Part 1: The 2002-03 Audited Financial Statements of the Government

Central government: results of the 2002-03 audits.

The Auditor-General issued the audit opinion on the Financial Statements of the Government of New Zealand for the Year Ended 30 June 2003 (the Financial Statements) on 18 September 2003. This is the same date on which the Minister of Finance, and the Secretary to the Treasury, signed their Statement of Responsibility for the Financial Statements.

Unqualified Opinion Issued

The audit report appears on pages 20-21 of the Financial Statements. The report includes our unqualified opinion that those statements:

  • comply with generally accepted accounting practice in New Zealand; and
  • fairly reflect:
    – the Government of New Zealand’s financial position as at 30 June 2003; and
    – the results of its operations and cash flows for the year ended on that date.

As in previous years, the Treasury has provided a comprehensive commentary on the financial performance and position, which is presented on pages 6-17 of the Financial Statements.

In addition to that commentary, we draw attention to the following significant items reflected in the reported results.

Consolidation Issues

The Financial Statements have been prepared on a fully consolidated basis for the first time for the year ended 30 June 2003. The Treasury has put significant effort into establishing systems and processes to capture and accurately report fully consolidated information. In general, the move to full consolidation went very smoothly.

Financial Reporting Standard No. 37: Consolidating Investments in Subsidiaries

Financial Reporting Standard No. 37: Consolidating Investments in Subsidiaries (FRS-37) came into effect for the 30 June 2003 Financial Statements, and is one of the drivers behind the switch to full consolidation. A significant aspect of FRS-37 is a revised set of tests to determine which entities are controlled and hence subject to consolidation within the Financial Statements.

The FRS-37 control test contains two limbs – a “power” limb and a “benefit” limb. When both limbs are satisfied, then an entity is controlled for the purposes of financial reporting.

The application of the control test to the Crown has proved difficult, particularly in cases where legislation provides entities with statutory autonomy and independence such as Tertiary Education Institutions (TEIs). Reaching a consensus on the application of the control test for TEIs has been a complex and time-consuming issue. Although the Treasury has been working on the issue since late-2001, the accounting treatment adopted in the 2003 Financial Statements was resolved only during the year-end audit.

The accounting treatment that the Treasury has adopted in the Financial Statements is to equity account for TEIs based on a 100% interest, rather than using line-by-line consolidation. This approach is based on a view that the control test is not satisfied because the Crown does not have the ability to determine the financing and operating policies of TEIs. However, the Crown’s relationship with TEIs does meet the “significant influence” test necessary for equity accounting under Financial Reporting Standard No. 38: Accounting for Investments in Associates. As the Crown’s interest in the TEIs’ residual assets is 100%, the somewhat unusual accounting policy adopted is 100% equity accounting for TEIs. This approach and the reasons for it are set out in Note 13 to the Financial Statements.

The accounting treatment adopted in the 2003 Financial Statements is based on a strict interpretation of the mandatory elements within FRS-37, rather than a more comprehensive interpretation of the standard that could be formed from reading the mandatory elements and the accompanying commentary paragraphs.

In our view, line-by-line consolidation is the treatment that best reflects the substance of the relationship between the Crown and the TEIs, and the intent of FRS-37. We have accepted equity accounting for TEIs, as the treatment does arguably comply with a strict interpretation of the mandatory elements within FRS-37, and because of the additional disclosures provided in Note 13 to the Financial Statements.

The additional disclosures enable readers to understand the effect on the financial statements if a line-by-line treatment had been adopted for TEIs. With these additional disclosures, we have accepted that the financial statements remain fairly stated.

The interpretation of FRS-37 adopted in relation to the TEIs had the potential to affect the accounting treatment for a number of other entities within the Financial Statements. Because of the late resolution of the TEI consolidation issue, the timetable was tight for analysis of the effect on other entities. This led to some difficulties in agreeing the correct treatment within the Crown reporting timetables.

As a result of this analysis, the financial statements of Offices of Parliament were removed from the consolidated Financial Statements. This was done because these entities do not meet the test for Crown control given their statutory independence, and the fact that the House of Representatives determines their appointments and budgets. Because of their small size, the removal of these entities has not had a significant effect on the Financial Statements.

