Public Hospitals: 2015–16 Audit Snapshot

Conclusion

In the year ended 30 June 2016, the public hospital sector generated a net deficit of $115.9 million—an improvement on the results from 2014–15.

We continue to assess the public hospital sector overall as having a medium financial sustainability risk level.

A challenge remains for some public hospitals to generate positive net results, and to replace assets faster than they use them.

Findings

Financial audit outcomes

Victoria's public hospital sector is made up of 87 public hospitals and 22 controlled entities. All of these hospitals and entities received clear audit opinions on their financial reports for the financial year ended 30 June 2016. Parliament and the Victorian community can have confidence in those reports.

The public hospital sector overall had a net deficit of $115.9 million in 2015–16—less than the $135.8 million net deficit in 2014–15. Increases in capital funding and revenue from private patients and residents drove this improvement.

Through our financial audits, we reviewed the relevant internal control frameworks of each public hospital, and found 236 control weaknesses and financial reporting matters that public hospitals need to address. Public hospitals have acted to remediate matters raised in previous audits—resolving 70 per cent of such matters in 2015–16. However some high and medium risk rated problems remain.

Financial sustainability

Overall the public hospital sector was assessed as having a medium risk to financial sustainability for the year ending 30 June 2016. However, some hospitals continue to face short-term challenges to meet their financial obligations over the next 12 months. This is consistent with our assessments in the previous five years. Capital replacement also remains a moderately rated financial sustainability risk for the sector overall.

Capital funding

In 2015–16, public hospitals received $901 million of capital and specific purpose income in the form of grants, donations and bequests, and capital contributions from the state and other parties. These funds are used by public hospitals to renew and upgrade existing assets, and acquire new assets.

Individual hospitals face challenges in generating sufficient income to renew assets at the pace they are consuming them. To address this, public hospitals continue to use short- to medium-term measures such as selling surplus assets or relying on donations as a means of funding. This is not sustainable in the long-term to address the shortfall between available capital funding and the sector's asset replacement needs for individual hospitals.

Recommendation

1. We recommend that public hospitals promptly address matters raised in this year's and previous audits to prevent their potential reoccurrence and rectify any weaknesses in their internal control environment to mitigate the risk of their financial statements having material errors (see Part 2).

Responses to recommendation

We have consulted with all of the public hospitals and the Department of Health & Human Services (DHHS) throughout the course of our audits, and we considered their views when reaching our audit conclusions. As required by section 16(3) of the Audit Act 1994, we gave a draft copy of this report, or relevant extracts, to those agencies and asked for their submissions and comments.

Three agencies provided responses for inclusion in this report. These responses are summarised below and the full responses are included in Appendix A.

DHHS notes that the report provides a reasonable analysis of the issue of public hospital financial sustainability, from the indicators used. It notes that the capital funding for public hospitals is managed through a central government allocation process, and that the department monitors hospital cash requirements on an ongoing basis.

Alfred Health and the Royal Children's Hospital highlighted that they will continue to work with DHHS on the items raised, and Alfred Health provided information on their capital plans, outlined in the case study in Part 4.

1.1 Victoria's public hospital sector

Victoria's public hospital sector is made up of 87 public hospitals and 22 controlled entities. The financial results of the controlled entities are consolidated into their parent entities' financial statements, and we do not discuss them separately in this report.

The Victorian public hospital sector provides health care services to all Victorians, and is primarily funded by the state and Commonwealth governments. Funding amounts vary, depending on the types of patients that hospitals treat and the services they provide.

A board governs each public hospital, in line with the Health Services Act 1988 and the terms and conditions of its funding. Each board is responsible to the Minister for Health for setting the strategic direction of the hospital, within the government's framework, and ensuring that the hospital:

• is managed effectively and efficiently
• provides high quality care and service delivery
• meets the needs of the community
• meets its financial and non-financial performance targets.

We have classified the 87 public hospitals into four groups—metropolitan, regional, rural and small rural—based on location, size and the funding they receive.

1.2 Funding public hospitals

1.2.1 Operating funding

Public hospitals must ensure their operations comply with the requirements of various agreements between the Commonwealth and state. These agreements include the National Health Reform Agreement, which, since July 2012, has provided for joint funding of public hospital services.

