major driver behind the number of entities recording high-risk financial sustainability indicators is the difficulty in setting their fees and charges at a level that would enable them to meet their obligations as they fall due and ensure the long-term maintenance of their assets. In many cases, if self-funded entities were to set their prices at a point that would allow them to do this, they may experience a reduction in public demand for their services.

The Department of Treasury and Finance should work with self-funded entities to find an appropriate balance between the fee-setting model and the ability for self-funded entities to improve their financial sustainability.

3.4 High-risk entities

Figure 3A indicates that there has been a deterioration in the financial sustainability of self-funded entities. A total of 15 of 45, or 33 per cent of entities were assessed as having a high financial sustainability risk in 2013–14, compared with 26 per cent in 2012–13.

This deterioration is due in part to the way these entities charge for their services. Given the nature of these entities, their governing boards and trusts have a limited ability to improve their financial sustainability. These entities may be unable to generate enough revenue to cover costs, including the long-term maintenance of their major assets, as measured by depreciation. This potentially compromises the services that they will be able to offer the public in future years.

The following entities have been rated as having a high financial sustainability risk in each of the five years since 2009–10:

• Docklands Studios Melbourne Pty Ltd
• Fed Square Pty Ltd
• Melbourne Convention and Exhibition Trust
• State Sport Centres Trust
• Victorian Arts Centre Trust
• Geelong Performing Arts Centre Trust
• Melton Entertainment Trust
• Port of Melbourne Corporation.

A detailed analysis of each of these entities follows.

The financial sustainability indicators for the 45 self-funded entities are set out in Appendix B.

3.4.1 Docklands Studios Melbourne Pty Ltd

Docklands Studios Melbourne Pty Ltd provides film and television studio facilities for hire. Dockland Studios has been rated high risk for the past five years, mainly due to significantly unfavourable underlying operating results, as shown in Figure 3B.

Figure 3B

Financial sustainability results 30 June 2014 – Docklands Studios Melbourne Pty Ltd

Source: Victorian Auditor-General's Office.

The Docklands Studios has recorded a deficit in each of the past five years. In four of those they reported a deficit greater than 50 per cent of revenue. The deficit in 2013–14 was $1.9 million, compared with $1.5 million in 2012–13, and depreciation expenses were $2.3 million, compared with $2.0 million in 2012–13. This, combined with an unfavourable capital replacement indicator, indicates that the Docklands Studios may have insufficient revenue to renew their assets as required. This indicates that the Docklands Studios has short- and long-term financial challenges.

3.4.2 Fed Square Pty Ltd

Fed Square Pty Ltd has also been rated as a high risk for the past five years. In 2013–14, it reported a deficit of $6.6 million and incurred depreciation expenses of $11.7 million. Fed Square Pty Ltd continues to have short- and long-term sustainability issues, as shown in Figure 3C.

Figure 3C

Financial sustainability results 30 June 2014 – Fed Square Pty Ltd

Source: Victorian Auditor-General's Office.

3.4.3 Melbourne Convention and Exhibition Trust

The Melbourne Convention centre opened in 2009 as a public private partnership (PPP). The private sector partner designed, constructed and financed the centre. The private sector partner will also maintain the centre for 25 years, after which time it will be returned to the state.

The Melbourne Convention and Exhibition Trust (MCET) is to meet half the costs of the PPP by repaying a $227.7 million loan to the former Department of State Development, Business and Innovation. The loan will be repaid over the period of the PPP. At 30 June 2014 approximately $200 million of this amount was still outstanding.

The underlying operating result for MCET continues to record a deficit. In 2013–14 it recorded a deficit of $18.6 million, which compares to a deficit of $28.7 million in 2012‑13. The depreciation expense for 2013–14 was $23.1 million, compared with $27.0 million in 2012–13. The indicators shown in Figure 3D indicate short- and long‑term financial challenges for MCET.

Figure 3D

Financial sustainability results 30 June 2014 – Melbourne Convention and Exhibition Trust

Source: Victorian Auditor-General's Office.

3.4.4 State Sport Centres Trust

The State Sport Centres Trust (SSCT) is a statutory authority which governs the Melbourne Sports Hub's four venues—the Melbourne Sports and Aquatic Centre (MSAC), the State Netball Hockey Centre, Lakeside Stadium and the MSAC Institute of Training.

As at 30 June 2014, SSCT's financial sustainability risks had not improved. SSCT reported a deficit of $9 million, compared with $6.7 million in 2012–13. This result included operating and capital funding of $8.1 million and depreciation expenses of $8.9 million. SSCT has also had an unfavourable liquidity indicator for the previous two financial reporting periods. As we have noted in previous years reports, SSCT does not have the ability to generate sufficient revenue to renew its asset base, which was $337.5 million at 30 June 2014—$323 million at 30 June 2013.

Figure 3E

Financial sustainability results 30 June 2014 – State Sport Centres Trust

Source: Victorian Auditor-General's Office.

3.4.5 Victorian Arts Centre Trust

The Victorian Arts Centre Trust (VACT) manages key performance venues in Melbourne, including Hamer Hall, the Arts Centre and the Sydney Myer Music Bowl.

VACT has had a high sustainability risk for each of the past five years due to unfavourable underlying operating result, capital replacement and self-financing indicators. By not being able to generate enough revenue to fund the depreciation costs of assets, the ability of VACT to renew these assets as required is put at risk.

For the year ended 30 June 2014, VACT reported an operating deficit of $13 million—$22.6 million in 2012–13—which included $16 million of depreciation expenses—$15.4 million in 2012–13. While the short-term financial sustainability of VACT has improved over 2013–14, the entity continues to face major financial challenges, as shown in Figure 3F.

Figure 3F

Financial sustainability results 30 June 2014 – Victorian Arts Centre Trust

Source: Victorian Auditor-General's Office.

3.4.6 Geelong Performing Arts Centre Trust

The Geelong Performing Arts Centre Trust (GPACT) manages the performing arts venue in Geelong, and, like the Victorian Arts Centre Trust, has received a high-risk rating due to unfavourable underlying operating result and self-financing indicators.

As with VACT, GPACT is not generating enough income to cover its depreciation expenses. For the year ended 30 June 2014, GPACT reported an operating deficit of $0.98 million, which included $1.03 million of depreciation expenses. Again, this means that GPACT may not be able to renew their assets as required, potentially impacting the services it is able to offer.

Figure 3G

Financial sustainability results 30 June 2014 – Geelong Performing Arts Centre Trust

Source: Victorian Auditor-General's Office.

3.4.7 Melton Entertainment Trust

The Melton Entertainment Trust (MET) operates the Harness Racing and Entertainment Complex (Tabcorp Park), situated in Melton which includes a harness racing track, hotel, bar, function centre, gaming and wagering facilities.

MET has had a high financial sustainability risk for each of the past five years due to unfavourable liquidity and self-financing ratios. MET has also reported operating losses in each of the past five years, generating an operating deficit of $0.84 million in 2013–14—$0.32 million in 2012–13. The depreciation expense for 2013–14 was $0.28 million—$0.22 million in 2012–13.

MET has had a liquidity issue in each of the past five years as well as a high sustainability risk for the self-financing indicator. This indicates that MET may have difficulty replacing assets using cash generated by operations.

MET's financial sustainability indicators for the year ending 30 June 2014 are shown in Figure 3H.

Figure 3H

Financial sustainability results 30 June 2014 – Melton Entertainment Trust

Source: Victorian Auditor-General's Office.

3.4.8 Port of Melbourne Corporation

The Port of Melbourne Corporation (PoMC) has had high financial sustainability risks for each of the past five years due to its unfavourable liquidity ratio.

At 30 June 2014, PoMC held current assets of $76.1 million—$72.6 million at 30 June 2013—and current liabilities of $188.5 million—$122.3 million at 30 June 2013. The increase in liabilities is driven by new borrowings, and the refinancing of short-term borrowings, to fund the Port Capacity Project which is discussed in Part 8 of this report. PoMC's liquidity ratio suggests that the entity could potentially not meet its short-term financial obligations, as they fall due. PoMC did record positive operating cash flows of $130.7 million for 2013–14—$116.2 million in 2012–13.

At 30 June 2014, PoMC reported an operating surplus after income tax of $72.8 million, compared with $65.9 million at 30 June 2013. It generated $368.4 million in revenue and had operating expenses of $295.6 million, including $73.6 million of depreciation. Over the long term, our indicators of financial sustainability— self-financing and capital renewal indicators—show a low financial sustainability risk, as illustrated in Figure 3I.

Figure 3I

Financial sustainability results 30 June 2014 – Port of Melbourne Corporation

Source: Victorian Auditor-General's Office.

In May 2014, the then state government announced that they would enter into a medium-term lease of the Port of Melbourne. However, this will depend upon the final policy position of the new state government.

Recommendation

1. That the Department of Treasury and Finance works with self-funded entities to review their underlying pricing model and sources of funding, in order to improve their long-term financial sustainability.

4.1 Introduction

Internal audit is a key mechanism available to help the secretaries of portfolio departments discharge their governance and oversight responsibilities. Internal auditors can review and appraise internal controls and identify areas of risk or weakness within an entity, providing assurance to the secretary and management on the operational effectiveness of key controls.

An effective internal audit function strengthens internal controls, adding credibility to both financial and non-financial information, as well as improving the efficiency of key controls and processes.

The Financial Management Act 1994 (FMA) and the Standing Directions of the Minister for Finance under the FMA (the Standing Directions) require public sector agencies to establish and maintain an adequately resourced internal audit function as part of their system of internal control.

4.2 Internal audit functions

All of the portfolio departments maintained an internal audit function during the financial year.

4.2.1 Key elements of an internal audit function

Key elements of an effective internal audit function are detailed in Figure 4A. This framework draws on the Standing Directions and the Australian National Audit Office's better practice guide Public Sector Internal Audit - an investment in assurance and business improvement, Better Practice Guide September 2012.

Figure 4A

Key elements of an effective internal audit function

Source: Victorian Auditor-General's Office.

These elements were considered as part of our review of the internal audit function at the nine portfolio departments.

Sourcing internal audit

Seven of the nine portfolio departments have outsourced their internal audit function. One department maintains the function internally and one department has co-sourced arrangements in place—where the internal audit function is provided by a combination of internal staff and outsourced providers.