We are aware that the Treasury has initiated discussions with standard-setters to seek clarification on the application of the control test in FRS-37 in the Crown context, and that the Financial Reporting Standards Board of the Institute of Chartered Accountants of New Zealand has agreed to consider the issue. It should also be noted that, in the future, the adoption of standards based on International Financial Reporting Standards (see pages 67-76) might again change the control test to be applied.

The Government is also proposing legislative change in the Public Finance (State Sector Management) Bill to incorporate a wider definition of the Crown reporting entity.

The timetable for the legislative change and any amendments to FRS-37 is not yet clear, and neither is it certain to happen. In any event, it is unlikely that there will be sufficient progress to enable any change in the treatment in the 2004 Financial Statements. We will monitor developments in this area, and provide input to the change processes.

Ministry of Health – Consolidation of District Health Boards

Last year, we highlighted the problems that arose in obtaining assurance over the accuracy of the consolidated financial results of District Health Boards (DHBs).1 Although there has been some improvement on this issue compared to 2001-02, the quality of the processes and controls in place at the Ministry of Health (the Ministry) for the collection, consolidation, and reporting of the results to the Treasury remained below the expected standard.

The main problems that arose this year were:

  • lack of appropriate quality control by the Ministry and the DHBs relating to the information reported for the Financial Statements; and
  • lack of expected controls for data collection and consolidation processes at the Ministry, to ensure accurate and reliable consolidation, with an appropriate audit trail.

As in the previous year, the significant issues that were encountered caused delays in the sign-off of the DHB consolidation by the Ministry’s auditors. Despite the difficulties, we were eventually able to gain assurance that the DHB information needed for the Financial Statements was materially correct.

We have recommended that the Treasury ensure that the processes used to collect and consolidate the DHB financial information are reviewed, and that robust processes with appropriate quality controls are in place for the 2004 Financial Statements.

We note that progress has been made to put in place the necessary process improvements for the 2004 audit. We will continue to monitor developments and provide input to the change processes.

Valuation Issues

Financial Reporting Standard No.3: Accounting for Property, Plant and Equipment (FRS-3) was, subject to transitional provisions, first applicable for the 2002 Financial Statements. During the 2002 audit, we found that many entities and valuers struggled to meet the requirements of this standard. We were pleased to note that the significant issues that arose in this area in 2002 have now been resolved, and that there were few new significant issues arising this year in relation to valuations of property, plant and equipment.

The Treasury has been active in providing useful valuation guidance for the tertiary and health sectors during the past year. In addition, the review group for DHB valuations (comprising representatives from the Auditor-General’s Office, the Treasury, the Ministry of Health, DHBs, and valuers) has proved valuable in providing a good level of quality, particularly with respect to consistency of valuation methodology.

Land and Buildings Not Currently Revalued

The Crown accounting policy is that land and buildings are revalued to fair value at least every five years. The Treasury has provided guidance to entities that land and buildings with a book value of less than $50 million do not have to be revalued, on the grounds of materiality.

During our audit, we became aware that some entities have a carrying value for the land and buildings slightly less than $50 million but the disclosed rating valuations are significantly greater than the carrying value. Although rating valuations are not acceptable as fair valuations under FRS-3, they do give an indication that the fair value of these assets is likely to be significantly greater than the carrying value.

We were satisfied that adjustment to the 2003 Financial Statements was not necessary because of materiality considerations. However, we have recommended that the Treasury review the reasonableness of the $50 million threshold for revaluation of land and buildings for all the entities in the Financial Statements.

Ministry for the Environment – Assets and Liabilities

In 2002, we raised the issue of identifying and accounting for environmental obligations with respect to landholdings.2 We reported that, in general, we were satisfied with what had been done to identify and account for environmental obligations.

We highlighted our remaining concern regarding the accounting for environmental liabilities associated with abandoned contaminated land (“orphan sites”). Our concern was that the approach adopted by the Ministry for the Environment (MfE) was to recognise a liability for only the annual amount of funding provided to the local authority when the funding agreement is signed, rather than recognising the liability for the full (not just annual) obligation (actual or constructive) to contribute to the remediation of the orphan site.