The National Health Reform Agreement outlines the responsibilities for public hospitals. It establishes a national framework for funding public hospital services using an activity-based funding (ABF) model—a system of funding based on the number of services provided to patients and the amount to be paid for delivering those services.

The state and Commonwealth also provide block grants for services provided by hospitals that may not be practicable to fund through ABF, such as teaching, training and research. Block funding is also provided for small rural hospitals.

Figure 1A shows the flow of funds from government to Victorian public hospitals.

Figure 1A

Funding flows from the Commonwealth and state to Victoria's public hospitals

Note: HACC is home and community care, a program that provides home support services so people can live independently at home for longer.

Source: Department of Health & Human Services.

1.2.2 Capital funding

At 30 June 2016, public hospitals controlled $13.5 billion in physical assets including buildings, furniture and fittings, minor plant and medical equipment.

Part 4 of this report contains further details on the capital funding for public hospitals.

1.3 What we cover in this report

In this report, we present a summary of the 2015–16 financial audits of Victoria's 87 public hospitals.

We identify and discuss the key matters arising from our audits and analyse information included in public hospitals' financial reports.

Figure 1B

Report structure

The financial audits of the 109 entities included in this report were carried out in accordance with section 15 of the Audit Act 1994 and Australian Auditing Standards. Each entity paid for the cost of being audited. The total cost of preparing this report was $235 000, which is funded by Parliament.

2.1 Conclusion

We issued clear audit opinions on all 87 public hospital financial reports for the financial year ended 30 June 2016. Parliament and the Victorian community can have confidence in those reports.

We found the internal controls that support public hospitals' financial reporting were adequate, to the extent we tested them.

The public hospital sector had a net deficit of $115.9 million in 2015–16—less than the $135.8 million net deficit in 2014–15. Increases in capital funding and revenue from private patients and residents drove this improvement.

The financial position of the public hospital sector improved, driven by a $93.7 million increase in the value of public hospital net assets in 2015–16.

2.2 Audits for the year ended 30 June 2016

Auditors' independent opinions on financial statements add credibility to those statements by providing reasonable assurance that the information they contain is reliable and accurate.

A clear audit opinion confirms that the financial report presents fairly the transactions and balances for the reporting period, in keeping with the requirements of relevant accounting standards and applicable legislation.

We conducted our financial audits of the public hospitals in accordance with the Australian Auditing and Assurance Standards.

Clear audit opinions were issued for all 87 public hospital and 22 controlled entities' financial reports for the financial year ended 30 June 2016.

2.3 The public hospital sector's financial results

We measure an entity's financial performance by its net result—the difference between its revenues and expenses. We measure an entity's financial position by looking at the difference between its total assets and total liabilities.

Figure 2A provides an overview of the financial performance and position of Victoria's public hospital sector for 2015–16 and 2014–15, by metropolitan, regional, rural and small rural groups.

Figure 2A

Financial overview of the public hospital sector, 2014–15 and 2015–16

Source: VAGO.

In 2015–16, the public hospital sector generated a net deficit of $115.9 million—an improvement of $19.9 million, or 14.7 per cent, on 2014–15. All groups except small rural hospitals reported better net results for 2015–16 than for 2014–15.

Revenue

In 2015–16, the 87 public hospitals generated revenue of $14.1 billion, including capital purpose income—an increase of $950.5 million, or 7.2 per cent, on 2014–15.

Activity-based funding and commonwealth block grants increased by $493 million, or 6.3 per cent, on 2014–15^[1]. There were also increases in capital funding and revenue from private patients and residents in 2015–16 compared to 2014–15.

Expenses

In 2015–16, the sector spent a total of $14.2 billion, an increase of $930.6 million, or 7.0 per cent, on 2014–15. This was due to employee benefits increasing by $496 million, or 5.8 per cent, and spending on supplies and consumables increasing by $285 million, or 16 per cent, on 2014–15.

2.3.1 Financial position

Assets and liabilities

At 30 June 2016, the sector controlled $16.5 billion in assets, an increase of $1.6 billion, or 10.6 per cent, since 30 June 2015. The sector also reported liabilities of $6.5 billion, an increase of $1.5 billion, or 29.7 per cent, since 30 June 2015.

