Part 11: Planning for the transition to the New Zealand equivalents to IFRS

Central government: Results of the 2004-05 audits.

11.1
In this Part, we provide an update on the progress made by the central government sector towards the transition to accounting and reporting in accordance with the New Zealand equivalents to IFRS1 (NZ IFRS2), and highlight some of the implications of that transition for the sector.

Background

11.2
In August 2003, the Government announced that NZ IFRS would be implemented in the financial statements of the Government as part of Budget 2007.3 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.

11.3
As this first set of NZ IFRS financial statements must include comparative figures presented on the same accounting basis, 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.

11.4
For those central government entities with 31 December balance dates (for example, tertiary education institutions and schools), the transition to NZ IFRS is 6 months earlier, meaning their opening balance sheets need to be restated at 1 January 2006.

The new standards and their anticipated effects on the central government sector

11.5
On 24 November 2004, the Accounting Standards Review Board (ASRB) approved the initial suite of standards for NZ IFRS. This initial group of approved NZ IFRS was described as the “stable platform”. This term is used by the International Accounting Standards Board (IASB) to describe the standards to be applied by countries adopting IFRS from 2005. The approved NZ IFRS “stable platform” is the New Zealand equivalent to the IASB’s “stable platform”.

11.6
Some aspects of the “stable platform” have already been amended, and the IASB is continuing to develop IFRS. The IASB’s work programme will lead to further changes to IFRS, and consequently NZ IFRS, before NZ IFRS are adopted by the central government sector. This creates a risk that some aspects of the adoption of NZ IFRS will not be fully resolved by the time the relevant information is required to be captured. Future developments at the IASB and the resultant changes to NZ IFRS will need to be monitored.

11.7
However, we are expecting the majority of the “stable platform” to mostly stay as it is now. There is, in our view, enough certainty to enable the sector to plan for the transition to NZ IFRS, assess the implications for financial reporting, and make the transition.

11.8
Over the past year, the Treasury has done a significant amount of work to plan for the transition, including identifying the major areas of change and the potential difficulty for the financial statements of the Government. The Treasury disclosed its plans for the transition, and its assessment of the likely significant effects of the transition, in the financial statements of the Government for the year ended 30 June 2005.4

11.9
We have continued to work closely with the Treasury in planning for the transition. Our auditors are also working closely with sector groups and individual agencies within the central government sector. While some agencies have made significant progress, the progress of others has so far been limited. We discuss this further in paragraphs 11.25-11.31.

11.10
As many agencies in the sector have yet to fully assess the likely effects of the transition on their financial statements, we are currently not in a position to comment definitively on the expected effects. However, we observe 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 accrued sick leave).
  • Some assets will no longer be recognised (for example, internally generated intangibles to the extent they exist in the sector).
  • There will be more disclosures in the notes to the financial statements.

11.11
Probably the most significant change is in accounting for financial instruments. Current New Zealand Generally Accepted Accounting Practice (GAAP) sets out only disclosure requirements. NZ IFRS set up new rules for recognising and measuring financial assets and liabilities. Derivative financial instruments will need to be accounted for “on balance sheet” at fair value. There will also be an increased requirement to account for other financial instruments at fair value. This may increase the volatility of reported financial performance. While there are options to reduce this volatility in some circumstances by adopting hedge accounting, the criteria that need to be met are quite onerous (for example, in terms of assessing hedge effectiveness and in record keeping).

11.12
We expect that accounting for financial instruments will be the most significant and complex NZ IFRS issue for the financial statements of the Government. These statements include a number of complex investment, borrowing, and derivative portfolios (for example, the New Zealand Debt Management Office and the Reserve Bank).

11.13
Another significant change will be for long-term receivables and advances that do not earn a market rate of return (such as the fines debtors and benefit recoveries). The current accounting policy is to record receivables and advances at amounts expected to be collected in cash, whereas under NZ IAS 39: Financial Instruments: Recognition and Measurement these assets will have a lower value, taking into account the time value of money.

