Opinion

In my opinion, the financial statements of the Department of Defence (Defence) for the year ended 30 June 2020:

1. comply with Australian Accounting Standards – Reduced Disclosure Requirements and the Public Governance, Performance and Accountability (Financial Reporting) Rule 2015; and
2. present fairly the financial position of Defence as at 30 June 2020 and its financial performance and cash flows for the year then ended.

The financial statements of Defence, which I have audited, comprise the following statements as at 30 June 2020 and for the year then ended:

• Statement by the Accountable Authority and Chief Finance Officer;
• Statement of Comprehensive Income;
• Statement of Financial Position;
• Statement of Changes in Equity;
• Cash Flow Statement;
• Administered Schedule of Comprehensive Income;
• Administered Schedule of Assets and Liabilities;
• Administered Reconciliation Schedule;
• Administered Cash Flow Statement; and
• Notes to and forming part of the financial statements, comprising a Summary of Significant Accounting Policies and other explanatory information.

Basis for opinion

I conducted my audit in accordance with the Australian National Audit Office Auditing Standards, which incorporate the Australian Auditing Standards. My responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of my report. I am independent of Defence in accordance with the relevant ethical requirements for financial statement audits conducted by me. These include the relevant independence requirements of the Accounting Professional and Ethical Standards Board’s APES 110 Code of Ethics for Professional Accountants (including Independence Standards) (the Code) to the extent that they are not in conflict with the Auditor-General Act 1997. I have also fulfilled my other responsibilities in accordance with the Code. I believe that the audit evidence I have obtained is sufficient and appropriate to provide a basis for my opinion.

Key audit matters

Key audit matters are those matters that, in my professional judgement, were of most significance in my audit of the financial statements of the current period. These matters were addressed in the context of my audit of the financial statements as a whole, and in forming my opinion thereon, and I do not provide a separate opinion on these matters.

Key audit matter
Valuation of specialist military equipment

Refer to Note 3.2A ‘Reconciliation of the opening and closing balances of property, plant and equipment, and intangibles’

Specialist military equipment includes platform assets in use and under construction and spare parts for these assets.

I considered the valuation of specialist military equipment to be a key audit matter due to:

• the balance being significant relative to Defence’s Statement of Financial Position ($71.8 billion as at 30 June 2020);
• the high degree of judgement applied by management to measure specialist military equipment at fair value due to the highly specialised nature of these assets; and
• the subjectivity in the valuation assessment due to the difficulty in obtaining the replacement costs of assets with a similar capability in the absence of an active market, the selection and application of appropriate indices, the determination and assessment of appropriate useful lives, and the identification of indicators of impairment.

How the audit addressed the matter

To address the key audit matter, I:

• assessed whether the selection of the method for determining fair value was appropriate for each class of specialist military equipment;
• assessed the competence, capability and objectivity of Defence’s valuation subject matter experts;
• tested the completeness and accuracy of data used in the year-end valuation process;
• assessed whether the useful lives applied to specialist military equipment (for the calculation of depreciation) were consistent with other available information including expected withdrawal dates for these assets;
• tested the accuracy of a sample of cost attribution models, and approvals of cost allocations related to specialist military equipment under construction;
• assessed whether the assumptions and judgements used by Defence to determine the impairment of specialist military equipment are consistent with other available information including changes to planned capability and unscheduled repairs and maintenance; and
• assessed management’s assurance process for impairment and inspected a sample of assets for indicators of impairment.

Key audit matter
Valuation of general assets

Refer to Note 3.2A ‘Reconciliation of the opening and closing balances of property, plant and equipment, and intangibles’

General assets comprise land and buildings ($20.0 billion), infrastructure ($6.5 billion), plant and equipment ($1.8 billion), heritage and cultural assets ($474.1 million) and intangibles ($899.3 million). These balances include assets under construction by Defence which are typically long term projects.

I consider the valuation of Defence’s general assets to be a key audit matter due to:

• balances being significant relative to Defence’s Statement of Financial Position;
• the high degree of management judgement required in respect of classifying project costs as capital or expense and the selection of valuation methods to measure fair value;
• the valuation of Defence’s land, buildings, infrastructure, plant and equipment and heritage and cultural assets being dependent on assumptions that require significant management judgement. These include capitalisation rates, current replacement costs, discount rates, and conditions of the assets. Where observable market data is not available, the valuation is subject to a higher level of judgement; and
• the subjectivity in determining appropriate useful lives and the assessment of the financial impact of indicators of impairment.

How the audit addressed the matter

To address the key audit matter, I:

• evaluated the appropriateness of Defence’s methodologies and the reasonableness of its key assumptions utilised in the valuation models;
• assessed the competence, capability and objectivity of management’s valuers;
• assessed whether the useful lives applied to the various asset classes (for the calculation of depreciation) were consistent with Defence’s planned usage of these assets;
• tested a sample of costs allocated to general assets under construction to assess the appropriateness of capitalisation in accordance with the Australian Accounting Standards; and
• assessed the reasonableness and appropriateness of judgements used by Defence to assess non-financial assets for impairment. This included the process of Defence to monitor impairment indicators specific to an asset’s use in the Defence context.