This increase in both assets and liabilities was due mainly to the first-time recognition in the financial reports of the $1.3 billion private≠–public partnership asset of the Victorian Comprehensive Cancer Centre, which houses the new Peter MacCallum Cancer Centre, and the corresponding finance lease liability of $1.1 billion.

2.4 General internal controls and financial reporting

Effective internal controls help entities to reliably meet their objectives, and are a prerequisite for delivering reliable, accurate and timely external and internal financial reports. Poor internal controls make it more difficult for entities to comply with relevant legislation and increase the risk of fraud and error.

In our annual financial audits, we consider the internal controls relevant to financial reporting, and assess whether entities have managed the risk that their financial reports will be incomplete and inaccurate.

The board of each public hospital is responsible for setting up and maintaining internal controls that help to:

• prepare and maintain accurate financial records
• report promptly and reliably, externally and internally
• appropriately safeguard assets
• prevent and detect errors and other irregularities.

In this section, we discuss:

• internal control weaknesses and financial reporting problems common in the 87 public hospitals in 2015–16
• the status of control weaknesses and financial reporting problems that previous audits have found.

2.4.1 Common internal control weaknesses and financial reporting problems

During our financial audits, we found that public hospitals' internal controls, to the extent we tested them, were adequate for ensuring that financial reports were reliable. However, we found some instances where hospitals need to strengthen internal controls or address financial reporting matters.

During 2015–16, our audit teams reported 236 internal control weaknesses and financial reporting problems to management, boards and audit committees. Figure 2B shows the number of issues identified, by risk rating, excluding matters rated as low risk. We define each risk rating in Appendix C.

Figure 2B

Management letter matters by subject area and risk rating, 2015–16

Note: Figure 2B excludes 118 low-risk matters raised.

Source: VAGO.

Financial reporting matters

A financial report is prepared from data contained in a financial system that is supported by transaction-level data in sub-systems, such as accounts payable, fixed assets, cash and payroll systems.

A reconciliation of the sub-system and main-system balances confirms that information is complete and accurate. A timely, independent review of such reconciliations reduces the risk of inaccurate information, undetected errors and non-resolution of errors.

Nineteen public hospitals had reconciliation issues because no independent reviews took place, they were not prompt, or the differences between the systems were not explained or corrected.

Expenditure and accounts payable matters

In 2015–16, public hospitals paid suppliers $2 billion. Proper controls should be in place to ensure payments are correct. At 12 public hospitals, we found problems with the authorisation and processing of payments.

Public hospitals sometimes use corporate credit cards to pay suppliers. Effective controls ensure that all transactions are appropriate and approved. Thirteen public hospitals have weak controls over how staff use corporate credit cards. We found no supporting documents for credit card payments or reconciliation of corporate credit card transactions.

Information technology controls

Information technology controls protect computer applications, infrastructure and information assets from many threats to security and access. Effective information technology controls:

• promote business continuity
• minimise business risk
• reduce the risk of fraud and error
• help meet business objectives.

Public hospitals rely extensively on information technology. In the Financial Systems Controls Report: 2015–16, tabled in November 2016, we noted that, as in 2015, common matters raised across government were also found in the public hospital sector during 2015–16. They were mostly about users' access and authentication controls.

Continuing internal control weaknesses and financial reporting problems

Management letters inform management, boards, and audit committees about the status of internal control weaknesses and financial reporting problems found in previous audits. We monitor these weaknesses and problems to ensure that entities act promptly to resolve them.

Figure 2C shows the internal control weakness and financial reporting problems raised in previous audits, with the resolution status, by risk rating.

Figure 2C

Internal control weaknesses and financial reporting problems—resolution status by risk rating

Note: Figure 2C excludes low-risk matters raised.

Source: VAGO.

At the start of 2015–16, 158 issues remained open. Seventy per cent of these matters were resolved during 2015–16.

However, 10 high-risk and 38 medium-risk problems raised in previous years remain unresolved. Failure to resolve these problems reduces the effectiveness of the internal control environment. This could lead to public hospitals being unable to achieve their objectives, comply with relevant legislation or identify material misstatements.

Appendix C includes information about time lines for resolution of internal control weaknesses and financial reporting problems.

3.1 Conclusion

For the year ending 30 June 2016, we have assessed the public hospital sector as facing a medium risk to financial sustainability. This is consistent with our assessments in the previous five years.