In addition, during the 2003 audit, a separate issue was identified in relation to certain landholdings of MfE that are not recognised in MfE’s Schedule of Crown Assets, and possible associated environmental liabilities that are also not accounted for. This issue has resulted in a qualification of the audit opinion on MfE. However, we were satisfied that the financial effect of these two issues was not material to the Financial Statements.

We have recommended that the Treasury maintain an active interest in the resolution of issues relating to MfE landholdings and environmental liabilities. We will continue to monitor progress in 2003-04.

Student Loans Valuation

In 2002, we again raised our concerns as to the valuation of the outstanding balance of the student loan scheme and, in particular, the methodology used to determine the provision for doubtful debts.3 We recommended that the Treasury determine an actuarial valuation for the scheme as soon as possible.

During the 2003 year, significant progress was made, and a fair value of $5,592 million was disclosed in note 9 to the Financial Statements. This fair value is slightly in excess of the carrying value (net of provisions) of the student loan portfolio of $5,370 million. We understand that it is intended to provide ongoing disclosure of the fair value in future Financial Statements.

Independent actuaries calculated the fair value, based on a new integrated data set of students’ educational and demographic information, with data on loans and incomes. The fair valuation model considers current debt owed by borrowers of various characteristics, including assumptions regarding their future income.

This has been the first attempt at determining a fair value for the student loan scheme. The fair value model contains a number of significant assumptions determined by the actuaries, based on their professional experience and the data available. Some of these assumptions will become more accurate as the loan scheme matures and further data becomes available. One of the critical assumptions is the discount rate, which is based on the after-tax risk-free rate, plus a risk premium. A 1% shift in the assumed discount rate alters the fair value by about $200 million.

Generally accepted accounting practice (GAAP) currently requires the disclosure of the fair value of financial assets such as the student loan scheme, but it does not currently require that financial assets be accounted for at fair value. GAAP for financial assets will change in the coming years with the move to standards based on International Financial Reporting Standards, but it is not yet clear whether new standards will require a change to accounting for the loan scheme at fair value.

We agree that a fair value for the student loan scheme should continue to be determined and disclosed in the Financial Statements on an annual basis, and recommend that the Treasury monitor developments in IFRS with respect to accounting for similar financial assets.

Accounting for Financial Instruments

In 2002, we noted that there were a number of areas where the Crown’s accounting policies and disclosures for financial instruments needed to be reviewed to ensure that they remained in line with the latest developments in GAAP for financial instruments.4 Some of the specific issues that we raised last year have yet to be fully addressed. These include:

  • inconsistencies between the accounting treatment of advances and their associated hedging;
  • whether all tactical trading activities should be reported on a mark-to- market basis; and
  • inconsistencies between the accounting treatment of foreign currency debt (at modified historical cost) and foreign currency assets (at market value).

A major effort is being made internationally to update IFRS on accounting for financial instruments. An updated standard is likely to have a significant effect on the accounting policies of entities such as the New Zealand Debt Management Office (NZDMO) and the Reserve Bank of New Zealand. Entities within the Crown reporting entity will need to start planning now to meet the requirements of IFRS-based standards.

We understand that the NZDMO has undertaken a “strategic accounting review” to address the accounting policy issues associated with its financial instruments, and that there is a timetable in place to address the issues that we have identified. We will continue to monitor progress in addressing those issues.

Fair Value of Debtor Portfolios

As well as the fair valuation of the student loan scheme (see paragraphs 1.32-1.37), there are other significant debtor portfolios in the Financial Statements which are valued on a historical cost basis but for which no fair value disclosure is made. These include portfolios where the debts are of such a nature that collection takes place over a significant period of time (for example: fines debtors and benefit recovery debtors). Unlike the student loan scheme, some of these debts do not accrue interest, and may have a fair value significantly less than their carrying value.

We have recommended that the Treasury provide guidance to departments on accounting for these debtor portfolios. We note, however, that the Treasury does not intend to change existing Crown accounting policies at this stage. We will continue to discuss this issue with the Treasury, including the possibility of additional note disclosures.

