Part 1: The 2003-04 audited financial statements of the Government

Central government: Results of the 2003-04 audits.

The Auditor-General issued the audit opinion on the Financial Statements of the Government of New Zealand for the Year Ended 30 June 2004 (the Financial Statements) on 17 September 2004. 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 2004; 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 matters.

Consolidation issues

Financial Reporting Standard No. 37: Consolidating Investments in Subsidiaries

This was the second year that the Financial Statements had been prepared on a fully consolidated basis. Financial Reporting Standard No. 37: Consolidating Investments in Subsidiaries (FRS-37) came into effect for the 2003 Financial Statements and was one of the drivers behind the switch to full consolidation.

The significant issue that arose from FRS-37 was in relation to determining the appropriate accounting treatment for tertiary education institutions (TEIs) within the Financial Statements. This remained an issue for the 2004 Financial Statements.

A significant aspect of FRS-37 was a revised set of tests to determine which entities were “controlled” and hence subject to consolidation within the Financial Statements.

The application of the “control” test to the Crown is difficult, particularly in cases where legislation provides entities such as TEIs with statutory autonomy and independence.

The accounting treatment that the Treasury adopted in the 2003 Financial Statements was not to consolidate TEIs line-by-line, but to equity account them based on a 100% interest. This accounting treatment has again been adopted for the 2004 Financial Statements.

This approach is based on the view that the “control” test is not satisfied, as the Crown does not have the ability to determine the financing and operating policies of TEIs, but that the Crown’s relationship with TEIs does meet the “significant influence” test necessary for equity accounting. 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.

In our view, line-by-line consolidation remains 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 it can be argued that the treatment complies with a strict interpretation of the mandatory elements of FRS-37, and because of the additional disclosures provided in Note 13. These enable readers to see the impact 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.

This issue demonstrates the difficulties of the “control” test in the Crown context. The Treasury has communicated with the bodies responsible for setting Financial Reporting Standards in New Zealand to seek clarification of the “control” test in the Crown context. In future, the adoption of New Zealand equivalents to the International Financial Reporting Standards (NZ IFRS) (see paragraphs 1.49-1.51 on pages 17-18) may again affect the “control” test to be applied.

We have recommended that the Treasury continue its discussions with standard setters on the application of the “control” test in the Crown context. The timeframe for any amendments to FRS-37 is not yet clear or certain. We will continue to monitor developments in this area.

Sub-consolidations: Ministry of Health and Ministry of Education

The Ministry of Health (MOH) and the Ministry of Education (MOE) are responsible for collecting, consolidating, and reporting to the Treasury the consolidated financial results of district health boards (DHBs) and tertiary education institutions (TEIs) respectively. Neither Ministry met the agreed timetable for producing these sub-consolidations for audit.

Last year, we highlighted the problems of ensuring that the consolidated results of DHBs were accurate. This year, we are pleased to see a considerable improvement in the MOH’s performance in that area, but the Ministry was late in providing the audit team with its consolidated information. We acknowledge that the consolidation timeframe is tight (being only 3 days), but the delays affected the ability of our auditors to achieve the level of review envisaged.

There were also issues this year with the timeliness of the MOE’s TEI sub-consolidation, and with its response to our auditor’s queries on that matter.

Given that the deadlines governing the overall Financial Statements audit were tight, the inability of these two Ministries to achieve them posed significant challenges to our audit teams.

We have recommended:

  • that the Treasury work with the MOH, the MOE, and ourselves to agree on a timetable for the sub-consolidations that provides sufficient time for audit; and
  • that all parties commit the resources that will ensure that these deadlines can be met in the future.

Valuation issues

Rail assets

On 30 June 2004, the Crown signed a number of agreements with Toll Holdings Ltd (Toll), including agreements on the purchase of the rail infrastructure and a track access agreement out to the year 2070. The accounting treatment for these agreements had to be determined, particularly the valuation of the Crown-owned land associated with the rail network and capital expenditure on the rail infrastructure.

In the Financial Statements, the rail access agreement with Toll has been accounted for as a finance lease, and the rail infrastructure and land as a lessor’s interest in a finance lease. Under this treatment, capital expenditure incurred by the Crown on the rail network is expensed, and the fair value of the land is discounted for the term of the access agreement.