11.14
Some of the other areas where the requirements of NZ IFRS are significantly different from current GAAP requirements, and are likely to significantly affect either the financial statements of the Government or individual entities within the central government sector, are:

  • business combinations (including a prohibition on goodwill amortisation, which is replaced by an annual impairment test);
  • 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);
  • employee entitlements (particularly a requirement to account for accumulating non-vesting sick leave);
  • property, plant, and equipment (particularly 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 information for “key management personnel”).

11.15
There are some other areas of significance to the financial statements of the Government that need further consideration before the effects of NZ IFRS will be fully known (for example, accounting for the substantial liabilities for accident compensation and defined benefit pension obligations).

11.16
The degree to which individual entities are affected will depend on the types of assets and liabilities they have and the transactions that they enter into. For some central government entities, the effects are 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 central government entities.

11.17 In April 2005, the ASRB approved Financial Reporting Standard 41: Disclosing the Impact of Adopting New Zealand Equivalents to International Financial Reporting Standards (FRS-41). FRS-41 requires the annual report of issuers5 to disclose information about planning for the transition to NZ IFRS, key differences in accounting policies that are expected to arise, and the estimated effects of adopting NZ IFRS on the financial report. Although most entities within the central government sector are not issuers as defined in section 4 of the Financial Reporting Act 1993, FRS-41 encourages other entities to also provide these disclosures. We support such voluntary disclosure.

11.18
Many entities in the sector provided some disclosures of this nature in their 2005 annual reports, although there was little detailed information on the expected effects. This was to be expected, given the state of progress towards the transition at that stage. However, we expect that there will be significantly more information about the effects of the transition included in annual reports for the year ending 30 June 2006.

Guidance for public benefit entities

11.19
IFRS 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, applying to both profit-oriented and public benefit entities,6 should continue in New Zealand. In order for NZ IFRS to be appropriate for public benefit entities, some adaptation of IFRS has been necessary.

11.20
The ASRB set out guidelines7 for 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)8 or existing New Zealand FRS.
  • 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. If an IFRS permits options that are not allowed in an existing FRS, a strong argument would need to be made for the ASRB to agree to retaining 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 Board.9

11.21
We reported last year that, in our view, providing additional guidance on applying 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 have worked closely with the Treasury and the Financial Reporting Standards Board (FRSB) on this issue over the past year, and we will continue to do so.

11.22
We are pleased to report that some of the concerns that we raised last year about guidance for public benefit entities have now been addressed. In particular, standard setters have now issued useful guidance to assist entities to determine whether they are a profit-oriented entity or a public benefit entity.10 This distinction is important because some of the requirements of NZ IFRS differ depending on the nature of the entity applying the standards.

11.23
The central government sector is made up of some entities that are clearly public benefit entities (such as government departments, district health boards, and schools) and some entities that are clearly profit-oriented entities (such as State-owned enterprises). However, there are some entities that have a mix of objectives (such as some Crown Research Institutes and other Crown entity companies). The guidance developed by the FRSB provides a framework for these entities to use to determine whether they should account under NZ IFRS as a public benefit entity or as a profit-oriented entity.

11.24
The FRSB has recently set up a public benefit entity working group on which we are represented. The working group is addressing topics that affect public benefit entities and that are not currently adequately addressed in NZ IFRS. We hope to continue our involvement in this working group. We will continue to raise the need for appropriate guidance for public benefit entities with those parties responsible for setting standards in New Zealand. We strongly prefer such guidance to form an integral part of the new standards, rather than be an “add-on” for the public sector.

Sector preparations for NZ IFRS

11.25
Over the past year, the Treasury has made significant progress in its planning for implementing NZ IFRS in the financial statements of the Government. This progress has included:

  • assessing the options available under NZ IFRS both on transition and for the ongoing application of NZ IFRS accounting policies;
  • preparing a preliminary set of NZ IFRS accounting policies for the financial statements of the Government and issuing these for consultation with the sector;
  • setting out a timetable for collecting the information needed for the transition from entities within the Government reporting entity; and
  • producing a draft NZ IFRS data pack to be used to collect NZ IFRS financial information from entities for the preliminary opening balance sheet at 1 July 2006, and for the NZ IFRS comparative information that will be collected during the 2006-07 financial year.