3.2 Challenges to financial sustainability

We use four financial sustainability risk indicators for a five-year period to assess the risks that public hospitals face. The financial sustainability risk indicators are based on the consolidated financial statements of each public hospital. Appendix B describes the financial sustainability indicators, risk assessment criteria and benchmarks we have used, and provides detailed analysis of each public hospital.

Forming a definitive view of an entity's financial sustainability requires an analysis that moves beyond historical financial considerations to include the entity's financial forecasts, strategic plans, operations and environment. We do not examine these additional considerations in this report.

3.2.1 Overall assessment

Figure 3A provides a snapshot of the four financial sustainability indicators by group against the sector average for the past five years.

For the year ended 30 June 2016, after considering all the indicators, we have assessed the public hospital sector as facing a medium risk to financial sustainability.

Figure 3A

Public hospitals' financial sustainability

Note: Red indicates an assessment rated as high risk, orange indicates medium risk and green indicates low risk.

Source: VAGO.

3.2.2 Short-term indicators

Short-term indicators—net result, liquidity and available cash days—focus on a public hospital's ability to maintain operating cash flows and adequate cash holdings, and to generate an operating surplus over the short term.

The hospital sector has improved its performance and reduced the risk of financial issues in the short term. Although the sector generated a low liquidity risk and reasonably consistent average number of cash days available overall, 24 hospitals continue to face challenges to meet their financial obligations over the next 12 months. These hospitals sought written confirmation from the Department of Health & Human Services that adequate cash-flow support would be available, if required, to allow them to meet current and future operational obligations when they fall due.

Net result

Figure 3B shows the average net result indicator for the sector and by group for a five‑year period.

Figure 3B

Average net result indicator, 2011–12 to 2015–16

Source: VAGO.

The sector depends heavily on grant funding from the state and Commonwealth governments. Under the funding model, public hospitals receive predetermined activity and block funding based on the operational services they agree to deliver during the financial year.

3.2.3 Longer-term indicator

Public hospitals should be maintaining existing assets, and providing new assets, to enable them to provide the quality of services required by the community. The longer‑term indicator of capital replacement assesses the ability of public hospitals to replace or renew fixed assets at the rate they use them. Annual expenditure used to calculate the capital replacement ratio includes spending on replacing existing assets as well as spending on new assets. The ratio can therefore be distorted over the short term by large projects that require acquisition of new assets.

Capital replacement

Overall, the sector has a medium risk for capital replacement across a five-year period. However, as shown in Figure 3C, each group shows fluctuations in capital expenditure. Rural and small rural hospitals, in particular, struggle to sustain capital spending for renewing or replacing assets at the rate they depreciate.

The noticeable peaks in Figure 3C on the average capital replacement indicator result in each group over five years relate to specific key events:

• metropolitan group—spending to construct the Victorian Comprehensive Cancer Centre (through the Peter MacCallum Cancer Centre) in 2014–15
• regional group—the capital expenditure for stage 1 of the redevelopment of Echuca Regional Health in 2013–14
• rural group—the capital expenditure by Gippsland Southern Health Service for the Leongatha hospital redevelopment project in 2012–13
• small rural group—the capital expenditure mainly by four hospitals in central and northern Victoria to expand and redevelop hospitals in 2014–15.

Figure 3C

Average capital replacement indicator for public hospitals, 2011–12 to 2015–16

Source: VAGO.

Public hospitals generally receive capital funding from both the state and Commonwealth. Therefore, the timing and extent of a public hospital's major capital works affects the outcome of this indicator. Public hospitals need to assess the longer‑term risks of not replacing assets as quickly as they are consumed.

4.1 Conclusion

At an overall sector level, public hospitals appear to have adequate capital funding to cover depreciation. However, individual hospitals face challenges in generating sufficient income for capital works to keep pace with their consumption of assets.

To address this, public hospitals continue to use short- to medium-term measures such as selling surplus assets or relying on donations as a means of funding. These are not sustainable in the long term to address the shortfall between available capital funding and the need for asset replacement in individual hospitals.

4.2 Public hospitals capital funding

In 2015–16, public hospitals received $901 million of capital and specific purpose income in the form of grants, donations and bequests, and capital contributions from the state and other parties. These funds are used by public hospitals to renew and upgrade existing assets, and acquire new assets.