Conclusion

The internal audit functions across the nine portfolio departments were generally sound. All the departments had policies in place and internal audit reported regularly to the audit committee. All portfolio departments had internal audit functions that reflected many of the better practice elements. Nevertheless, there are opportunities for improvement across the portfolio departments.

The average annual expenditure on internal audit has reduced by approximately 8 per cent since 2011–12 across all of the nine portfolio departments. At the same time, operating expenditure across the portfolio departments has increased by approximately 2 per cent and the departments have encountered significant operational changes impacting their risk profiles over the same period, indicating that portfolio departments may be treating internal audit as discretionary and non-essential in nature.

4.3 Policy

The Standing Directions require public sector entities to have an internal audit charter in place that is approved by the audit committee.

The portfolio departments' internal audit charters generally conformed to the Standing Directions and the better practice elements outlined in Figure 4A by including the following:

• internal audit's role and responsibilities
• reporting lines from internal audit to management and the audit committee
• independence requirements for internal audit
• ensuring the internal audit function had direct access to the Secretary
• ensuring the internal audit function had open access to documents, records and employees.

The following better practice elements were not well addressed and could be improved by many of the portfolio departments:

• specifying the role of internal audit in relation to fraud control, this may include reference to another fraud control policy or framework
• outlining the process for selecting an internal audit service provider
• specifying that the performance of internal audit be assessed annually.

By defining a clear role for internal audit in the mitigation and identification of potential fraud, portfolio departments would be increasing their assurance that key fraud prevention controls are operating effectively.

4.4 Management practices

Each of the portfolio departments had developed an internal audit program outlining what was to be audited and there was regular reporting to the audit committee and Secretary on the status of recommendations.

4.4.1 Internal audit plans

All nine portfolio departments developed and prepared internal audit plans on an annual basis. These were presented to each respective audit committee for approval. Information provided to the audit committees was comprehensive and sufficient to allow each committee to form an assessment.

The Standing Directions state that an internal audit plan must be approved by the audit committee and address relevant elements of the agency's risk profile. All nine portfolio department's internal audit functions used the departmental risk register in aiding them to prepare an internal audit plan.

Internal audit plans typically included relevant better practice elements pertaining to resources, scope, timing and budget.

4.4.2 Independence of internal audit

A key aspect of the internal audit function is its independence from the entity's staff and operations, which enables it to provide objective advice and assurance to the audit committee, Secretary and management. While a potential conflict of interest may not be cause for concern, the internal audit charter should outline processes to ensure the audit committee is made aware of any potential conflict of interests and that these are appropriately assessed. The charter should outline actions to be taken to mitigate the conflict, if required.

The head of internal audit at all portfolio departments had direct reporting lines to the audit committee. At six of the nine portfolio departments, the head of internal audit also had direct reporting lines to the departmental Secretary.

The Standing Directions require management to provide internal audit with full, free and effective access to records, documents and employees. All of the nine portfolio departments were compliant with this direction.

Additional services provided by outsourced internal audit providers

Eight of the nine portfolio departments outsourced some, or all, of their internal audit function to external service providers. Six of these eight portfolio departments engaged their outsourced internal audit providers to perform other work, in addition to their internal audit role. These additional services generally include commercial, strategic and consulting advice. Five of the departments spent more on these additional services than on the internal audit fee.

Figure 4B compares the total value of the additional work carried out by these providers against the total internal audit fee at these six portfolio departments.

Figure 4B

Comparison of additional services provided by outsourced internal auditors against the internal audit fee, year ended 30 June 2014

Source: Victorian Auditor-General's Office.

Better practice suggests that internal auditors must maintain objectivity and ensure no perceived or actual conflicts of interest exist between their primary role as the internal auditor and the additional work conducted. The additional fees paid to outsourced internal audit providers at these departments could potentially be perceived as a conflict of interest risk. Portfolio departments should take due care before engaging an existing internal audit provider to perform additional work, outside the agreed scope of internal audit to ensure there is adequate transparency in reporting to the audit committee. This should include ensuring there are no conflicts of interest, there is adequate scrutiny of contract scope and that appropriate segregation of duties controls are in place.

We noted that where the internal audit providers are engaged in additional work, portfolio departments generally had processes in place to mitigate any potential conflicts of interest. This included the internal auditor reporting on the scope and cost of any additional work to the audit committee, and declarations to the committee and secretary regarding any conflicts of interest that have arisen.

4.5 Governance and oversight

The internal audit governance arrangements at the nine portfolio departments are generally sound and robust.

4.5.1 Internal audit performance assessment

The Standing Directions and better practice criteria set out the responsibilities of audit committees. These include monitoring management actions to resolve any issues raised by internal audit and reviewing the performance of the internal audit function.

All of the portfolio departments audit committees monitor actions taken by management to resolve the issues raised by internal audit. This is usually undertaken through the maintenance of an issues register which ranks issues based on risk and assigns a responsible member of staff to address the issue.

Each portfolio department's audit committee reviews the performance of their internal audit function annually. The intensiveness of these reviews, the nature of the key performance measures applied, and the reporting regimes vary.

Key performance measures

Performance evaluations against key performance measures is an effective way of ensuring an internal audit function maximises its value. All portfolio departments audit committees assessed their internal audit function against a set of key performance indicators (KPIs). The suite, range and detail of the KPIs varied. While some departments measured their internal audit function against 20 specific KPIs, others measured performance against a handful of broad KPIs. In each case the measures appeared relevant and appropriate to the department.

As part of this review, the KPIs used by audit committees were compared to the requirements of the Standing Directions and the Australian National Audit Office's Public Sector Internal Audit - an investment in assurance and business improvement, Better Practice Guide September 2012. The better practice KPIs are:

• timeliness and cost of internal audits commensurate with the objectives or benefits of the internal audit
• acceptance of recommendations made by internal audit
• quality of assurance reviews, advisory services and internal audit support activities, including stakeholder satisfaction
• progress in delivery of the approved program
• internal audit staff qualifications and professional development
• internal audit staff satisfaction
• the overall contribution made by the internal audit function.

Most of these KPIs were included within each portfolio department's performance reporting regime.

The KPIs that were least used by portfolio departments include:

• acceptance of recommendations made by internal audit
• internal audit staff qualifications and professional development
• internal audit staff satisfaction.

Portfolio departments could improve their performance monitoring of the internal audit function by using more of the better practice key performance indicators.

Internal audit status report

Mature internal audit functions prepare regular status reports for presentation to the Secretary and audit committee. Such a report typically lists internal audit activities and achievements for the year against the approved plan and helps the audit committee comply with its governance and oversight obligations under the Standing Directions.

Five of the portfolio departments' internal audit functions currently produce an annual status report. The development of this report for each portfolio department would enhance the respective departmental audit committee's ability to discharge their governance responsibilities under the Standing Directions.

External assessment of internal audit

The Institute of Internal Auditors' International Standards for the Professional Practice of Internal Auditing require an external assessment of the internal audit function to be conducted at least once every five years by a qualified independent party from outside the organisation. As well as providing quality assurance over internal audit work, such external reviews allow an objective evaluation and scrutiny of all aspects of the internal audit function. Four of the portfolio departments had not commissioned an external assessment within the past five years.

4.6 Internal audit conduct

As part of this review, we identified key risk areas that are common across all nine portfolio departments. An analysis of the internal audit work that has been completed at each portfolio department over the past three years identified that:

• most departments gained assurance over key areas of focus and risk
• three departments did not review data quality
• two departments did not review their financial delegation controls
• eight departments did not review executive performance management and bonuses
• two departments did not review entertainment expenditure.

While any internal audit plan should be tailored to take into account the key risks at each individual portfolio department, it is of concern that only one of the nine portfolio departments looked at executive performance management and bonuses, especially given the significant risks to reputation and operations associated with inappropriate executive remuneration. Internal audit could provide an independent review of executive remuneration processes to ensure they are appropriate.

Education and competency

This review found that the professional qualification of internal audit staff was sound. Most internal audit staff had a professional accounting designation and the majority were members of the Institute of Internal Audit. In relation to information systems, the majority of internal auditors held Certified Information Systems Auditors qualifications.

Internal auditors working at portfolio departments generally had more than five years internal audit experience.

4.7 Spending on internal audit

The past three years have been a period of significant change within portfolio departments, with key initiatives such as the former government's Sustainable Government Initiative reducing staff numbers and implementing cost savings. Additionally, the recent machinery of government changes have led to structural and procedural changes across a number of portfolio departments.

Change on this scale increases the risk that key controls may not work as intended, that a fraud or error may occur, and that material misstatements may be recorded in the financial statements. Alongside other assurance reviews, such as safety or environmental audits, the internal audit function is a key tool to assist senior management in maintaining the governance structure required to mitigate these issues, and to provide assurance that the changes have not weakened key controls.

The average annual expenditure on internal audit has reduced by approximately 8 per cent since 2011–12 across all of the nine portfolio departments. At the same time, operating expenditure across the portfolio departments has increased by approximately 2 per cent over the same period, and the departments have encountered significant operational changes.

The average amount spent on internal audit, annually, by all departments over 2012–13 and 2013–14 was $826 654. That is, on average, 0.02 per cent of their total operating expenditure. The range of spending by individual portfolio departments varied between 0.01 per cent and 0.18 per cent of total operating expenditure.

By way of comparison, the November 2013 Queensland Audit Office report Results of audits: Internal control systems identified that the average internal audit budget at the 20 Queensland departments was 0.13 per cent of total operating expenditure. While the optimal expenditure on an internal audit function will vary depending on the nature and risk profile of an entity's operations, this analysis casts doubt over the recent trends in spending on internal audit.

Reduced spending on internal audits and the potential reduction in internal audit coverage of the portfolio department functions is concerning, and indicates that the portfolio departments may be treating internal audit as discretionary and non-essential in nature. It should not be viewed as a potential source for cost savings, but as a source of assurance and improvement—particularly regarding the processes associated with the department's changing functions.

Recommendations

That portfolio departments:

1. improve and document processes for the assessment and mitigation of the potential conflicts of interest of internal auditors, and ensure that this is not compromised when engaging internal audit service providers to perform additional services
2. improve the key performance measures used to review the internal audit function, and utilise these to conduct regular assessments of the function
3. review expenditure on, and coverage of, the internal audit function to ensure that adequate and appropriate assurance is being obtained over the functions and processes within the portfolio department.