During the audit, we discussed with the Treasury the appropriateness of this accounting treatment. The Treasury’s view is based on the criteria for a finance lease under SSAP-18 Accounting for Leases and Hire Purchase Contracts, specifically:

  • the agreements being effectively non-cancellable;
  • the collectibility of the access payments being assessed as reasonably predictable; and
  • the lease term being assessed as for a major portion of the useful life of the asset.

It is arguable whether the access agreement is a finance lease that passes substantially all the risks and rewards of ownership to Toll, or whether the term of the access agreement is for the majority of the life of the rail network asset as a whole.

The agreements between the Crown and Toll are complex, and a number of elements need to be considered. They include:

  • the “use it or lose it” clauses in the access agreement in relation to both freight and passenger services;
  • the other operators that will use the network, including the Auckland metro operator and small-scale heritage operators;
  • the Crown’s decision-making powers in relation to maintenance and capital investment in the network, including the ability to make additional investment on public policy grounds; and
  • the commercial property rights passed to the Crown with the surrender of the old core lease.

An alternative accounting treatment would be to capitalise as property, plant, and equipment the capital expenditure incurred on the rail network, and to record the rail land at fair value (subject to further consideration of the relatively small amounts of land retained by Toll under the revised core lease).

As at 30 June 2004, we were satisfied that the differences between the accounting treatment adopted by the Treasury and the alternative described above were not material to the Financial Statements. This may not be the case in future years, as the Crown meets its capital investment commitments under the agreements with Toll.

For future years, our current view is that depreciated replacement cost would be the most meaningful method of accounting for the rail infrastructure assets in the Crown Statement of Financial Position. This would be consistent with the approach adopted for some of the Crown’s other major infrastructural assets, such as the State highway network. The determination of depreciated replacement cost may also provide useful information for the management of this major asset.

We have recommended that the Treasury, together with the New Zealand Railways Corporation, review the accounting treatment of the rail assets during 2004-05. This is to ensure that it refl ects the nature of the rail network assets and the substance of the rail agreements, taking into account all relevant guidance and international precedents.

Fair value of land and buildings

Crown accounting policy is that land and buildings are recorded at fair value. The Treasury has advised entities included in the Crown reporting entity, on the grounds of materiality, that they are not required to revalue land and buildings with a book value of less than $50 million.

Last year, we noted that some entities (including Air New Zealand Limited) had not revalued their land and buildings for the purposes of the Financial Statements, despite the disclosed rating valuations being significantly greater than the carrying values. In Air New Zealand’s case, the carrying value of land and buildings was greater than the $50 million threshold.

Although rating valuations are not acceptable as fair valuations under FRS-3, they indicate that the fair value of these assets is likely to be significantly greater than the carrying value.

This year, we again noted that the land and buildings of Air New Zealand had not been revalued to fair value for the purposes of the Financial Statements. It was agreed that a consolidation adjustment would be made in the Financial Statements to reflect the rating valuation of Air New Zealand’s land and buildings as an approximation of fair value.

The Treasury reviewed the reasonableness of the $50 million threshold for the revaluation of land and buildings, and concluded that it was unlikely that any other entities had land and buildings with a fair value significantly different to the carrying value.

For the purposes of the Financial Statements, we have recommended that the Treasury ensure that all entities comply with the requirement to revalue land and buildings holdings with a value greater than $50 million to fair value for the purposes of the Financial Statements.

Student loans valuation

Note 9 to the Financial Statements discloses the fair value of student loan balances as $5,734 million. This is $261 million lower than the carrying value (after provisions) of $5,995 million. In the 2003 Financial Statements, the disclosed fair value of the student loan balances was $222 million greater than the carrying value.

We have agreed with the Treasury’s view that the difference between fair value and carrying value does not represent an impairment of the asset and that no write-down was required in the 2004 Financial Statements. The reasons for this are, firstly, that the fair value determination at this stage is only an approximation and, secondly, that generally accepted accounting practice in New Zealand (NZ GAAP) is not clear about the appropriate accounting treatment in these circumstances.

This is only the second year that a fair value for student loan balances has been disclosed in the Financial Statements. The fair value exercise is highly complex and requires collaboration between the Ministry of Education, the Inland Revenue Department, and the Ministry of Social Development. The fair value model contains a number of significant assumptions based on the professional experience of the actuaries and the data available. Some of these assumptions will become more accurate as the loan scheme becomes more mature and further data is available.

