Part 4: Planning for conversion to the New Zealand equivalents of International Financial Reporting Standards

Central government: Results of the 2003-04 audits.

4.1
Last year, we reported on the decision to convert to reporting in accordance with International Financial Reporting Standards (IFRS1), and the consequent issues emerging for central government. In this part, we provide an update on the progress made towards the transition to the New Zealand equivalents of IFRS (NZ IFRS2), and highlight some of the implications for the central government sector.

Background

4.2
In December 2002, the Accounting Standards Review Board (ASRB) announced its decision that New Zealand reporting entities would be required to apply new standards, based on IFRS, for reporting periods beginning on or after 1 January 2007. Reporting entities have the option to apply the new standards from periods starting on or after 1 January 2005.

4.3
In August 2003, the Government announced that NZ IFRS would be implemented in the financial statements of the Government as part of Budget 2007. This means that the first set of audited financial statements of the Government reported under NZ IFRS will be for the year ending 30 June 2008. However, as comparative figures must be presented on the same basis of accounting, the comparative figures for the year ending 30 June 2007, and an opening balance sheet at 1 July 2006, will need to be restated in accordance with NZ IFRS. For those central government entities with 31 December balance dates (for example, tertiary education institutions and schools), the transition comes six months earlier. Their opening balance sheets will therefore need to be restated at 1 January 2006.

4.4
We understand that some state-owned enterprises (SOEs) and Crown entities are considering adopting NZ IFRS at an earlier date than the Crown. If any of these entities choose to adopt NZ IFRS earlier than the Crown, they will have to maintain two sets of information. One set would be in accordance with the policies that they adopt under NZ IFRS (for their own reporting). The other would be in accordance with the current New Zealand FRS (for reporting to the Crown for consolidation purposes, until the Crown financial statements are also prepared on an NZ IFRS basis).

ASRB approval of the NZ IFRS “stable platform”

4.5
On 24 November 2004, the ASRB approved the initial suite of standards for NZ IFRS. The adoption of these standards is the culmination of 2 years’ intensive work by standard setters and those few parties (including the Office of the Auditor-General) that have been providing submissions on the exposure drafts of NZ IFRS.

4.6
The initial group of approved NZ IFRS is described as the “stable platform”. This term is used by the International Accounting Standards Board to describe the standards to be applied by countries moving to adopt IFRS from 2005. The approved NZ IFRS “stable platform” is the New Zealand equivalent of the IASB’s “stable platform”.

4.7
It should be noted, however, that some aspects of the “stable platform” are still being developed by the IASB (particularly accounting for financial instruments), and that the “stable platform” will not be stable for long. The IASB has a number of projects in progress that are likely to lead to changes to IFRS, and consequently NZ IFRS, before NZ IFRS are adopted by the central government sector in the year to 30 June 2008.

One set of standards for all reporting entities

4.8
The current set of standards in New Zealand has been described as “sector-neutral”, in that the standards have been developed for all reporting entities, and the same standards apply to both profit-oriented and public benefit entities3. IFRS, on the other hand, have been developed with a focus on profit-oriented entities. NZ IFRS have preserved the format, language, and structure of IFRS, but the ASRB has decided that a single set of standards should continue in New Zealand, applying to both profit-oriented and public benefit entities.

4.9
In our view, there are a number of benefits in retaining a single set of standards, including efficiency in applying the standards (preparers and auditors can achieve a better understanding of a single set of standards), and more clarity and cross-sector comparability for readers of financial statements. However, it is important to appreciate that, while the standard setters in New Zealand have been able to preserve one set of standards, those standards can no longer be considered sector-neutral. This is because the adaptions made to IFRS (in accordance with the ASRB’s guidelines – see paragraph 4.10) have resulted in differing requirements for public benefit entities and profit-oriented entities in some circumstances.