5.1 Introduction

The Victorian public sector includes three significant insurance agencies that provide insurance services, collect premiums and commit to meeting the state's liability for claims. These insurance agencies are the Victorian WorkCover Authority (VWA), the Transport Accident Commission (TAC) and the Victorian Managed Insurance Authority (VMIA).

The VWA is responsible for workers' compensation insurance in Victoria, TAC is responsible for compulsory third-party motor vehicle insurance in Victoria and VMIA is responsible for the Victorian government's general insurance requirements.

At 30 June 2014 these three agencies held total assets of $27.6 billion compared with $24.8 billion at 30 June 2013, and held total liabilities of $25.2 billion—$23.9 billion at 30 June 2013. Approximately 91 per cent of these assets are held in investments. Approximately 94 per cent of the total liabilities are in relation to outstanding insurance claims.

Figure 5A sets out the investments, total assets and outstanding insurance claims held by all three insurance agencies. It highlights that assets held have been higher than total claim liabilities in each of the past five years.

Figure 5A

Assets and outstanding claim liabilities of state insurance agencies 2009–10 to 2013–14

Source: Victorian Auditor-General's Office.

Given the scale, nature, complexity and uncertainty of the valuation of these assets and liabilities it is critical that these agencies are prudentially managed to:

• ensure the schemes are viable and have sufficient assets to fund liabilities
• safeguard the interests of policyholders and claimants
• minimise the risk of any adverse impact on the state's financial position.

5.2 Prudential Insurance Standards

In September 2010, the Department of Treasury and Finance (DTF) issued the Prudential insurance standards for Victorian Government insurance agencies (the Standard). The Standard complements existing requirements of the Public Administration Act 2004 and the Financial Management Act 1994 and together these form a prudential supervision framework (the Framework) that applies to the insurance agencies.

The Standard is broadly based on the Australian Prudential Regulation Authority's (APRA) standards. It should be noted that recent updates by APRA to their prudential standards are currently being reviewed by DTF, and changes to the DTF Standard are being considered. This Part reviews elements of the framework in place for the agencies and DTF as at 30 June 2014.

The Standard requires the insurance agencies to develop and implement policies addressing key risk management and operational areas—including capital management, premium pricing, investment objectives and reviewing liability values.

The Standard assigns accountability to the board of directors of each insurance agency to ensure the appropriate application of, and compliance with, the Standard. Each board is required to take reasonable steps to satisfy themselves that the Standard has been properly implemented.

The assigned responsibility for each board of directors covers:

• the development and implementation of appropriate policies and procedures to ensure compliance with the Standard
• the requirement to annually verify and attest to DTF that each agency has appropriate governance, risk and prudential management arrangements in place
• an obligation to report to DTF, in a timely manner, any events that affect the application of the Standard
• appointing an external actuary.

The Standard designates DTF as the prudential supervisor. In this role, the Standard specifies that DTF is responsible for the development and maintenance of the Standard, but is not expected to undertake intrusive supervision to ensure compliance. Under the Standard, DTF has the authority to investigate, or require the investigation of, compliance with the Standard as appropriate.

The Standard requires each agency's board of directors to submit an annual attestation to DTF confirming that they have complied with the requirements of the Standard. The annual attestation should provide assurance to DTF that the insurance agencies have appropriate governance arrangements in place and are financially viable. Our review considered DTF's processes for gaining assurance over the reliability of the agency's annual attestation of compliance with the Standard. It also considered each agency's verification processes supporting their attestation of compliance with the Standard, and any of their disclosures made relating to it.

Capital adequacy

The fundamental objective of the Standard is to ensure capital adequacy for public sector insurers, so that the insurance schemes do not adversely impact on the state's finances.

DTF sets capital adequacy parameters for the insurers, which dictate capital policies and activity levels. The minister provides each insurer with a Risk Preference Statement, which specifies a number of risk preferences including:

• preferred funding ratio range and target levels between 80 and 120 per cent—the funding ratio is essentially calculated as scheme assets divided by scheme liabilities
• funding risk appetite—in terms of the probability that agencies funding ratio will fall below the mid-point of the target range in any one year
• the discount rate to be used in valuing scheme liabilities
• the government's dividend requirements for each agency.

Figure 5B, shows that for the past five years agency funding ratios have generally been within the preferred funding ratio range—aside from the 2011–12 financial year where both the TAC and VMIA ratios fell below the low point of the range. This was largely due to reductions in market values, which in turn reduced the value of assets held. Where this occurs, the Standard requires agencies to submit a capital management plan to the Minister for Finance that aims to move the funding ratio back to the preferred funding range over a five-year period.

TAC has been the only agency to fall outside the range on more than one occasion since 2010, however, it has implemented plans to improve its position—with evident improvement in 2012–13 and 2013–14.

Figure 5B

Funding ratios, 2009–10 to 2013–14

Source: Victorian Auditor-General's Office.

An adverse trend in agency funding ratios is not immediately catastrophic because the schemes largely comprise 'long tail' liabilities—liabilities where claims are not settled for potentially many years after the expiration of the policy—and are supported by significant annual premium cash flows and asset portfolios. It is also noted that agency funding ratios are very sensitive to investment returns—as influenced by financial markets—and key valuation assumptions, such as discount rates.

All three state insurance agencies have a committee in place to annually endorse a capital management work plan that details the criteria to effectively monitor and ensure compliance with the Standard, as well as reviewing the agency's prudential insurance policies.

The annual financial audit of the agencies' financial statements does not provide assurance on the long-term viability of the schemes.

5.3 Attestation process

Each agency's annual attestation to DTF is expected to certify that it has maintained appropriate policies and practices to ensure compliance with the Standard. The annual attestation also certifies that the agency has critically reviewed its compliance with the Standard within the past twelve months. The annual attestation is required to be provided by the board of directors and chief executive officer.

In order to certify the annual attestation, agency boards need to ensure they have appropriate arrangements in place. Each agency has implemented processes to provide their respective board of directors with assurance regarding the annual attestation. Details of these processes follow.

5.3.1 Policies

The Standard requires that each agency develops and implements financial policies relating to:

• liability reserving
• capital management
• pricing
• investment of assets
• reinsurance
• actuarial review.

The Standard requires that policies are reviewed at least once every five years. This requirement cannot be fully tested for compliance as the Standard has not yet been in place for five years. However, all three insurance agencies have review schedules in place that are expected to ensure compliance.

The prudential insurance policies at VWA and TAC were checked against the Standard when it was originally issued in 2010 and have not been subject to review since that time. These agencies do not re-check their policies unless the Standard is changed. The prudential insurance policies at VMIA have been reviewed and approved by the board on an annual basis since being developed in 2010.

5.3.2 Management and governance practices

In order to prepare and certify the annual attestation, each agency's board of directors needs to obtain reasonable assurance about their agency's compliance with the Standard. To this end, each agency has created a responsible committee or group and implemented processes for it to provide assurance to its board, though its audit and risk committees. These groups are the Capital Management Group at VWA and TAC, and the Capital Committee at VMIA (the capital committees).

The capital committees are responsible for:

• monitoring agency compliance with internal policies relating to the Standard
• preparing an annual compliance checklist
• providing evidence to support compliance with the Standard
• reviewing actions taken by management to ensure compliance.

The compliance checklist at each agency is aligned to the Standard and is periodically reviewed by their internal auditors as part of the prudential supervision audit.

Each insurance agency's audit and risk committee assesses management's assertions of compliance with the Standard—including reports from the capital committees and then provides recommendations to the each agency's board about the agency's compliance with Standard. The decision paper provided to these committees is typically accompanied by a management confirmation that the agency has established and maintained prudential policies consistent with the Standard, complied with all requirements of internal prudential policies and the Standard and subjected its compliance with the Standard to critical review within the past 12 months. The decision paper will also typically include a recommendation about the finalisation of the annual attestation. Complete documented evidence supporting this certification is not always included in the information provided to audit and risk committee.

Once the audit and risk committee has reviewed the prepared attestation, their recommendation is presented to the board of directors. This recommendation will not typically contain the compliance checklist or other detailed supporting evidence.

The agency boards are required to certify that their agency has established, and maintained, appropriate prudential policies and has complied with their policies and the Standard. The boards also have to verify that compliance with the Standard has been subject to critical review within the past 12 months

Boards seek information to detail that management assertions of compliance are well founded and supported by appropriate evidence—this includes periodic assurance from their internal audit function.

5.3.3 Internal audit

Each of the insurance agency's internal auditors review the effectiveness of management's underlying processes and the documented evidence that supports the agency's attestation of compliance with its prudential policies and the Standard.

TAC's internal auditors conduct these reviews annually. Its internal audit in August 2014 found that TAC had strong controls in place to meet the obligations of the Standard and found management to have undertaken a thorough compliance process.

VWA's last internal audit was performed in August 2014 with no adverse findings. As a result of consistent findings that VWA maintained strong controls, processes and practices regarding prudential supervision and in agreement with VWA's internal auditors, this review was moved to a three-year rotational plan. The maintenance of annual internal audits would assist in ensuring that VWA critically and independently reviews its compliance every 12 months—consistent with the requirements of the Standard.

VMIA's internal auditors conduct a review annually. The last internal audit was completed in August 2014. This review identified no issues and confirmed that VMIA had strong controls in place to meet its obligations under the Standard.

Conducting annual internal audits of the agency's attestation process would be consistent with the requirements of the Standard, however, the Standard does not mandate how frequently internal audits need to occur.

5.3.4 DTF overview and monitoring

In addition to the annual attestation received from the agencies, DTF has implemented other processes to gain some assurance over the reliability of their annual compliance with the Standard.

However, DTF's position is that the agency boards are ultimately responsible for compliance with the Standard. This approach relies on agency boards exercising sufficient oversight to ensure that their organisations are prudently managed.

The supervision approach adopted by DTF is relatively 'light touch'—it relies primarily on the annual compliance certifications of the agencies and does not verify the accuracy of those certifications. DTF does obtain some assurance through the review of quarterly reporting by agencies, reviewing corporate and business plans and gathering other information from each agency.

DTF also participates in regular meetings with the agencies regarding investment strategies and actuarial reviews.