Application of Standards Based on International Financial Reporting Standards

In December 2002, the Accounting Standards Review Board (ASRB) announced that International Financial Reporting Standards (IFRS) will apply to financial reporting by both public and private sector entities for reporting periods starting on or after 1 January 2007, with the option of adoption from as early as 2005.

In August 2003, the Government announced that IFRS would be implemented in the Financial Statements as part of the 2007 Budget. This means that the first audited Financial Statements under IFRS will be for the year ending 30 June 2008 (with comparative figures to 30 June 2007 restated in accordance with IFRS-based standards).

The reasons for not adopting at the earlier 2005 date are primarily associated with the significant revisions to IFRS-based standards that are currently under way, and which will continue to be in progress for some time. We support the decision to implement IFRS-based standards in the Financial Statements from the 2007 Budget.

We understand that some State-owned enterprises are planning to adopt IFRS-based standards at the earlier date. It will be important that these entities are able to report information in accordance with both the existing Crown accounting policies and IFRS-based standards, until the Financial Statements are also prepared on an IFRS basis.

Given the revision process currently in progress for IFRS standards, the effect on the Financial Statements of adopting IFRS-based standards is not yet clear. Areas where change is currently expected include:

We have recommended that the Treasury continue to plan for the adoption of IFRS-based standards from the 2007 Budget, and that it continue to provide the necessary input into the standard-setting process to ensure that IFRS-based standards are appropriate and relevant to the New Zealand public sector environment. We will continue to work closely with the Treasury on these issues.

We discuss the implications of the change to NZ IFRS in more detail on pages 67-76.

Resolution of Issues Raised Previously

Department of Conservation Assets

In 2002, we encountered a number of significant issues in relation to property, plant and equipment under the control of the Department of Conservation (DOC). These issues resulted in a qualification of the audit opinion on the financial statements of DOC. The most significant of these issues from a Crown perspective was the failure to account for boundary fences on the conservation estate. A mixture of ownership and valuation issues associated with these assets was not resolved before the 2002 Financial Statements were signed. The omission of these assets was highlighted in Note 11 to the 2002 Financial Statements.

We are pleased to note that DOC has addressed these issues in the 2002-03 year. This included valuing a statistical sample of fencing assets and extrapolating to provide a total value (net of depreciation) of $94 million, which has been disclosed in Note 12 to the 2003 Financial Statements.

Crown Research Institute Databases and Reference Collections

During the 2001-02 audit, we raised the issue of the Crown Research Institute (CRI) databases and reference collections. These are held and managed by CRIs but have not been included in either their statement of financial position or the Crown’s (they were transferred from the Crown to the CRIs at nil value in 1992). Insufficient information was available to provide a reliable value for recognition of these assets, and additional disclosure was included in Note 11 to the 2002 Financial Statements to highlight the non-recognition of these assets.

During 2003, the CRI sector undertook a review of their collections, and consulted with independent external valuers as to how the collections that met the definition of assets should be valued. In a number of cases, it was determined by the valuers that no appropriate methodology or expertise to value these collections existed at this time. Our auditors have reviewed and concurred with the approach taken by each CRI. Additional disclosure has been provided in Note 12 to the 2003 Financial Statements, as to the nature of these collections and the reasons why they remain at nil value.

Tertiary Education Institutions – Crown-owned Land and Buildings

During the 2001-02 audit, we noted that tertiary education institutions’ Crown-owned land and buildings were carried at valuations based on rateable values. As noted in paragraph 1.26 on page 15, this treatment is not acceptable under FRS-3.

These assets were due for revaluation at 31 December 2002, and we recommended that the Treasury liaise with the Ministry of Education to ensure that the asset revaluations were carried out in accordance with FRS-3.

During the 2002-03 year, TEI Crown-owned land and buildings were revalued in accordance with the requirements of FRS-3. We have reviewed the valuation and consider it to be appropriate.

1: Central Government: Results of the 2001-02 Audits, parliamentary paper B.29[03a], pages 15-16.

2: Ibid, pages 19-20.

3: Ibid, pages 18-19.

4: Ibid, pages 20-21.

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