Guidance for public benefit entities

4.10
In June 2003, we raised concerns with the ASRB that inadequate consideration was being given to the effects of changes to standards on public sector reporting. After discussion, the ASRB established the following guidelines4 to be used in adapting IFRS in New Zealand:

  • The IFRS disclosure requirements cannot be reduced for profit-oriented entities.
  • Additional disclosure requirements can be introduced for all entities.
  • The IFRS recognition and measurement requirements for profit-oriented entities cannot be changed.
  • Recognition and measurement requirements can be amended for public benefit entities, with a rebuttable presumption that amendments are based on existing International Public Sector Accounting Standards (IPSAS)5 or existing New Zealand FRS.
  • The introduction of guidance materials for public benefit entities should be based on the same principles as those applying to the amendment of recognition and measurement requirements (as outlined above).
  • The elimination of options in IFRS is permitted for all entities, on a case-by-case basis. Where an IFRS permits options that are not allowed in an existing FRS, a strong argument would need to be made in order for the ASRB to agree to the retention of such options in the NZ IFRS. In reaching a view on this issue, the ASRB will be mindful of the approach adopted by the Australian Accounting Standards Board6.

4.11
In our view, the provision of additional guidance on the application of NZ IFRS to public benefit entities is crucial to ensure that NZ IFRS are relevant and appropriate for the New Zealand public sector environment. We are concerned that valuable guidance, built up over a decade and based on our experience as the first country to apply accrual accounting in the public sector, could disappear. We have worked closely with the Treasury on this issue over the past year, and we will continue to do so.

4.12
A number of the recently approved NZ IFRS include some additional requirements, options or guidance that apply to public benefit entities. However, we believe that further guidance is required, and that this needs to be addressed as a priority. In our view, the main areas where additional guidance should be provided are:

  • How to distinguish a public benefit entity from a profit-oriented entity – A number of public sector entities exist both for the benefit of the public and to make a profit, and it is debatable whether they fall within the definition of a public benefit entity. In addition, we note that most public sector entities are ultimately controlled by a public benefit entity (usually the Crown or a local authority). This creates issues where consolidated groups contain a mix of public benefit entities and profit-oriented entities. In such circumstances, there will be a temptation for all subsidiary entities to be treated as public benefit entities, which may not be appropriate. We acknowledge that the Financial Reporting Standards Board of the Institute of Chartered Accountants of New Zealand is currently developing such guidance.
  • The application of NZ IAS 16: Property, Plant and Equipment to public benefit entities, particularly in relation to infrastructural assets – Much of the guidance needed is already contained in the current standard on property, plant and equipment (FRS-3), and could be supplemented by the knowledge gained in the public sector from applying that standard. The guidance should address such issues as componentisation, component accounting, classification of assets into classes, and calculating depreciated replacement cost (e.g. guidance on optimisation).
  • How to determine whether a public benefit entity controls another entity – The current consolidation standard (FRS-37) includes extensive guidance that has been built up, through the experience of applying consolidation principles in the public sector, over the last decade. The nature of relationships and arrangements between entities frequently differs markedly between the public sector and the private sector. In paragraphs 1.8-1.12 (see pages 10-11), we discuss the difficulties of applying this guidance in some circumstances (particularly where entities have statutory autonomy and independence. Notwithstanding this, the guidance in FRS-37 has proven to be very useful in seeking to apply the standards.
  • The application of non-financial performance reporting – NZ IFRS appear to have carried foward most of the guidance in terms of reporting non-financial performance information. In our view, however, NZ IFRS have not gone far enough regarding non-financial performance reporting. It is debatable whether any of the carried-forward material has any standing, given that NZ IFRS state that they are developed for application to financial statements, and acknowledge that statements of service performance are not financial statements but rather part of a financial report. There are statutory requirements for some public sector entities to report non-financial performance, and, in some cases, that information is required to be prepared in accordance with generally accepted accounting practice (GAAP). Reporting of non-financial performance is important to the public sector because of these requirements. To ensure that non-financial performance reporting remains at a level consistent with current New Zealand FRS, it is essential, in our view, that changes be made to NZ IFRS to remove room for debate about the authority of non-financial reporting requirements in NZ IFRS.