The model will also become more accurate as the quantity and quality of data improves. This year, significant problems were encountered in attempting to refresh the historic data in the model with an additional year’s student loan data. The additional data could not be extracted, and so the model has used the previous data rolled forward an extra year with updated assumptions.

NZ GAAP currently requires the disclosure of the fair value of financial assets such as the student loan scheme (subject to constraints of timeliness and cost), but does not require that such assets be accounted for at fair value. NZ GAAP for financial assets will change in coming years with the move to NZ IFRS. However, it is not yet clear whether NZ IFRS will require a change to account for the loan scheme at fair value, and therefore whether recognition of an impairment loss will be required in circumstances such as this.

We have recommended that the Treasury continue to work with the appropriate Government departments to develop the student loan fair value model, and that particular efforts be made to resolve the issues that prevented the model being updated this year. We have also recommended that the Treasury continue to monitor developments in International Financial Reporting Standards with respect to accounting for similar financial assets.

Fair value of other debtor portfolios

A number of Government departments are responsible for debt portfolios (i.e. assets of the Crown) where the debts are collected over a significant period of time. Student loan debt is one example of this and, as discussed above, a fair value for the student loan portfolio has been determined and disclosed. However, there are other significant debt portfolios in the Financial Statements for which the fair value is not disclosed.

These portfolios include some that have lengthy collection periods and do not accrue interest on outstanding balances. In these cases, the fair value is likely to be less than the carrying value of the debt. Examples of such debtor portfolios are:

  • Ministry of Social Development – $769 million gross ($445 million after provisions) Crown debt (e.g. benefit recoveries); and
  • Ministry of Justice – $482 million gross ($321 million after provisions) unpaid fines.

In the case of the Ministry of Justice, an attempt was made to determine a fair value for the unpaid fines balance. However, because of significant errors in the Ministry’s methodology, this was not disclosed in the Financial Statements.

We have recommended that the Treasury provide guidance on determining fair values of debtor portfolios to ensure that fair value disclosures are available for the 2005 Financial Statements and beyond.

Issues with significant impacts on future financial statements

Public Finance Amendment Act 2004

The Public Finance Amendment Act 2004 came into force on 25 January 2005. It has a number of impacts on future Financial Statements, including changing the reporting entity from the “Crown” to the “Government reporting entity”. The Public Finance Act 1989 (the Act) now defines the “Government reporting entity” as follows –

Government reporting entity means:

(a) the Sovereign in right of New Zealand; and

(b) the legislative, executive, and judicial branches of the Government of New Zealand.

The revised definition clarifies that the three branches of government are to be included within the Government’s financial statements under the Act. As a result, the Offices of Parliament will be re-incorporated into the Government’s financial statements. Currently, these Offices are not included in the Financial Statements because they are instruments of the House of Representatives rather than of the Crown.

The Treasury will therefore need to plan for re-incorporating the Offices of Parliament into the Government’s financial statements in future.

Foreshore and seabed

Section 13(1) of the Foreshore and Seabed Act 2004 states –

On and from the commencement of this Act, the full legal and beneficial ownership of the public foreshore and seabed is vested in the Crown, so that the public foreshore and seabed is held by the Crown as its absolute property.

We have recommended that the Treasury consider how the Crown’s ownership of the foreshore and seabed should be accounted for in future Financial Statements.

Application of New Zealand equivalents to International Financial Reporting Standards

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

In Part 4 of this report (pages 41-49), we discuss the progress made to date towards transition to NZ IFRS and highlight some of the issues and impacts (to the extent known at this stage) for the Financial Statements and the central government sector.

We have recommended that the Treasury continue to provide the necessary leadership and guidance to entities within the Crown sector on the move to NZ IFRS.

Resolution of issues raised previously

Ministry for the Environment (MfE) – Assets and liabilities

Last year, we highlighted an issue in relation to certain MfE land holdings that were not recognised in the Crown Statement of Financial Position, and possible associated environmental liabilities that were also not accounted for. Although the financial impact of the issue was not material to the Financial Statements, it resulted in a qualification of our 2003 audit opinion on MfE.

We are pleased to note that MfE has appropriately valued these land holdings in 2004, and that they are now included in the Crown Statement of Financial Position. We also note that plans are now in place to appropriately manage these assets.

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