An internal audit was commissioned by DTF in June 2013 to review the adequacy of the Standard and DTF's actions to gain assurance that the Standard was complied with. Overall the internal audit found that the Standard and associated frameworks provided sound controls, however, two low-risk findings were identified. These findings noted that DTF should:

• formalise the monitoring processes and procedures guiding its staff as they execute their prudential duties—the lack of formalised procedures had led to inconsistent levels of documentation regarding work performed
• amend the Standard to bring it in line with other prudential standards in relation to the establishment and monitoring of risk management policies.

DTF accepted all of the recommendations made in the internal audit report and has undertaken the following actions:

• formal monitoring policies and processes to support the Standard have been developed and documented as a guide—under this guide a checklist is to be completed to assess if each agency fulfils its obligations under the Standard
• all processes are being reviewed for consistency and revised versions of the Standard have been drafted for consultation with the relevant agencies—the revised Standard is to reflect relevant APRA's standards for insurers.

In contrast to DTF's supervisory role over the insurance agencies, its prudential oversight of the Victorian Funds Management Corporation (VFMC) is more intensive. DTF not only receives compliance attestations from VFMC, but also engages a prudential supervisor who undertakes testing of the veracity and integrity of assertions VFMC provides. This includes testing substantive compliance with relevant requirements and undertaking direct reviews to gain assurance that VFMC has appropriate policies and processes in place to manage material risks.

DTF has not engaged an independent prudential auditor for the insurers, as insurance agency assets are managed by VFMC, and therefore the risks associated with their investment portfolios are effectively subject to a level of oversight by VFMC's prudential supervisor. This does not extend to consideration of capital adequacy or other key requirements of the Standard.

Additional testing of the insurance agencies' compliance with the Standard by a DTF appointed prudential auditor would provide significant and appropriate levels of assurance over compliance with the Standard. By comparison, APRA performs prudential reviews as part of its key supervisory activities to assess the effectiveness of processes and procedures at private sector insurers. A form of additional review by DTF would provide improved assurances regarding the prudential performance of the state's insurance agencies.

Recommendations

1. That the Department of Treasury and Finance strengthens its supervision of the insurance agencies by appointing a prudential auditor to provide independent assurance about the reliability of the insurance agencies' annual attestation of compliance with the Prudential insurance standards for Victorian Government insurance agencies.
2. That the Department of Treasury and Finance provides additional guidance to insurers regarding the level and frequency of internal audits to be conducted at all insurers, to ensure a consistent and comprehensive approach.
3. That the Victorian WorkCover Authority engages its internal auditors to conduct an annual assessment of its compliance with the Prudential insurance standards for Victorian Government insurance agencies, to bring its practices in line with the better practice undertaken by the other insurers.

6.1 Introduction

Infringement notices are issued by enforcement agencies—such as Victoria Police—to persons who have committed an offence. They generally require the offender to pay a fine, but may also attract other penalties—such as demerit points in the case of traffic offences. Actions that could incur a fine include speeding, running a red light, jaywalking, incorrect parking or not having a valid ticket for travel on public transport.

There are over 120 agencies that can issue an infringement notice. These agencies include local government entities, universities, hospitals and public transport bodies. Money collected by these entities in relation to infringement notices—with the exception of local government and university entities—is recognised as fine revenue by the State of Victoria.

This Part focuses on infringement notices issued through the former Department of Justice (DoJ) for three categories of offences—predominantly traffic offences—which make up 88 per cent of total fine revenue recognised by the state. These infringement notices are for:

• mobile and fixed traffic camera offences
• tollway offences stemming from journeys on the CityLink or EastLink toll roads
• 'on-the-spot' offences.

In 2013–14, 3.1 million infringement notices—3.5 million in 2012–13—were issued for these types of fines, generating revenue in DoJ's financial statements of $590.1 million—$632.6 million in 2012–13.

The former Department of Transport, Planning and Local Infrastructure (DTPLI) recognised revenue relating to public transport infringement notices of $18.0 million in 2013–14 compared with $16.8 million in 2012–13.

Infringement notices are only written off once they are deemed uncollectable—a minimum of five years after an enforcement order has been issued or the Magistrates' court has issued a warrant for the Sheriff's office to commence proceedings to collect the outstanding debt.

For the year-ended 30 June 2014, $53.1 million of fines under warrants were written-off by DoJ—$54.9 million in 2012–13. DTPLI wrote off $5.1 million of public transport fines in 2013–14—$5.5 million in 2012–13.

6.2 Conclusion

In 2013–14, $53.1 million of the fines under warrants relating to the categories assessed by this report, were written-off by DoJ compared with $54.9 million in 2012–13.

Debt management practices at the Department of Justice and Regulation (DJR) can be improved, as set out in this report.

6.3 Background

The framework for the issuing, serving and enforcement of infringement notices is governed by the Infringements Act 2006 (the Act). The Act details how an infringement notice can be issued, enforced and paid in the event of financial difficulties—through a payment plan, community work and/or imprisonment.

Other legislation, such as the Road Safety Act 1996, details the offences for which an infringement notice may be issued, and indicates the number of penalty or demerit points to be applied to a particular offence. The dollar value of each penalty point to be levied is set through the Monetary Act 2004, and revised annually.

In 2014–15, the legislative framework regarding infringement notices has been amended through the Fines Reform Act 2014, which introduces a new model for collecting and enforcing infringement notices. This became effective subsequent to the period covered in this report.

The former Attorney-General, as minister responsible for the Act, publishes an Annual Report on the Infringements System each year. The report provides a summary of the number and type of infringement notices issued during the financial year, and the initiatives taken to enforce them.

This Part focuses on fines issued by Victoria Police, through the DoJ, for:

• 'on-the-spot' fines
• mobile and fixed traffic camera offences
• tollway offences.

This Part also comments on public transport infringement notices issued through the former DTPLI.

'On-the-spot' offences

On-the-spot fines are issued by Victoria Police officers at the time an offence occurs. The officer will usually hand the infringement notice to the offender immediately. Some of the common offences that attract on-the-spot infringement notices are:

• speeding
• use of a mobile phone when driving
• driving a non-registered vehicle
• jaywalking
• drunk and disorderly behaviour.

Mobile and fixed traffic camera offences

Traffic camera infringement notices relate to all offences that are captured on mobile and fixed cameras. Common offences include speeding and not stopping at a red light.

Tollway offences

In order to travel on tolled sections of the CityLink and EastLink tollways, a driver must pay a toll. Where payment is not received, and the tollway operators have been unable to recover the toll through invoicing the owner of the vehicle, the details are passed to Victoria Police who issue an infringement notice.

Public transport offences

When an infringement notice is issued for an offence on public transport—such as travelling without a valid ticket—the infringement notice is issued through DTPLI. The offences which can occur on public transport are detailed in the Transport (Compliance and Miscellaneous) Act 1983.

6.4 Structure of the infringement notice systems

Infringement notices

An infringement notice can only be issued following the detection of an offence by an authorised member of an enforcement agency. It is then verified through the agency's quality checks to confirm an offence has occurred, and that it is enforceable. The responsible authority will then issue an infringement notice to the named person. It is expected that the offender will pay the fine associated with the infringement.

Figure 6A details the key stages of an infringement notice. At any stage of this process, the offender could nominate to pay the original infringement fine and any additional costs in full, or through a payment plan, community service or imprisonment.

Figure 6A

Stages of an infringement

Source: Victorian Auditor-General's Office.

Cancellations

Cancellation or withdrawal of an infringement notice may occur for several reasons, the most common being:

• when an infringement notice from a road safety camera is issued to the registered proprietor of the vehicle, and that person then nominates another person as the driver at the time of the offence—this results in a cancellation of the original infringement notice and a new one being issued
• the person receiving an infringement notice writes to the issuing agency to request an internal review of the offence prior to the matter proceeding to Magistrates' court, which may result in a withdrawal of the infringement notice and the issue of an official warning in its place
• the person to whom the infringement notice was issued successfully challenges the infringement at court—this can occur at any point in the process outlined in Figure 6A.

If an infringement notice is challenged at court, the original infringement notice, and any additional fees incurred up to this point are cancelled, and the offence becomes a matter for the court to review. If the challenge is successful, no costs are generally incurred by the offender. If the offence is upheld, a court fine will be issued which may be greater than the penalty imposed by the original infringement notice.

Write-offs

Non-payment of an infringement notice will attract additional fees as noted in Figure 6A. The write-off of an infringement notice—being the original fine plus any additional fees—will only occur after a minimum of five years has passed since an enforcement order was issued or the infringement court has issued a warrant for the Sheriff's office to commence proceedings to collect the outstanding debt for recovery. The five-year period came into force in 2010–11, extending the previous three-year period to recover the fine. Infringement notices can only be written off with the approval of the Attorney-General.

Enforcement orders can expire where an offender is not a Victorian resident as the infringement court does not have the power to enforce the infringement notice, or when the Sheriff's office is unable to locate the offender.

If the Sheriff's office is unable to locate the offender within five years the warrant will expire and the outstanding debt may be written off for accounting purposes. However, a new warrant can be issued at any time in relation to the outstanding debt, if the offender is located.

6.5 Internal controls

In 2013–14, DoJ was responsible for the administration and management of infringement notices issued by Victoria Police. As of 1 January 2015, this responsibility has moved to the new DJR.

This responsibility includes storing the details of the offence and person the infringement notice was issued to, conducting internal quality reviews to make sure the infringement notices issued are appropriate, and managing the stages outlined in Figure 6A.

A summary of the key agencies and systems involved in the administration and management of infringement notices is shown in Figure 6B.

Figure 6B

Key agencies and systems in the infringement notice process

Source: Victorian Auditor-General's Office.

Serco Traffic Cameras Pty Ltd

Serco Traffic Cameras Pty Ltd (Serco) is responsible for capturing evidence from both mobile and fixed traffic cameras across Victoria. These responsibilities include:

• managing and maintaining mobile traffic cameras
• operating mobile cameras as per site and time requests from Victoria Police.

Images captured by Serco are passed onto Victoria Police for verification checks to confirm that enforceable offences have been detected. The details of the offences are then provided to Tenix Solutions Pty Ltd (Tenix).

Tenix Solutions Pty Ltd

Tenix is responsible for recording the infringement details within the Victorian Infringement Management System (VIMS), as well as generating and issuing the infringement notices. This includes processing withdrawals, cancellations, and the generation of new infringement notices.

