May 2002
Audit of Fiscal Transfer Payments to the Provinces and Territories
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1. Executive Summary

Under the direction of the Department of Finance Internal Audit and Evaluation Division, Consulting and Audit Canada undertook an audit of two of the three fiscal transfer payments to the provinces and territories, specifically the Canada Health and Social Transfer (CHST) and the Territorial Formula Financing (TFF). In 1997, the Office of the Auditor General (OAG) performed a broad scope audit of the Equalization Program. Consequently, at this time, audit activity for the Equalization Program was limited to a review of the status of the Management undertakings resulting from the OAG audit.

The federal-provincial fiscal program, administered by the Federal-Provincial Relations Division of the Department of Finance, helps ensure that all provincial governments have sufficient revenues to provide reasonably comparable levels of public service at reasonably comparable levels of taxation. In 2001-02, the CHST will provide $34.4 billion in cash and tax points and the TFF will total $1.5 billion. These payments are extremely significant to the provinces and territories and as such, they receive close scrutiny by the provinces and territories.

The CHST is a statutory program, which is authorized and defined by the Federal-Provincial Fiscal Arrangements Act. TFF payments are "vote" items, which arise out of the Territorial Formula Financing Agreements between the Federal government and each of the three territories.

The objectives of the audit of the transfer payments were to ensure that the payments are being administered in compliance with relevant legislation, regulations and agreements and to ensure that management control mechanisms are in place and operating effectively. The audit proceeded under a phased approach with the first phase being the CHST and the second phase being the TFF. CHST and TFF calculations were tested for compliance with the governing acts and agreements and key management controls were documented, evaluated and tested.

Based on our tests and analysis, we conclude that the CHST and the TFF payments are administered in compliance with respective legislation, regulations and agreements and that control mechanisms are in place and operating effectively, and that appropriate action has been taken in response to the recommendations prescribed following the OAG audit of the Equalization Program.

As an additional service to management, process maps of the key activities and controls in the CHST and the TFF payment operations have been prepared and are annexed to this report.

2. Audit Objectives, Scope and Approach

2.1 Objectives

The objectives of the audit were to ensure that:

1. The CHST and the TFF program payments are made in accordance with the respective legislation and agreements;

2. Management control mechanisms are in place and operating effectively;

3. If required, the transfer payments complied with the Treasury Board Policy on transfer payments; and

4. Appropriate management action had been taken in response to the recommendations prescribed in the OAG’s audit of the Equalization program.

2.2 Scope

The audit focused on the program payment and estimate activities of the Federal-Provincial Relations Division, (FPRD) and addressed compliance and control effectiveness issues relative to the Program Payment and Estimates Section. Compliance was tested by comparing key CHST and TFF payment calculations to the enabling legislation and agreements. Control effectiveness was reviewed through risk and control analysis and through discussions with provincial and territorial counterparts. As the transfer payment amounts are audited annually by the OAG, during the Public Accounts audit, substantiation of these amounts or of inputs received from other areas was not performed in this audit. Additionally, one of the key sets of input values in the transfer payment calculations, personal and corporate income tax numbers by province and territory, is also audited annually, on behalf of the provinces and territories, by the OAG.

Program payment and estimate activities were not reviewed for compliance with the Treasury Board Policy on Transfer Payments as this issue had been addressed in discussions between the Department of Finance, Internal Audit and Evaluation Division and the Treasury Board Secretariat.

2.3 Audit Approach

The audit methodology consisted of:

• Interviewing selected staff members in the Federal-Provincial Relations Division, the Financial Services Division and Federal-Provincial Taxation Section;

• Reviewing relevant legislation and agreements;

• Documenting the significant activities of the CHST and the TFF calculation and payment process;

• Testing payment calculations for compliance with applicable legislation and agreements, identifying, assessing and examining key controls; and

• Interviewing by phone, a sample of provincial and territorial counterparts to the FPRD.

3. Audit Findings

3.1 Background

The Canada Health and Social Transfer payment program is the largest federal transfer to the provinces and territories. It is a combination of cash payments (2001-02 - $18.3 billion) and tax transfers (2001-02 - $16.1 billion) in support of health care, post-secondary education, and social assistance and services, including early childhood development. CHST estimates are calculated in February and October of each year. Estimates for each fiscal year are calculated / recalculated on eight successive, six month periods, as more accurate input numbers become available.

