Quarterly Financial Report (QFR) for the Quarter Ended June 30, 2013

1. Introduction

This quarterly report has been prepared by management as required by section 65.1 of the Financial Administration Act and in the form and manner prescribed by the Treasury Board (TB). This report should be read in conjunction with the Main Estimates. This report has not been subject to an external audit or review.

The Defence mission is to defend Canada and Canadian interests and values, while contributing to international peace and security. On behalf of the people of Canada, the Canadian Armed Forces (CAF) and the Department of National Defence (DND) stand ready to perform three key roles:

• Defend Canada - by delivering excellence at home;
• Defend North America - by being a strong and reliable partner with the United States in the defence of the continent; and
• Contribute to International Peace and Security - by projecting leadership abroad.

The Defence mission is delivered through seventeen program activities. A summary description of these program activities can be found in Section II - Report on Plans and Priorities.

Basis of Presentation

This quarterly report has been prepared by management using an expenditure basis of accounting. The accompanying Statement of Authorities includes the Department's spending authorities granted by Parliament and those used by the Department consistent with the Main Estimates for fiscal year (FY) 2013-2014. This quarterly report has been prepared using a special purpose financial reporting framework designed to meet financial information needs with respect to the use of spending authorities.

The authority of Parliament is required before moneys can be spent by the Government. Approvals are given in the form of annually approved limits through appropriation acts or through legislation in the form of statutory spending authority for specific purposes.

As part of the Parliamentary business of supply, the Main Estimates must be tabled in Parliament on or before March 1 preceding the new FY. Budget 2012 was tabled in Parliament on March 29, 2012 after the tabling of the Main Estimates on February 28, 2012. As a result the measures announced in Budget 2012 could not be reflected in the 2012-2013 Main Estimates.

In fiscal year 2012-2013, frozen allotments were established by Treasury Board authority in departmental votes to prohibit the spending of funds already identified as savings measures in Budget 2012. In 2013-2014, the changes to departmental authorities were reflected in the 2013-2014 Main Estimates tabled in Parliament.

The Department uses the full accrual method of accounting to prepare and present its annual departmental financial statements that are part of the departmental performance reporting process. However, the spending authorities voted by Parliament remain on an expenditure basis.

2. Highlights of fiscal quarter and fiscal year to date (YTD) results

In the following section on financial highlights the Department is providing explanations for differences, for the fiscal quarter and fiscal YTD, at June 30, 2013 as compared to the same period last year, exceeding a materiality threshold of $20M or for those items with an unusual percentage increase/decrease.

Statement of Authorities

Total annual budgetary authorities available for use decreased in the first quarter of FY 2013-2014 from that of FY 2012-2013 by $1,815 million (9%). This net decrease is the result of decreases in Vote 1 spending authority of $1,217 million, in Vote 5 spending authority of $470 million, in Vote 10 spending authority of $81 million, and a decrease of spending authority for Statutory Payments of $47 million.

The change in spending authority is summarized below:

The $832 million decrease for the Canada First Defence Strategy (CFDS) is the result of the expired budgetary spending authorities, which were approved for a three year period between 2010-2011 and 2012-2013. For 2013-2014 and onwards, the department will seek renewed budgetary spending authorities for the CFDS through the supplementary estimates process.

The change in Vote 10 spending authority was due to a decrease in transfer payment programs and the decrease in Statutory Payments was largely due to lower employee benefit contributions as a result of the 2010 Strategic Review and Budget 2012 Spending Review.

Statement of Departmental Budgetary Expenditures by Standard Object

Compared to last year, overall expenditures increased $245.1M (6.6%) in the first quarter of FY 2013-2014 primarily due to a payment related to the Manuge v. Her Majesty the Queen class-action lawsuit (Manuge case).

The standard objects with the most significant increases in Q1, as compared to the same quarter last year were:

• Personnel ($89.9M) - primarily due to higher disability insurance costs brought about by the Manuge case;
• Utilities, Materials and Supplies ($20.2M) - primarily due to the replenishment of aviation fuel reserves emptied during maintenance of storage tanks; and
• Other Subsidies and Payments ($364.2M) - primarily due to a payment related to the Manuge case settlement.