Information regarding an offence, once validated by Victoria Police, is provided to Tenix. DJR perform sample checks to make sure the infringement notice is enforceable.

VIMS interfaces with DJR's general ledger financial system, and provides the key financial information regarding fines revenue that is recognised in its annual financial statements. This is consolidated into the State of Victoria's annual financial report.

6.5.1 Assurance over outsourced providers

Pursuant to the Financial Management Act 1994, an entity is responsible for maintaining an effective internal control environment over its transactions. This responsibility extends to the control environment of external providers who provides services to the entity. Outsourced financial functions, such as VIMS—which provide information for the entity's annual financial statements—must also be subject to internal and external scrutiny. This helps to assure the entity about the accuracy and completeness of the data it receives.

VIMS is managed and maintained by Tenix on behalf of DJR. DJR needs to be assured that Tenix has designed, implemented and maintained the operating effectiveness of key controls. For the financial year-ended 30 June 2014, DoJ had not sought or received an assurance report from the auditors of Tenix regarding the operating effectiveness of key internal controls.

DJR, as the current responsible department, should seek assurance over the operating effectiveness of internal controls of its third-party service providers through mechanisms such as an auditor's report issued under the Australian Standard on Assurance Engagements ASAE 3402 Assurance Reports on Controls at a Service Organisation. This recommendation was raised with the former Secretary of DoJ, and the audit committee, through our management letter.

6.5.2 Oversight of outsourced providers

In 2013–14, DoJ monitored the performance of the outsourced providers Serco and Tenix according to a set of pre-determined key performance indicators (KPI's) and service standards as specified under their respective contracts. The KPI's are set up to assist in the accurate and timely issuing of an enforceable infringement notice. Subject to performance, the operators may be entitled to a financial bonus or abatement.

Some of the KPI's included in the contracts are:

• delivery of compliant camera hours—Serco
• time taken for the transfer of images to Victoria Police—Serco
• data accuracy—Serco
• issuing of infringement notices in a timely manner—Tenix
• warrant management—Tenix
• call centre performance—Tenix.

DoJ's oversight of its providers includes sample checking of data input into VIMS, review of evidence supporting an infringement notice, and quality control checks of discussions between the outsourced providers and the person who has received an infringement notice.

There are no requirements for Tenix, or Serco, to actively manage the collection of outstanding infringement notices.

6.6 Analysis of infringement notices

In 2013–14, 3.1 million infringement notices were issued for 'on-the-spot' fines, traffic camera and tollway offences—compared with 3.5 million in 2012–13—generating net revenue of $590.1 million in DoJ's financial statements—$632.6 million in 2012–13. During the same period, DTPLI recognised fine revenue of $18.0 million—$16.8 million in 2012–13.

Figure 6C details the value of infringement notices issued for each of the DoJ categories over the five-year period 2009–10 to 2013–14.

Figure 6C

Net revenue generated from infringement notices, 2009–10 to 2013–14

Source: Victorian Auditor-General's Office.

Cancellations

With respect to 'on-the-spot' fines, traffic camera and tollway offences, infringement notices worth $102.6 million were cancelled or withdrawn in 2013–14—$102.5 million in 2012–13.

Figure 6D shows the percentage of infringement notices for each of the DoJ categories that have been cancelled from 2009–10 to 2013–14.

Figure 6D

Percentage of cancelled infringement notices per category 2009–10 to 2013–14

Source: Victorian Auditor-General's Office.

In 2013–14, 18.5 per cent of infringement notices relating to traffic camera offences were cancelled compared with 18.4 per cent in 2012–13. This equates to $62.3 million compared with $62.7 million in 2012–13. This is significantly higher than the other categories of offences.

A key reason for cancellation of a traffic camera infringement notice is that the person receiving the notice nominated another person as the driver. At this point, the infringement notice is cancelled and a new notice issued.

Additional cancellations of infringement notices arise from requests by the offender to challenge the infringement in court, or to be issued with an 'official warning' instead of paying the notice. It should be noted that applications for official warnings are reviewed by Victoria Police on a case-by-case basis with the nature of the offence and the person's past driving history considered.

Write-offs

As at 30 June 2014, DoJ reported $1.62 billion—$1.46 billion at 30 June 2013—of outstanding debt relating to all infringement notices.

For the year-ended 30 June 2014, $53.1 million of fines under warrants, for the categories of offences reviewed in the Part, were written-off by DoJ—$54.9 million in 2012–13. Figure 6E highlights the level of fines under warrants written-off for each of the five years since 2009–10.

Figure 6E

Value of infringement fines under warrant written-off, 2009–10 to 2013–14

Source: Victorian Auditor-General's Office.

The level of write-off has remained relatively stable in recent years. Due to a change in policy during 2010–11, which extended the period before an infringement notice can be written-off from three to five years, no fines and fees relating to warrants were written off during 2010–11 and 2011–12.

Our audit indicates that DoJ does not analyse the write-off of fines by category, or type, to assist in improving the collection and enforcement of unpaid fines. Reports containing fines written-off by category, and type, are not generated.

We did, however, identify that DoJ prepared, and analysed, reports on the rate of collection of outstanding infringements, by category. This analysis focuses on the percentage of infringements collected but does not delve into detail about the level of, or reasons for, fines that are written off. A greater analysis of information relating to write-offs could improve the collection of unpaid fines.

6.7 Changes to the infringements framework

There were a number of reforms to the infringement framework during 2014, which have been designed to improve the framework, and are summarised below:

The Sentencing Advisory Council Report

The Sentencing Advisory Council (the Council) released a report in May 2014 on the imposition and enforcement of court fines and infringement notices in Victoria. The report was the Council's response to a government request for advice on these areas. The Council found that the current system of fines was fragmented, creating avoidable obstacles to both payment and enforcement.

In total 49 recommendations were proposed to reform the system, across the following themes:

• harmonising payment and management of court fines and infringement penalties
• enforcement by the administrative body
• enforcement by the court
• conversion of court fines and infringement penalties into imprisonment
• infringement penalties heard in open court and internal review
• tolling infringement offences
• imposition and enforcement of court fines and infringement penalties against children.

Fines Reform Act 2014

The Fines Reform Act 2014 introduces a new model for collecting and enforcing debts—including infringement notices—through the creation of a new body called Fines Victoria.

Key features of the Fines Reform Act 2014 include:

• a Director of Fines Victoria (the Director) is to be appointed by the Secretary of DJR to manage the recovery of legal debt
• more options will be introduced for vulnerable people with infringement fines who have incapacities and hardships to ensure that fair consideration of their circumstances are applied
• stronger and more automated enforcement sanctions will be applied by the Director to recover fines
• existing sanctions such as driver licence and vehicle registration suspension will be rolled out more widely
• availability of a single account for tracking and paying infringement and court fines
• oversight powers of the Director with regards to recommendations and reporting to the Attorney-General.

The Fines Reform Act 2014 received royal assent on 1 July 2014, and commences operation on 1 July 2016.

Road Safety Amendment (Operator Onus) Act 2012

The Road Safety Amendment (Operator Onus) Act 2012 amended the Road Safety Act 1986 resulting in changes with respect to infringement notices for traffic offences, amendments included within this came into operation on 1 July 2014.

The amendments were implemented to discourage businesses paying an infringement notice when an employee has broken the road rules while driving a corporate vehicle and to ensure demerit points are applied to individual drivers.

In the past, if a vehicle registered under a business name was involved in a traffic offence, the infringement notice was issued to the business. The business owners could choose to:

• pay the initial fine and a fine for 'failing to nominate a driver', which was $867 in 2013–14, or
• nominate an individual as the driver.

Where an individual was nominated the original infringement notice was cancelled and a new one issued to the individual, who also accrued demerit points. Where a business elected to pay the fines, no demerit points were accumulated.

Effective from 1 July 2014, a business is issued with an infringement notice of $2 952 per offence and there is no longer a fine for 'failing to nominate a driver'. Accordingly, a business can either:

• pay the $2 952 up to a maximum of three offences during a 12-month period before the matter is passed to the courts who may levy an additional fee of $17 713 per offence, or
• nominate an individual as the driver, which results in the original infringement notice being cancelled and a new one issued to the individual.

On-the-spot fines for public transport

Effective from 1 August 2014, on-the-spot public transport fines can now be issued by authorised public transport agency officers under changes to the Transport (Compliance and Miscellaneous) Act 1983. Similar to on-the-spot fines issued by Victoria Police, the offender can be issued with an infringement notice at the time the offence is recorded.

Public transport offenders will now be given an option of paying the infringement notice immediately, with a reduced penalty being imposed—$74 at 1 December 2014. If this option is not selected, the details of the offence are passed to the Department of Economic Development, Jobs, Transport and Resources—who took over responsibility for public transport offences on 1 January 2015—for a full-penalty infringement notice to be issued.

Recommendations

That the Department of Justice and Regulation:

1. obtains assurance over the operating effectiveness of internal controls at third‑party service providers
2. routinely reports on, and undertakes an analysis of, the categories and types of fines written off in order to improve the collection of unpaid fines.

7.1 Introduction

Victoria's alpine resorts are located at Mt Buller, Mt Stirling, Falls Creek, Mt Hotham, Mt Baw Baw and Lake Mountain. These alpine resorts are visited by over 1.2 million people annually. Victoria has five alpine resort management boards (the resorts) that oversee operations at each of these geographical locations.

The ability of the resorts to generate surpluses and be financially sustainable is subject to the fluctuations in annual snowfall. This presents a challenge to manage a business that is heavily dependent on the length of the winter season, snowfall levels and visitor numbers.

The objective of the resorts should be to maintain the condition of the public infrastructure assets that they manage, while servicing their debt levels and maintaining their operating activities within a financially sustainable framework.

This Part comments on the resorts' financial results and sustainability for the five years to 31 October 2013. The results of the alpine resorts had previously been reported within our Tertiary Education and Other Entities: Results of Audits parliamentary reports. In 2013–14 the format of the Tertiary sector report was altered with the results of universities and technical and further education (TAFE) institutes reported in two separate reports. As part of this alteration, the alpine resorts were removed from the Tertiary sector report and are now reported within this report.