4.13
We will continue to raise the issue of guidance for public benefit entities with those parties responsible for setting standards in New Zealand. Our strong preference is for such guidance to form an integral part of the new standards, rather than be seen as an “add on” for the public sector.

Impact of the new standards

4.14
The approval of the “stable platform” of NZ IFRS provides a degree of certainty, enabling entities to plan for the transition and assess the implications for their financial reporting. We are currently analysing the changes between the approved NZ IFRS and current NZ GAAP. We have been working closely with the Treasury, who are also assessing the likely effect on the central government sector and the financial statements of the Government.

4.15
In general terms, we expect that:

  • there will be changes to the values at which some assets and liabilities are measured;
  • there will be some assets and liabilities recognised for the first time (for example, derivative financial instruments); and
  • some assets will no longer be recognised (for example, internally generated intangibles). There will also be increased disclosures in the notes to the financial statements.

4.16
One area of significant change is in the accounting for financial instruments, an area where the New Zealand FRS sets out only disclosure requirements. The new NZ IFRS establish rules for the recognition and measurement of financial assets and liabilities. There will be an increased requirement to account for financial instruments at fair value, including derivative financial instruments. This is likely to increase the volatility of reported financial performance, and, while there are options to reduce this volatility through the adoption of hedge accounting, the criteria that need to be met for adopting hedge accounting are onerous (for example, in terms of hedge effectiveness, and in record keeping). As a result, such options will not be worthwhile for some entities.

4.17
Other areas where the requirements of NZ IFRS are significantly different from current FRS requirements, and which may significantly affect entities within the Crown reporting entity, include:

  • deferred tax (the whole approach to accounting for deferred tax is changing, and will result in more deferred tax assets and liabilities being recognised by those central government entities that pay tax – for example, State-owned enterprises);
  • business combinations (including a prohibition on goodwill amortisation, which is replaced by an annual impairment test);
  • intangible assets (including a prohibition on the recognition of internally generated intangibles such as brands);
  • property, plant and equipment (including increased disclosures, and a requirement for profit-oriented entities to account for asset revaluations on an asset-by-asset basis rather than the current class of assets basis); and
  • related parties (including disclosures of compensation for “key management personnel”).

4.18
The degree to which individual entities are affected will depend on the types of assets and liabilities that they have, and the transactions that they enter into. For some government departments and Crown entities, the impact is likely to be limited, and managing the transition to NZ IFRS is therefore likely to be uncomplicated. However, this will not be the case for all entities.

4.19
The Financial Reporting Standards Board has issued an exposure draft, ED-96: Disclosing the Impact of Adopting New Zealand Equivalents to International Financial Reporting Standards. ED-96 proposes mandatory disclosure in the annual report of issuers7 of information about the implications of adopting NZ IFRS, and planning for the transition to NZ IFRS. Although most entities within the central government sector are not issuers, ED-96 encourages other entities to also provide the disclosures. In our view, such disclosures are helpful. They demonstrate that entities are planning for the transition to NZ IFRS, and provide an early indication to stakeholders of the likely impacts of the transition.

4.20
We agree that appropriate communication with stakeholders on the transition to NZ IFRS is important. This will include bankers and lenders, in relation to loan covenants and the financial measures used to assess credit worthiness and credit ratings. Other stakeholders include the users of financial statements, including employees (possibly with elements of remuneration linked to reported financial performance), and Parliament, including the Select Committees responsible for the financial reviews of government departments, State-owned enterprises, and Crown entities.

4.21
We have outlined above some of the implications for accounting and financial reporting (to the extent they are known at this stage). The workload and training requirements for finance teams in some public sector entities may need to increase, if the transition to NZ IFRS is to progress smoothly. New policies and procedures will need to be determined in some areas, and systems may need adapting (for example, in entities with complex financial instrument transactions, to meet fair value and hedge accounting requirements). The transition to NZ IFRS is likely to result in additional costs through the transition period.

