Justice Canada payroll fiasco has lessons for investors

Thousands of lawyers at Justice Canada got as much as $50 million in time off they weren’t entitled to due to a multi-year administrative problem, reports CBC.

Justice department lawyers were responsible for entering leave into two scheduling systems, CBC explains. When a lawyer entered time off into the first program, she didn’t always update the second one, which was the actual payroll software. In more than 3,700 cases, the payroll software showed the lawyers had unused leave, even though they had already taken it.

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The situation has set off an administrative and labour-relations headache for the ministry, and a payroll review stretching back to 2007. Yet the cost of the mistake, first noticed in 2013, wasn’t reported in the government’s financial statements.

A CBC source within the department alleges the ministry was trying to avoid reporting the mistake to the House of Commons. But CBC reports the only public mention of the problem is a single reference to “new key controls” for leave in the notes to the department’s financial statements.

An internal department document also states the mistake only cost $2.5 million, a number so small the ministry deemed it immaterial to its finances, and therefore unnecessary to report. However, the Treasury Board, which sets government-wide policies, says “the concept of materiality does not apply in recording and reporting on appropriations usage; all amounts are important.”

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The CBC article states the government’s accounting standards aren’t as strict as the ones for publicly traded companies, and that “publicly traded private-sector companies are compelled by strict regulations to disclose multimillion-dollar accounting errors.”

Unfortunately for investors, “that’s just nonsense,” says Al Rosen, co-founder of Accountability Research Corporation. He was a technical advisor to three Auditors’ General of Canada and is a past chair of the Canadian Justice Review Board.

“Materiality is defined as whether [the amount is] an omission or an inclusion that would change a person’s decision or influence their decision to buy, hold or sell.” As a number, Rosen says materiality usually starts between 5% and 10% of profit before tax. So, for a company with $1 billion in pre-tax profit, $50 million could be material, but for a company with $2 billion in pre-tax profit, $50 million might not be.

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Further, he says, materiality depends on what each company’s directors, officers and auditors deem it to be. “Each company sets its own materiality limits, but that’s not understood by analysts and the general investing public.” North American accounting standard-setters have attempted to create rules over the years, but “they’ve always backed away.”

As for how materiality is defined within the federal government, Rosen says he’d look at whether the annual deficit was misstated due to the exclusion of the amount in question. In 2013/2014, the deficit was $5.2 billion (5% of that is $260 million).

While the Department of Justice’s net financial position in 2013/2014 was negative $25.7 million – on the same level as a $50 million misstatement – Rosen says governments define materiality differently. “It would tend to be judged on whether [the amount] will affect your credit rating if you issued more bonds.”

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That’s not to say the payroll issue is “small potatoes,” as it was characterized by union and management officials, according to the CBC’s source.

“I would attack the looseness of the system,” says Rosen, “and why it’s taken this long to discover the problem and analyze whether there’s any money owed.” He’d also be concerned if other departments were also using dual timekeeping systems.

“Would I change my view of how efficiently the government is being run because of $50 million? No. But would I be concerned that they seem to be ignoring their own systems? Yes.” He says these type of system issues should fall under the purview of the Auditor General and Comptroller General of Canada.

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.