The financial statements of the majority of the alpine resorts for the year-ended 31 October 2014 had not been finalised at the time of publication. Accordingly, this Part only considers the collective financial results for all the resorts to 31 October 2013. The results for the resorts to 31 October 2014 will be commented on as part of the Portfolio Departments and Associated Entities: Results of the 2014–15 Audits report.

7.2 Financial result

The Victorian alpine resorts reported a combined surplus of $0.6 million for 2012–13, compared with a $1.7 million deficit in 2011–12. This result is largely due to government support.

Figure 7A shows the total underlying operating results of the resorts for the years from 2008–09 to 2012–13, and the level of government support.

Figure 7A

Alpine resort's underlying operating results 2008–09 to 2012–13

Source: Victorian Auditor-General's Office.

We have been advised that the alpine resorts have put measures in place to improve their financial operations.

Total revenue generated by the alpine resorts in 2012–13 was $45.3 million. This was an increase of 3 per cent from the $43.8 million generated in 2011–12 and was largely due to increased government funding. While revenue from government funding has historically been approximately 10 per cent of total revenue for the resorts, there was an increase during 2012–13.

In line with expectations, total operating expenditure decreased in 2012–13 by 1 per cent to $44.7 million—predominantly due to a reduction in seasonal staff required to operate the resorts.

At 31 October 2013, the alpine resorts controlled $390 million of assets—$389 million in 2011–12. Asset balances have remained consistent over the past five years and are made up almost entirely of property, plant and equipment. Asset values are mainly affected by changes in underlying land values.

At 31 October 2013, the alpine resorts held combined liabilities of $13 million—$12 million at 31 October 2013—these mainly consist of trade payables, employee provisions and interest bearing loans. Liability balances have remained consistent over the past five years.

7.3 Financial sustainability risks

To remain financially sustainable, alpine resorts should be agile in regards to their expenditure and have contingency plans in place to respond appropriately to the unpredictability and variability in snow seasons. Our financial sustainability analysis shows there are inconsistencies in how well this is being achieved.

Figure 7B provides a financial sustainability risk assessment for each of the resorts for the five financial years to 31 October 2013.

Figure 7B

Financial sustainability assessments, 2008–09 to 2012–13

Source: Victorian Auditor-General's Office.

The resorts at Mt Baw Baw and Lake Mountain have been regularly assessed as high risk over the five years to 31 October 2013. This indicates there may be ongoing financial sustainability risks at these alpine resorts that are not being appropriately addressed. The results of the individual alpine resorts are included in Appendix B.

7.3.2 Capital replacement

Alpine resort activities and services are capital intensive and heavily reliant on infrastructure to generate revenue. The capital replacement indicator is a long-term measure of each resort's ability to maintain and replace these assets.

Our analysis of the trends in the capital replacement indicator over the past five years shows a decline in the spending on asset maintenance and renewal. Figure 7C shows the average capital replacement ratio for all five resorts over the five years from 2008–09 to 2012–13.

Figure 7C

Capital replacement ratio 2008–09 to 2012–13

Source: Victorian Auditor-General's Office

Over the five years to 31 October 2013, Mt Baw Baw has maintained a capital replacement indicator of less than one. This shows that the level of spending on asset maintenance and renewal has been less than the amount of assets consumed annually, as measured by depreciation.

While the capital replacement indicator for Mt Hotham and Mt Buller are greater than one, they are only marginally so. Consequently, these alpine resorts should also be closely monitoring the condition of their assets.

Recommendation

1. That the alpine resorts develop strategies to improve their long-term financial sustainability.

8.1 Introduction

This Part details the progress of significant projects underway in Victoria at 30 June 2014. The projects we comment on are those where Parliament or the public would have a reasonable expectation of independent disclosure of the related financial implications.

8.2 Port capacity project

The $1.6 billion port capacity project, announced in April 2012, aims to expand the Port of Melbourne's container and automotive terminal capacity. Its centrepiece is the redevelopment of Webb Dock and the construction of a new international container terminal capable of handling at least one million standard containers per year. The first international container is planned to cross the terminal's dock in December 2016.

The project also includes the consolidation of Victoria's car and automotive trade at a new facility to be built at Webb Dock West opposite the new container terminal, and alongside a new on-port automotive pre-delivery inspection facility. The automotive terminal will be designed to handle one million cars a year. The new facilities are expected to become progressively operational from late 2015, starting with the pre‑delivery inspection facilities.

The Port of Melbourne Corporation (PoMC) is responsible for funding and delivering the base infrastructure for the project. Works are being completed in:

• site preparation and other early works—including base earthworks and establishing site levels for the new facilities
• roads and services works—including constructing new roads to connect the terminal and Melbourne's freeway network
• maritime works—the largest component of the project, includes the delivery of a new 920 metre wharf, dredging and the associated re-engineering of the existing Webb Dock East wharves
• Swanson Dock works—facilitating the relocation of services at Swanson Dock dependent on the incumbent stevedores' commitment for further investment and expansion.

Once the base infrastructure is complete, private sector participants will be selected by PoMC to deliver, finance and operate the superstructure, including the:

• international container terminal—Webb Dock East—comprising around 30hectares of waterfront terminal, a utility 'off-dock' area and an adjoining empty container facility
• automotive terminal—including laying of pavement for vehicle storage
• pre-delivery inspection hub.

Also included in the project scope for the superstructure, is the facilitation of additional container capacity at the two existing container terminals at Swanson Dock.

8.2.1 Progress as at 30 June 2014

From October 2012, expressions of interest were sought in connection with the three base infrastructure works packages being funded by PoMC. Expressions of interest closed in December 2012.

The successful bidder for initial site preparation works commenced in March 2013 and those works were completed in November 2013.

A shortlist of bidders for the roads and services, and maritime works packages was identified in May 2013 to proceed to a 'request for proposal' phase. The announcement of the successful bidder was made in November 2013 for the roads and services works, and in January 2014 for the maritime works.

Construction associated with the roads and services works package is scheduled to be completed by mid-2015 and operational in early 2016. Construction associated with the maritime works package is scheduled to be completed by late 2016 or early 2017.

Bids for the privately-financed superstructure components of the project were sought by PoMC during 2013. The successful operators for the new automotive pre-delivery inspection hub and automotive terminal were announced in December 2013 and these facilities are expected to be operational by 2016. The successful proposal for the new international container terminal was announced in May 2014 and the facility is expected to be operational by late 2016 or early 2017.

The successful proponents for the superstructure components of the project will be awarded leases to operate the facilities until 2040, after which time the facilities, excluding equipment, will revert to PoMC. The project remains on schedule to be completed within approved milestones and budget.

8.2.2 Project expenditure

A breakdown of the budget, actual and committed expenditure—and expected completion dates for each component of the base infrastructure works as at 30 June 2014 is provided in Figure 8A.

Figure 8A

Port capacity project: base infrastructure: budget, actual and committed expenditure, and expected completion dates as at 30 June 2014

(a) Other expenditure supports the delivery of the base infrastructure works packages. It includes a risk event allowance to be utilised if identified project risks eventuate at any stage during the project's duration.

Source: Victorian Auditor-General's Office.

Total expenditure of $128.9 million had been incurred to 30 June 2014. This includes $113.0 million of capital expenditure and $15.9 million of other operating expenditure.

The base infrastructure works will be funded by PoMC at an estimated cost of $921 million. PoMC will borrow to finance these works and recover those costs through port charges.

The successful proponents for the superstructure components of the project—with an estimated construction cost of approximately $680 million—will privately finance those works. PoMC will not contribute to the construction costs or the operating costs during the lease term.

8.3 Regional Rail Link

The Regional Rail Link (RRL) will provide approximately 90 kilometres of new track to separate regional and metro trains between Southern Cross Station and West Werribee, via Sunshine. The project is being delivered in a number of works packages, and also includes extensive station works, and 15 new road and rail separations.

The Regional Rail Link Authority (RRLA) was established as an administrative office of the former Department of Transport, Planning and Local Infrastructure to manage delivery of RRL.

8.3.1 Progress as at 30 June 2014

RRL was originally expected to be completed by December 2014. Following a 2011 government review, the project completion time frame was changed to 2016. While the 2014–15 State Budget announced a revised earlier completion date of 2015, the Main Road St Albans level crossing works now included within the project are not expected to be completed until 2017.

Preparatory works and Southern Cross works have been completed, and the remaining works packages were underway at 30 June 2014.

8.3.2 Project expenditure

A breakdown of budget, actual and committed expenditure—and expected completion dates for each component of RRL, as at 30 June 2014 is provided in Figure 8B.

Figure 8B

Regional Rail Link: budget, actual and committed expenditure, and expected completion dates as at 30 June 2014

Source: Victorian Auditor-General's Office.

The original project budget of $4 317 million was revised in March 2011 to $5 568 million to include additional contingency provisions, signalling equipment, land acquisition, and the removal of the level crossings at Anderson Road, Sunshine.

A further amendment reducing the project budget to $4 807 million was approved in January 2013. The decrease was attributed to improved scope certainty, construction efficiencies and innovation, and removal of the contingency provisions.

The 2014–15 State Budget announced another amendment to the project budget, further reducing it to $4 102 million based on the current project delivery progress, while also including $202 million of level crossing works at Main Road St Albans within the project.

8.3.3 Project funding

The Commonwealth Government originally proposed funding of $3 225 million for the project over seven years from 2008–09, with the state to provide the remainder. However, the Commonwealth Government reduced its funding to $3 057 million in light of the 2014 budget revision. The state's contribution is therefore now budgeted to be $1 045 million.

8.4 Western Highway upgrades

The Western Highway upgrades comprise the following components:

• realignment of Anthony's Cutting near Bacchus Marsh
• construction of overtaking lanes and rest areas, and bridge strengthening works between Stawell and the South Australian border
• duplication of the Western Highway between Ballarat and Stawell.

8.4.1 Progress as at 30 June 2014

Anthony's Cutting realignment

The Anthony's Cutting realignment consists of two parts—a five kilometre highway connection and a new highway interchange. The highway connection was completed in June 2011.

In January 2012 the former Minister for Planning rejected a permit to remove five trees on Bacchus Marsh Road that form part of an Avenue of Honour. This meant the original scope for the highway interchange could not proceed.