Key audit matter
Existence and completeness of inventories

Refer to Note 3.2B ‘Inventories’

Defence had a balance of $7.4 billion in inventories as at 30 June 2020 which include general stores inventories ($2.3 billion), fuel ($68.0 million) and explosive ordnance ($5.0 billion).

I consider the existence and completeness of inventories to be a key audit matter due to the variety and number of inventory items which are managed differently across a large number of geographically dispersed locations.

A key element of assurance as to the existence and completeness of Defence’s general stores inventories is the completion of an annual National Asset and Inventory Sample. This statistical approach is developed with the assistance of an expert engaged by Defence. The COVID-19 pandemic affected the ability of Defence to fully execute the planned 2019-20 activities. Travel and movement restrictions necessitated the selection of alternate locations and resulted in reduced coverage. Travel and movement restrictions also adversely impacted the ability to obtain audit evidence as to the existence and completeness of inventory in 2019-20.

How the audit addressed the matter

To address the key audit matter, I:

• assessed whether Defence’s COVID-affected National Asset and Inventory Sample remained appropriate given the changes to the planned approach;
• observed the performance of Defence’s National Asset and Inventory Sample at a selection of Defence locations prior to the COVID-19 pandemic;
• re-performed a sample of counts performed by Defence under its National Asset and Inventory Sample subsequent to its executed program where I was unable to observe the initial activity as planned;
• tested the design and operating effectiveness of key controls that apply to system components, processes and data within the logistics and financial management information systems; and
• substantiated a sample of transactions processed through Defence’s logistics information systems by agreeing quantities purchased to invoices, warehouse delivery dockets and stock taking records.

Key audit matter
Valuation of employee provisions

Refer to Note 4.4A ‘Employee provisions’

Defence administers four defined benefit plans that entitle Australian Defence Force members to retirement and death benefits based on past service.

I consider the valuation of the administered employee provisions to be a key audit matter due to:

• the balance being significant relative to Defence’s Administered Schedule of Assets and Liabilities ($188.2 billion as at 30 June 2020); and
• the measurement of the provision being complex, requiring significant professional judgement in the selection of key long-term assumptions (including such matters as salary growth and discount rates, pension indexation rate, pension take-up rate and invalidity retirements) to which the valuation of these plans are highly sensitive.

In addition, the Australian Accounting Standards include detailed requirements for the presentation and disclosure in respect of defined benefit plans.

How the audit addressed the matter

To address the key audit matter, I:

• assessed the design and operating effectiveness of key internal controls over membership data used for the valuation of the defined benefit provisions;
• evaluated the reasonableness of the review performed by management’s expert to confirm the integrity of the data used for estimating the defined benefit provisions;
• evaluated the appropriateness of the methodology and reasonableness of the key assumptions applied in estimating the defined benefits;
• assessed the reasonableness of the results of the valuation including the explanations for the changes in the valuation; and
• evaluated the appropriateness of the disclosure of the significant assumptions applied, including sensitivity analysis.

Accountable Authority’s responsibility for the financial statements

As the Accountable Authority of Defence, the Secretary is responsible under the Public Governance, Performance and Accountability Act 2013 (the Act) for the preparation and fair presentation of annual financial statements that comply with Australian Accounting Standards – Reduced Disclosure Requirements and the rules made under the Act. The Secretary is also responsible for such internal control as the Secretary determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the financial statements, the Secretary is responsible for assessing the ability of Defence to continue as a going concern, taking into account whether Defence’s operations will cease as a result of an administrative restructure or for any other reason. The Secretary is also responsible for disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the assessment indicates that it is not appropriate.

Auditor’s responsibilities for the audit of the financial statements

My objective is to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes my opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with the Australian National Audit Office Auditing Standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements.

As part of an audit in accordance with the Australian National Audit Office Auditing Standards, I exercise professional judgement and maintain professional scepticism throughout the audit. I also:

• identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for my opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control;
• obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of Defence’s internal control;
• evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by the Accountable Authority;
• conclude on the appropriateness of the Accountable Authority’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on Defence’s ability to continue as a going concern. If I conclude that a material uncertainty exists, I am required to draw attention in my auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify my opinion. My conclusions are based on the audit evidence obtained up to the date of my auditor’s report. However, future events or conditions may cause Defence to cease to continue as a going concern; and
• evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation.

I communicate with the Accountable Authority regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that I identify during my audit.

From the matters communicated with the Accountable Authority, I determine those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters. I describe these matters in my auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, I determine that a matter should not be communicated in my report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.

Australian National Audit Office

Grant Hehir
Auditor-General
Canberra 1 October 2020