4.22
In general, we would expect central government entities, with appropriate guidance from the Treasury, to have the capability and resources to cope with the challenges of the transition to NZ IFRS. However, the central government sector does include some groups of entities that have limited capability (for example, schools and reserve boards). The effect of NZ IFRS on the generally fairly simple financial statements of these entities is expected to be limited (but this is dependent on the form of the differential reporting framework to be established for small entities under NZ IFRS). Nevertheless, there is a need for specific consideration of their ability to cope with the transition, and we will continue to work with the Treasury to ensure that the effect NZ IFRS will have on these entities is appropriately considered.

4.23
The local government sector is planning to adopt NZ IFRS a year earlier than central government. We are working closely with the local government sector, and we expect the lessons from the local government transition experience to be extremely helpful for the central government transition.

Effect on auditors

4.24
The transition to NZ IFRS is also a significant challenge for the Office of the Auditor-General, and the auditors appointed to audit entities on behalf of the Auditor-General.

4.25
Auditors need to be trained in the requirements of the new standards, and audit approaches will have to be reviewed and adapted, to meet the revised reporting requirements. There will be additional audit work required, in relation to restated opening balance sheets and comparative figures, and in assessing revised accounting policies and processes (such as those required for hedge accounting). This additional work will need to be included within an already tight work programme, and will have some implications for audit fees.

4.26
We fully expect to be able to meet these challenges, and we have established a major project in the Office of the Auditor-General to ensure that our auditors are ready to audit in an NZ IFRS environment.

Summary

4.27
Significant progress has been made over the past year towards the implementation of NZ IFRS, but much work remains to be done. A major achievement has been the ASRB’s approval of the “stable platform” of NZ IFRS.

4.28
We have some concerns that, to date, insufficient priority has been given to guidance on applying NZ IFRS to public benefit entities. However, we are pleased to see progress on the most pressing area where guidance is required; that is, in determining when an entity is a public benefit entity. We will continue to liaise with standard setters over the other matters identified in paragraph 4.12 (see pages 44-45).

4.29
The approval of the “stable platform” means that there is now some certainty from which to assess the impacts of the transition to NZ IFRS. However, all the implications of the transition are not yet fully clear. As well as affecting financial reporting, the transition may require amendments to processes and systems. The changes will be significant for some central government entities, but less so for others.

4.30
The conversion to NZ IFRS will affect the workload and training requirements of finance teams in some central government entities. We will continue to work closely with the Treasury in its planning for the transition to NZ IFRS by the central government sector.

4.31
In addition, the Office of the Auditor-General has a significant project under way, to ensure that our auditors are ready to audit in an NZ IFRS environment.

1: The term IFRS is used to refer to International Accounting Standards Board (IASB) standards. The standards comprise:

  • International Accounting Standards (IASs), inherited by the IASB from its predecessor body, the International Accounting Standards Committee (IASC), and the interpretations of those standards.

  • International Financial Reporting Standards (IFRS) – the new standards being issued by the IASB, and the interpretations of those standards.

2: NZ IFRS will comprise:

  • New Zealand International Accounting Standards (NZ IASs), and the interpretations of those standards.

  • New Zealand International Financial Reporting Standards (NZ IFRSs), and the interpretations of those standards.

3: Public benefit entities are entities whose primary objective is to provide goods or services for a community or a social benefit, and where any risk capital has been provided with a view to supporting that primary objective rather than for a financial return to equity shareholders. They include most public sector entities.

4: Accounting Standards Review Board Release 8, paragraph 27.

5: IPSAS are developed and issued by the international Public Sector Accounting Standards Board of the International Federation of Accountants, for application to public sector entities.

6: One of the functions of the ASRB is to liaise with the Australian Accounting Standards Board, with a view to harmonising New Zealand and Australian financial reporting standards (section 24, Financial Reporting Act 1993).

7: ED-96 uses the concept of an “issuer” as defined in section 4 of the Financial Reporting Act 1993.

page top