Further planning activities—including community and stakeholder consultation—resulted in the development of a revised package of works known as the Bacchus Marsh Traffic Improvements Package. This package was announced by the then Victorian Government in March 2014. Planning and pre-construction activities have commenced. Ongoing discussions are occurring with the state, commonwealth and local governments to agree on scope and funding arrangements.

Stawell to South Australian border

Construction of overtaking lanes and bridge strengthening works between Stawell and the South Australian border were completed during 2013–14. In February 2014, the Commonwealth Government approved an additional road safety intersection and bridge works within the original $50 million budget. These works are expected to be completed in 2015.

Western Highway duplication

The duplication of the Western Highway, between Ballarat and Stawell, is being completed in stages.

Duplication between Ballarat and Burrumbeet was completed in January 2013. Duplication between Burrumbeet and Beaufort commenced in June 2012 and is expected to be completed in 2015—completion of this section has been delayed due to adverse weather.

In April 2014 a contract was awarded for the 15 kilometre duplication between Beaufort and Buangor. Construction commenced in late 2014 and is expected to be completed in 2016.

Expressions of interest have been called for construction of the Buangor Bypass. The bypass will add an additional six kilometres of duplicated road.

8.4.2 Project expenditure

A breakdown of budget, actual and committed expenditure—and expected completion dates for each project component as at 30 June 2014 is provided in Figure 8C.

Figure 8C

Western Highway upgrades: budget, actual and committed expenditure, and expected completion dates as at 30 June 2014

(a) Dependent on agreement between the state, Commonwealth and local governments to the scope and funding of associated works.

(b) Dependent on planning and funding negotiations with the Commonwealth Government.

Source: Victorian Auditor-General's Office.

The $505 million budget for the Western Highway duplication between Ballarat and Stawell is supported by a funding agreement with the Commonwealth's contribution capped at $404 million. The remainder is to be funded by the state.

The original funding allocation was sufficient to complete the duplication to Buangor, which is 50 kilometres short of Stawell. Additional funding of $157.3 million was approved in September 2014 to complete the duplication between Buangor and Ararat, which is still some 30 kilometres short of Stawell.

9.1 Introduction

Public private partnerships (PPPs) are increasingly being used by governments across Australia—alongside traditional procurement methods—to deliver social and economic infrastructure to the community.

At 30 June 2014, 19 facilities operated in Victoria under a PPP arrangement, and a further two were being built. The 21 PPPs are listed and described in Appendix E.

Infrastructure Australia—a Commonwealth entity—defines a PPP project as a project where:

• the private sector provides public infrastructure and any related services and
• there is private investment or financing.

Generally under a PPP, the private sector will design, build, finance, maintain and operate the public infrastructure for a period of time before transferring ownership of the asset to the state.

Although PPPs are an alternate financing vehicle to traditional government procurement methods, value for money should be a key consideration in determining between the public and private provision of infrastructure. Infrastructure Australia recognises that the aim of a PPP is to deliver improved services and better value for money primarily through appropriate risk transfer, encouraging innovation, greater asset utilisation and an integrated whole-of-life management, underpinned by private financing. PPPs can potentially deliver significant benefits in design, the quality of services and the cost of infrastructure by drawing upon the best available skills, knowledge and resources in the public or private sectors.

9.2 Delivery of, and accounting for, PPPs

Each PPP arrangement has its own unique characteristics and no two are the same. To promote better-practice and a consistent approach to their delivery, Partnerships Victoria—a division of the Department of Treasury and Finance (DTF)—released a framework which all Victorian public sector agencies entering into PPPs should comply with. The framework is underpinned by a national PPP policy and guidelines released by Infrastructure Australia, and is supported by other investment and asset management policies and guidelines released by DTF. Figure 9A details the Partnerships Victoria PPP framework and other relevant policies and guidelines.

Figure 9A

Relevant guidance for Victorian PPP infrastructure projects

Source: Victorian Auditor-General's Office from Partnerships Victoria Requirements, May 2013.

Accounting for PPPs is complex as both the public and private sectors have an interest in the underlying infrastructure. There is currently no Australian accounting standard which explicitly prescribes the accounting treatment for PPP transactions. The Partnerships Victoria framework provides guidance on the delivery of PPP projects, but not how to account for them.

AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors requires that transactions and other events are accounted for in accordance with their substance and economic reality, with reference to the requirements in other Australian accounting standards dealing with similar transactions. The application of AASB 108 requires management judgement, and it is common practice for agencies entering into a PPP to engage specialists to provide independent accounting advice. Not only is this at a cost to the state, it also increases the risk that agencies inconsistently apply Australian accounting standards when preparing financial statements.

In 2010 DTF prepared draft accounting and reporting guidance for PPP projects, aimed at ensuring consistency and best practice. The Victorian Auditor-General's Office was consulted, and provided input and feedback in 2011 and again in 2012 regarding the content of this material. It is therefore disappointing that—some four years on, and with an additional six PPPs being entered into over that period—this guidance has not been finalised and made available to portfolio agencies.

9.3 Disclosing the total cost of PPP projects

The total cost of PPP projects to the state is generally more than the PPP contract cost disclosed by the portfolio agencies in their annual financial reports and in the Annual Financial Report of the State of Victoria (AFR). This is because the state can incur additional direct costs relating to these projects, such as land acquisition, environmental works, and planning and preparation works, and these costs can be significant.

While these related PPP costs or commitments are included in the AFR, they may not be easily identified as associated with the PPP. This is because Australian accounting standards do not require all costs associated with a project or its development to be drawn together, and portfolio agencies do not elect to disclose the information collectively. Consequently, a reader of the financial statements may have difficulty in identifying and isolating the total costs associated with individual capital projects, be they part of a PPP or not.

Australian Accounting Standards set the minimum requirements for accounting and disclosures, however, for the public sector a higher level of disclosure around PPP projects would increase transparency for the public and minimise the opportunity for ambiguity and misunderstanding.

In light of these shortcomings, in this Part we analyse and comment on the total cost to the state of the 21 PPPs operating or being built in Victoria, over the remaining life of the contracts. We also comment on one significant PPP under procurement and two under construction.

9.4 Cost of PPP projects to the state

The private sector consortium responsible for delivering a PPP generally recoups costs associated with it through periodic service payments from the state, third-party user fees, or a combination of both. Each payment profile impacts the costs incurred by the state, and ultimately the financial performance and position of the state, differently.

The total nominal cost to the state of the 21 PPPs operating or being built in Victoria, over the remaining life of the contracts, is $36.6 billion—excluding GST. This includes $24.5 billion of capital and financing costs and over $12 billion of contracted operating and maintenance costs.

PPP arrangements generally meet the definition of a finance lease under Australian accounting standards. The present value of all finance leases—including some PPP's—are recognised in the balance sheet as a liability and are disclosed in the notes to of the AFR. However, amounts associated with PPPs cannot be distinguished from other finance leases, because:

• Interest charged on finance lease liabilities is expensed in the comprehensive operating statement as it is incurred, and is not recognised as a liability in the balance sheet.
• Future interest charges are disclosed in the notes to the AFR.
• Contracted operating and maintenance costs are accounted for as commitments which are also expensed in the comprehensive operating statement as they are incurred. They are not recognised as liabilities in the balance sheet, but are disclosed by way of note.
• The nominal and present values of operating and maintenance commitments associated with PPPs are disclosed in the notes to the AFR.

In addition to the 21 PPPs operating or being built in Victoria, there were four infrastructure projects at 30 June 2014 which were approved by the former government to be delivered by PPP—including stage 1 of East West Link, the CityLink Tulla widening project and the construction of Ravenhall prison. Stage 1 of East West Link is commented on below.

A further three projects were earmarked to be delivered in future years by PPP in the 2014–15 State Budget.

9.4.1 Service payment PPP

A service payment PPP is one where the government pays a private sector consortium a periodic service fee for the availability of a facility. Service fees over the life of the contract cover the cost of constructing, financing, maintaining and operating the facility. If the asset is not available for use, performance standards not met, or contracted services not provided, payments to the private sector consortium are reduced.

Nineteen PPP projects currently operating or being built in Victoria are being funded by periodic service payments from the government. The total annual nominal cost of these PPPs—excluding GST—over the remaining life of the contracts is provided in Figure 9B.

Figure 9B

Total annual nominal cost of service payment PPPs

Source: Victorian Auditor-General's Office.

Figure 9B only includes PPPs that were operating or being built in Victoria at 30 June 2014. As new PPPs are entered into annual costs will increase, and contractual obligations of the state are likely to extend past 2041–42.

The increase in costs in 2016–17 is a result of the expected commissioning of the Victoria Comprehensive Cancer Centre in June 2016 and stage 1 of the Bendigo Hospital development in December 2016. Amounts payable to the consortium for the Bendigo Hospital development include construction costs funded by a one off $566 million contribution by the state, payable to the consortium upon commissioning of stage 1 work.

Service payment PPPs result in greater budget certainty compared to a traditional procurement approach, due to whole-of-project and whole-of-life costs being incorporated into contracts. As indicated in Figure 9B, the payment profile is relatively even, with the exception of 2016–17, reflecting the level of service provision over the contract period.

However, the requirement to pay periodic service payments reduces the quantum of discretionary funds available in the future for other public services and infrastructure. This form of PPP creates long-term contractual obligations, generally over 20 to 30 years, where there is limited or no flexibility in the timing or value of payments. These PPPs require effective governance and contract management to ensure value for money is achieved. As projects move into their operating phase, it is important that government measures whether expected benefits of the PPP arrangement have been realised to inform future procurement decisions.

9.4.2 User-pays PPP

A user-pays PPP project is one where a third party pays a fee to use the infrastructure, and there is generally no direct payments by the state to the private sector. The project's financial performance depends on the number of users, and the cost to the state associated is generally in the form of foregone revenue. In some instances, the private sector consortium delivering a user-pays PPP is guarantee minimum revenue in the terms of the PPP and any short fall between actual user fees collected and minimum revenue guaranteed in the contract is met by the state.

EastLink and CityLink are the two PPP projects currently operating in Victoria that are being funded by user fees. There are no direct payments being made by the state to the private sector for these projects. Costs to the state are primarily associated with managing each contract.

As part of the EastLink and CityLink PPP arrangements, the state has leased certain land and road infrastructure to the private sector consortiums over the life of the contracts. At the expiration of the contracts, the assets are to be returned to the state together with the road networks.