The Territorial Formula Financing is an agreement based, annually voted, federal cash transfer to the territories. The TFF allows the territorial governments to offer public services comparable to the provincial governments. The current agreements run from April 1, 1999 to March 31, 2004. The TFF is "gap-filling" based, in that through a series of formulas, it measures and pays the difference between the territories’ expenditure needs and their revenue means. As with the CHST, the TFF estimates are calculated and recalculated eight successive times, as new data become available. Because the TFF is a vote item and not a statutory transfer like the CHST, additional monitoring of payments in comparison with funding obligations is required to ensure compliance with voted amounts.

The CHST and the TFF programs are calculated by Program Payments and Estimates Section (PPES), in the Federal-Provincial Relations Division of the Department of Finance (FPRD) and are reviewed and authorized by the Director, FPRD. Program Payments and Estimates Section activities are supported by the General Legal Services Division, the Fiscal Policy Division and two sections of FPRD; CHST and Policy Development, and TFF and Northern Policy Development Sections. As these CHST and TFF payments are extremely significant to the provinces and territories, all three sections have regular interaction with their provincial and territorial counterparts. Provincial and territorial counterparts subject the transfer entitlements to varying degrees of scrutiny.

3.2 CHST Compliance

CHST estimate compliance testing was completed comparing the enabling legislation, the Federal-Provincial Fiscal Arrangements Act, (Part V, CHST), to the October 2001 estimates prepared by FPRD. Key formulas and balances from the Act were tracked to the October 2001 estimates and key calculations were reperformed. Testing indicated that the CHST payment process was in compliance with the Act.

3.3 TFF Compliance

TFF estimate compliance was tested by selecting a number of key elements from each of the three territorial agreements and tracking them to the October 2001 estimates prepared by FPRD. Recalculations of the selected elements were also performed. Testing indicated that the TFF payment process was in compliance with the three federal / territorial agreements.

3.4 Control Framework

During the audit, key management processes and controls were charted and evaluated, and the existence of significant controls was confirmed. Control design and performance were judged to be adequate.

The transfer values are estimated using complex formulas and end-user maintained computer applications. Calculations and payment reconciliations for both CHST and TFF are performed in a LAN based, EXCEL worksheet environment. Estimate and entitlement calculations and payment reconciliations are performed in EXCEL by professional level, FPRD employees. Revised amounts to be input to the EXCEL worksheets are entered to Input Tables and not directly to the EXCEL formula cells. This practice serves to protect the formulas from unintended changes to EXCEL calculation cells, when data entry occurs.

Before being released, both the CHST and the TFF estimates go through a fairly rigorous review process:

• For both CHST and TFF, two separate sets of a new estimate are calculated (by two separate employees) and any output differences between the two calculations are reconciled and appropriately adjusted.

• Also, newly calculated CHST and TFF estimates are validated through comparison to the most recent, previous estimates and explanations of any changes, which have occurred, are obtained and noted.

• Before release, both estimates and payments are reviewed by the Division’s management team and approved by the Director, Federal-Provincial Relations.

The Nature of Key Controls and the Operating Environment

Under the existing operations, which appear to be working well, key controls over CHST and TFF are officer dependent, as they rely on the knowledge and commitment of the Federal-Provincial Relations Divisional staff. Loss of key personnel could pose a risk to the continuity of operations.

Currently, the Program Payments and Estimates Section Chief and an Economist, are able to program, calculate and reconcile the CHST estimates. Also, the Chief and an Analyst are able to program, calculate and reconcile the TFF estimates. For both transfer payment programs, critical experience, knowledge and oversight responsibilities remain centered in the Chief through his efforts to confirm the accuracy and completeness of information. For any organization, the concentration of experience and knowledge is not a preferred arrangement.

This is particularly true, in an environment where end-user, worksheet type computer applications are being utilized. In an end-user environment, users perform application security, data input and verification, program development and execution, and report preparation and validation.

Senior management is aware and understands the nature of these risks to operations and the importance of insuring staff continuity. Process documentation and cross-training activities are currently underway, aimed at further strengthening operational continuity and increasing the number of people with expertise in all facets of CHST and TFF transfer payment processing.

Use of EXCEL

We assessed the risk exposures presented by reliance on EXCEL, an end user software, as the application system for the various transfer payment programs. Discussions have been held with two senior consultants, who have performed considerable system related analysis across government departments. In their view, they found EXCEL to be a robust software and the success of its utilization is largely dependent of the management knowledge and the key controls, which surrounds its use. To this end, management is encouraged to continue to provide key personnel in FPRD with opportunities to maintain and further their proficiency in EXCEL and their awareness of the data integrity features it provides.

3.5 Conclusion

We examined the management control framework surrounding the CHST and TFF transfer payment processes, including conferring with a number of FPRD's provincial and territorial financial counterparts. Based on this examination, we conclude that effective management control frameworks are in place over the calculation, payment and recording of CHST and TFF transfer payments.

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