These increases in the quarter were offset by expenditure reductions relating to:

• Transportation and Telecommunications ($21.4M) - primarily due to a reduction in travel and relocation costs;
• Professional, Special and Other Services ($54.6M) - primarily due to a change in the timing of Wideband Global Satellite Communications System payments compared to last year;
• Rentals ($26.8M) - primarily due to a reduction in expenditures for software applications brought about by Shared Services Canada (SSC) assuming responsibility for some of this activity as of 1 April 2013;
• Repair and Maintenance ($24.4M) - primarily due to a reduction in expenditures against the Department’s capital construction program; and
• Acquisition of Machinery and Equipment ($73.4M) - primarily due to changes in contractual delivery dates of several major projects.

Revenue increased by $20.4M primarily due to advance payments received from the United Kingdom related to the provision of service to British Army units training in Canada.

3. Risks and Uncertainties

To fulfill its mission, National Defence purchases the goods and services necessary to train military forces, conduct operations at the request of the Government of Canada and acquire related infrastructure and equipment both domestically and internationally.

As such, National Defence’s financial transactions are exposed to a broad range of external financial and economic risks such as inflation, foreign exchange and commodity price fluctuations. Depending on how these risks unfold, they could lead to surpluses or shortages. For example, an appreciation of the Canadian dollar or deterioration of commodity prices, oil in particular, could result in lower spending. Conversely, a depreciation of the Canadian dollar or increase in commodity prices could result in budget pressures.

National Defence’s capital acquisition program includes a number of large multi-year acquisition projects. Delays in contracting and procurement activities, or delays in deliveries by suppliers for individual projects, can lead to reduced expenditures or budgetary surpluses.

While National Defence considers key economic and financial risk factors including defence specific inflation and foreign exchange in developing expenditure strategies, these risks are outside of the control of National Defence.

Additionally, significant unforecasted operational demands can occur at any time, requiring National Defence to respond anywhere on the globe. Depending on the extent of the operational demand, the cost of unforecasted operations would be mitigated either through internal reallocations or by requesting incremental funding from Government.

4. Significant Changes in Relation to Operations, Personnel and Programs

Impacts related to change initiatives such as the 2010 Strategic Review and the savings initiatives related to Budget 2012 will continue to shape DND/CAF operations, personnel and programs throughout 2013-2014. Activities to find better, more effective and efficient ways for DND/CAF to do its work, and move into a new era of renewal will be ongoing. Despite the challenging economic times, DND/CAF will continue to deliver a combat-effective, multi-role military for Canada and Canadians by enhancing operational capabilities and reducing corporate and institutional overhead. Details related to Budget 2012 initiatives are provided in the next section.

5. Budget 2012 Implementation

This section provides an overview of the savings measures announced in Budget 2012 that are being implemented in order to refocus government and programs; make it easier for Canadians and business to deal with their government; and modernize and reduce the back office.

The departmental authority reductions as a result of Budget 2012 moving forward are:

• $692.4M in 2013-2014; and
• $1,106.1M in 2014-2015 and ongoing.

DND/CAF reviewed spending and programs to ensure they are effective and efficient, as well as responding to the priorities of Canadians. DND/CAF Budget 2012 initiatives focus on process reform, administrative efficiencies, reducing reliance on contracted services, and rebalancing the workforce. This allowed the DND/CAF to ensure the right people with the right experience were in place to realize the important missions for which they are responsible on behalf of all Canadians.

Savings for FY 2013-2014 will be achieved by maintaining the Regular and Reserve force strength of the CAF at 68,000 and 27,000 respectively, deferring anticipated growth over the medium term, and reducing total contracted services and grants and contributions.

The mitigation strategy has been to phase-in the reductions and to balance the savings across the Department, with a focus on increased efficiencies.

As of June 30, 2013, DND/CAF has achieved $ 307.4M (44%) of the $692.4M in proposed savings for FY 2013-2014. Maintaining CAF growth at the levels noted above has resulted in savings of approximately $251M in previously planned expenditures and a further savings of $0.4M has been achieved through reductions in grants and contributions. After considering expenditure reductions associated with Strategic Review and the transfers for Communications Security Establishment (CSE) and SSC, the net reduction to expenditures for contracted services is approximately $40.6M. Furthermore, a reduction in personnel costs for full-time Reservists and the civilian workforce related to Budget 2012 initiatives of $9.6M and $5.8M respectively has also been achieved.

Approved By:

Dated: 23 AUGUST 2013

Ottawa, Canada

6. Financial Tables

• Statement of Authorities
• Departmental Budgetary Expenditures by Standard Object