The long-term direct financial impact on the state's Budget is significantly less for these PPPs compared to those funded through periodic service payments. The private sector generally bears some or all market (demand) risk, and the revenues earned through user fees should be sufficient to fund construction, repay debt, meet operating and maintenance costs, and generate the required equity return.

9.5 Auditing PPP arrangements

With 21 PPPs currently being operated or built by the government—on which $36.6 billion—excluding GST—of public funds will be spent—it is important that these arrangements are subject to the same scrutiny as other public spending.

However, as the state has increasingly sought partnerships, alliances or other service delivery models involving the private sector, the provisions of the Audit Act 1994 have failed to keep pace with these developments. Consequently, the Auditor-General's mandate to review public expenditure on large projects has diminished. Simultaneously there has been continued, if not increased, expectations from the community in terms of transparency and accountability.

This issue was raised in the Victorian Auditor-General's Office Annual Report 2013–14, tabled in Parliament in October 2014.

9.6 East West Link

The East West Link project is a proposed 18 kilometre new roadway that will extend across Melbourne from the Eastern Freeway to the Western Ring Road. Stage 1 of the project, or the eastern section, will run 6.6 kilometres from the end of the Eastern Freeway at Hoddle Street to CityLink at the Tullamarine Freeway. In mid-2014, planning was approved for stage 1 as well as a further southerly connection to the Port of Melbourne area. The Linking Melbourne Authority (LMA) is responsible for overseeing and managing delivery of the project on behalf of the State.

In September 2014, the state entered into a PPP with a private sector consortium to design, finance, construct, operate and maintain stage 1 at an estimated cost of $5.3 billion. The total project budget—including the PPP contract, other costs to the state and ancillary projects—is $7.3 billion.

The consortium will maintain the road for a 25-year period, after which time control reverts to the state.

The state contribution is $2 billion and the Commonwealth's contribution is $1.5 billion. The remainder is to be re-paid through periodic payments to the consortium over the life of the contract. The state would use toll revenues from road users to partly fund its contribution to the project.

In 2014, the former government also announced funding to continue planning stage 2, or the western section, of the project from the Port of Melbourne area to the Western Ring Road.

As at 14 January 2015, the East West Link project has been suspended while its future is being determined by the new state government. On 7 January 2015, the state government announced that LMA is to be disbanded.

Further comments, or audit findings on this project, may be included in future VAGO reports.

9.6.1 Progress as at 30 June 2014

Geotechnical drilling for stage 1 commenced in May 2012.

A shortlist of consortiums tendering for stage 1 was released in September 2013, the consortiums submitted their bids in April 2014, and the successful tenderer was announced—and contracts signed—in September 2014.

In November 2013, LMA acquired apartments in inner Melbourne at a cost of $96 million to facilitate the project. A financial contribution of up to $14 million was agreed in connection with the relocation of sporting facilities at Royal Park. Compulsory acquisition of further properties commenced in August 2014.

9.6.2 Cost to the state

A breakdown of the budget, actual and committed expenditure, and expected completion dates for preliminary stage 1 works underway at 30 June 2014 is provided in Figure 9C.

Figure 9C

East West Link preliminary stage 1 works: budget, actual and committed expenditure, and expected completion dates as at 30 June 2014

(a) Early stage works include the relocation of sporting facilities at Royal Park at an estimated cost of $14.1 million.

Source: Victorian Auditor-General's Office.

The former state government allocated $294 million in its 2013–14 Budget to commence procurement and preliminary works—including the preparation of a business case, engineering surveys, geotechnical drilling and property acquisitions. The timing of this funding was re-phased in the 2014–15 Budget to $191 million in 2013–14 and $103 million in 2014–15.

The state approved an additional $187 million in its 2014–15 Budget for further planning, procurement, property acquisition and other costs associated with stage 1.

9.7 Bendigo Hospital development

The Bendigo Hospital development involves the construction of a new expanded facility adjacent to the existing hospital. The project is being delivered in the following stages:

• stage 1—development of an integrated cancer centre and integrated mental health facilities
• stage 2—development of a multi-storey car park and helipad.

The Department of Health & Human Services (DHHS), in consultation with Bendigo Health, is responsible for delivering the project.

In May 2013, the state entered into a PPP with a private sector consortium to design, finance, build and maintain the new hospital for 25 years, before transferring ownership to the state.

9.7.1 Progress as at 30 June 2014

Construction of stage 1 commenced in June 2013 and is scheduled to be completed in December 2016. At 30 June 2014, site remediation, bulk excavation and construction of prototype rooms had been completed. Pouring of the basement ground slab was 90 per cent complete and formwork for level 1 of the west building and level 3 of the east building had commenced.

Construction of stage 2 is scheduled to commence in January 2017 and be completed in June 2018.

9.7.2 Cost to the state

Figure 9D details the state's financial commitments to the consortium and other costs it expects to incur over the life of the PPP.

Figure 9D

Bendigo Hospital and associated infrastructure: estimated cost of construction and operation, as at 30 June 2014

(a) The leased asset and liability will be reported in Bendigo Health Care Group's financial statements on commissioning of the new facility which is expected to occur in December 2016. The value of the asset will include construction costs funded by a $566 million state contribution, payable to the consortium upon commercial acceptance of stage 1 work.

(b) Discount rate of 8.06 per cent and 8.07 per cent used to calculate the net present value of the principal portion of stage 1 and stage 2 costs, respectively.

(c) Discount rate of 8.06 per cent and 8.07 per cent used to calculate the net present value of the interest portion of stage 1 and stage 2 costs, respectively. Discount rate of 7.18 per cent used to calculate the net present value of all other operating costs.

(d) Direct costs associated with establishing the contractual and lease arrangements, critical infrastructure work, fire services upgrade, demolition, enabling work, and relocation and building of five new ambulance stations around Bendigo.

Source: Victorian Auditor-General's Office.

As at 30 June 2014, costs of $70 million had been incurred by the state.

9.8 Victorian Comprehensive Cancer Centre

The Victorian Comprehensive Cancer Centre (VCCC) is intended to be a world-class cancer centre. Scheduled to be operational by June 2016, the facility will:

• house the relocated Peter MacCallum Cancer Centre
• provide new cancer research and clinical care facilities for Melbourne Health
• provide cancer research space for the University of Melbourne.

VCCC will consist of a north and south facility. In December 2011, the state entered into a PPP with a private sector consortium to design, finance and construct the south facility. The consortium will maintain the south facility for a 25-year period after which ownership will revert to the state. The consortium will also complete the north facility, however, these works do not form part of the PPP and are being delivered under a traditional procurement approach.

At the north facility, four new floors will be constructed on top of an existing Royal Melbourne Hospital building. They will house:

• a 42-bed critical care unit
• a new sterilising services department
• two new operating theatres—one with an intra-operative magnetic resonance imaging (MRI) machine
• a new 32-bed haematology inpatient unit.

At the south facility, a new 13 floor building will be constructed on the site formerly known as the Royal Dental Hospital. It will house:

• a 96 bed overnight inpatient unit
• 110 chemotherapy, medical and surgical same-day beds and chairs
• six operating theatres and two procedure rooms
• a dedicated clinical trials unit
• a cyclotron
• eight radiation therapy bunkers with five linear accelerators
• more than 25000 square metres of research space
• a 700-space basement car park.

The north and south facilities will be linked by covered bridges crossing Grattan Street, Carlton.

9.8.1 Progress as at 30 June 2014

As at 30 June 2014, construction was progressing to schedule.

North facility

Site works within the existing Royal Melbourne Hospital building have been completed to enable construction of the additional four floors. Construction of the four floors has commenced. The north facility is scheduled to be completed and available for service delivery in late 2015.

South facility

Structural works of the new building have been completed up to level seven. Commercial acceptance of the south facility is scheduled for June 2016.

9.8.2 Cost to the state

North facility

A breakdown of budget, actual and committed expenditure, and the expected completion date for the north facility as at 30 June 2014 is provided in Figure 9E.

Figure 9E

VCCC north facility: budget, actual and committed expenditure, and expected completion date, as at 30 June 2014

Source: Victorian Auditor-General's Office.

As at 30 June 2014, costs of $51 million had been incurred by the state for the north facility. Upon completion, the state will be responsible for the ongoing operation and maintenance of the north facility.

South facility

Figure 9F details the state's financial commitments to the consortium and other costs the state expects to incur on the south facility.

Figure 9F

Victorian Comprehensive Cancer Centre south facility: estimated cost of construction and operation, as at 30 June 2014

(a) The 2013–14 the former Department of Health's financial report disclosed that the leased asset and liability will be recognised on commissioning of the new south facility which is expected to occur in June 2016. The financed leased asset and liability will be reported in the Peter MacCallum Cancer Centre financial statements in 2015–16.

(b) Includes $300 million that the state will contribute towards the design and construction of the VCCC south facility during the construction phase.

(c) Discount rate of 9.17% used to calculate NPV

(d) Discount rate of 8.33% used to calculate NPV

(e) Management of project development, state delivered works, ICT, enabling works and relocation allowance.

Source: Victorian Auditor-General's Office.

As at 30 June 2014, costs of $164 million had been incurred by the state for the south facility.

9.8.3 Funding for the project

North facility

The north facility is funded through state and Commonwealth Government contributions.

South facility

The south facility is being funded through contributions from the state and Commonwealth governments, The University of Melbourne, as well as proceeds from the sale of Peter MacCallum Cancer Centre properties, philanthropic donations, and a loan from the Treasury Corporation of Victoria. Figure 9G details the funding sources for design and construction of the south facility.

Figure 9G

Victorian Comprehensive Cancer Centre: south facility funding sources:

Source: Victorian Auditor-General's Office

Recommendation

1. That the Department of Treasury and Finance finalises accounting and reporting guidance for public private partnership projects, and makes it available to Victorian public sector agencies.

RESPONSE provided by the Secretary, Department of Treasury and Finance

Acting Auditor-General's response to the Department of Treasury and Finance

The Secretary's response states that our recommendations are broadly accepted. What follows is an 'action' plan in which seven recommendations were actually accepted. Six recommendations had an agreement either to consider or to further consult. This is disappointing.

RESPONSE provided by the Secretary, Department of Education and Training

RESPONSE provided by the Acting Secretary, Department of Justice & Regulation