Figure 4A shows the total capital funding received by public hospitals across a five‑year period, classified by group.

Figure 4A

Capital funding received, 2011–12 to 2015–16

Source: VAGO.

Capital funding received by the public hospital sector has been relatively consistent over the last five years—averaging $852 million annually. Metropolitan and regional groups receive most of the capital funding as they manage $12.4 billion of the sector's $13.5 billion of assets.

Figure 4B shows total capital funding compared with total depreciation, over a five‑year period.

Figure 4B

Total capital funding and depreciation, 2011–12 to 2015–16

Source: VAGO.

At a sector level, total capital funding covers depreciation—which is a measure of the consumption of assets in a given year. However, capital funding is used not only to renew and upgrade existing assets, but also to acquire new assets. Large projects for new assets receive significant capital funding—for example, the Victorian Comprehensive Cancer Centre. Consequently the inclusion of new asset capital funding means that funding for existing assets may not equate to the depreciation of existing assets.

There are individual hospitals across the sector that are not replacing assets at the rate they are being used, as measured by depreciation. This is most prevalent in the rural and small rural hospital groups, who reported the least amount of capital funding relative to the metropolitan and regional hospitals.

Figure 4C shows the capital funding against depreciation for the rural and small rural groups.

Figure 4C

Total capital funding and depreciation for rural and small rural hospitals, 2011–12 to 2015–16

Source: VAGO.

Figure 4C shows, over a five-year period, that capital funding is lower than depreciation. As a result, public hospitals need to look at alternative sources of income to supplement their capital funding. This is consistent with our capital replacement indicator result in Figure 3A.

4.3 Case studies

We looked at four public hospitals to provide an insight into the challenges that hospitals face in funding asset renewal and replacement, and the actions they take to overcome those challenges. The four types of action these public hospitals took were to:

• identify and sell surplus assets
• use donations, usually given to a public hospital's charitable foundation
• seek additional funding streams, such as a loan from the Department of Health &Human Services (DHHS) or funds generated by subsidiaries
• work with DHHS to ensure that a redevelopment of the public hospital will provide funding for new equipment.

4.3.1 Selling surplus assets

Figure 4D shows a case where a small rural hospital sold surplus assets and applied other strategies to fund the purchase of assets or defer replacement.

Figure 4D

Case study: Castlemaine Health

Source: VAGO.

4.3.2 Donations

In 2015–16, the sector received $61.4 million in donations. Donations and fundraising activities are often used by public hospitals for health research, educational programs and as supplementary capital funding.

Figure 4E outlines the recent challenges faced by the Royal Children's Hospital (RCH) to fund new equipment that was not replaced when it moved into new premises in 2011. RCH received no significant extra capital funding between 2014−15 and 2015−16. It instead sought additional support from the Royal Children's Hospital Foundation (the foundation), to replace and upgrade equipment.

Figure 4E

Case study: Royal Children's Hospital

Source: VAGO.

4.3.3 External support

In some instances, public hospitals have sought to generate additional income streams to help replace assets. This has included income from subsidiaries that are generating surpluses and freeing up cash by seeking an interest-free loan from DHHS to fund operations.

In the case study in Figure 4F, we discuss the loan made to Alfred Health (AH) and the effect this loan will have on the hospital's ability to fund assets over the next four financial years as it is repaid and the revenue received by the hospital from its subsidiary Whole Time Medical Specialists Private Practice Trust (WT).

Figure 4F

Case study: Alfred Health

Source: VAGO.

4.3.4 Future redevelopments

In 2015–16, the government allocated $1 million to planning for the redevelopment of Goulburn Valley Health (GVH).

As at 30 June 2016, GVH held $102 million in fixed assets, of which $15.3 million are operating past their economic lives, and GVH must provide short-term solutions to keep these assets operational, as described in Figure 4G. GVH is working with DHHS to ensure that funding for new assets is part of the redevelopment plan for their public hospital.

Figure 4G

Case study: Goulburn Valley Health

Source: VAGO.

RESPONSE provided by the Secretary, Department of Health & Human Services

RESPONSE provided by the Chief Executive, Alfred Health

RESPONSE provided by the Chief Executive Officer, The Royal Children's Hospital Melbourne