11.26
The Treasury’s NZ IFRS timetable requires all entities within the Government reporting entity to provide it with a preliminary NZ IFRS opening balance sheet within 2 weeks of their 2006 statutory reporting deadline (mid-October for government departments and State-owned enterprises, and mid-November for Crown entities). In addition, all government departments, the larger Crown entities, and State-owned enterprises will be required to provide the Treasury with monthly interim financial results under NZ IFRS from December 2006 (so the Treasury can collate NZ IFRS comparative figures to use in the monthly financial statements of the Government to be published in the 2007-08 year).

11.27
In order to meet these requirements, entities will need to be able to report to the Treasury under both current New Zealand GAAP and NZ IFRS for the year ending 30 June 2007. This includes monthly reporting by government departments, the larger Crown entities, and State-owned enterprises. Entities may need to maintain accounting records under 2 different accounting bases to meet these requirements.

11.28
The transition to NZ IFRS is expected to affect both the workload and training requirements of finance teams in some public sector entities. The transition is also likely to result in some additional costs during the transition period.

11.29
We are pleased to note that there has been progress towards the transition to NZ IFRS by many individual entities within the Government reporting entity, although the degree of progress is variable. Most of the larger entities have set up NZ IFRS transition projects and have completed or are completing assessments of the effects of NZ IFRS. However, some of the smaller entities have done limited NZ IFRS planning to date. For many of the smaller entities the transition to NZ IFRS will be straightforward, but this will not be so in all cases.

11.30
We are also pleased to note that the Treasury has undertaken some initiatives to assist entities in the transition, including issuing a guidance paper on accounting for sick leave under NZ IFRS and working with groups of entities on NZ IFRS issues that apply to a number of entities (for example, accounting for debt portfolios). These initiatives are a very effective means of assisting the sector in the transition. Another valuable initiative to support the transition has been the formation of a group of mainly government department finance personnel that is meeting regularly to discuss and address NZ IFRS issues.

11.31
Overall, we are satisfied with the progress made by the sector to date. However, there remains much to be done. The financial statements of the Government include some very complex accounting issues, and there are some entities within the Government reporting entity that are very significantly affected by NZ IFRS. Some of these entities have still to implement systems and business processes to enable them to account under NZ IFRS. For some entities, meeting the Treasury timetable for collecting preliminary NZ IFRS opening balance sheet information may be a challenge. To meet this challenge, it is important that the Treasury continues to be proactive in providing guidance on issues affecting the sector as a whole and that, where appropriate, entities share information on NZ IFRS transition issues and their resolution.

Effect on auditors

11.32
The transition to NZ IFRS is a significant challenge for the Office of the Auditor-General and for the auditors appointed to audit entities on behalf of the Auditor-General.

11.33
There will be additional audit work required for 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. Entities will need to ensure that such additional audit fees are incorporated into their budgets.

11.34
Over the past year, we have put all our professional staff through extensive training on NZ IFRS. We are continuing to develop resources for auditors to ensure that they are fully prepared to audit in an NZ IFRS environment. We are currently auditing the restated NZ IFRS opening balance sheets in the local government sector. This will prove useful in testing our knowledge and audit approaches under NZ IFRS. We will continue to share our knowledge of the local government sector’s experience of NZ IFRS with the central government sector.

11.35
The coming years will be a significant challenge for us and our appointed auditors as we change to auditing in an NZ IFRS environment. We are confident that we will fully meet these challenges, and that we will achieve our over-riding objective of supporting the change to NZ IFRS at least cost, and with minimum fuss, in a constructive, co-operative manner.

Summary

11.36
The central government sector has made significant progress over the past year towards the implementation of NZ IFRS.

11.37
Although NZ IFRS will continue to be subject to some change before they are adopted, there is enough stability within NZ IFRS to allow entities to plan for, and manage, the transition.

11.38
Accounting for financial instruments is expected to be the area of greatest challenge for the sector, although the effect on individual entities will vary depending on the nature of their assets, liabilities, and underlying transactions.

11.39
We are pleased with the progress made in providing guidance on NZ IFRS for public benefit entities, and consider that the formation of a public benefit entity working group by the FRSB is a positive step.

11.40
The Treasury has made significant progress in its planning for using NZ IFRS in the financial statements of the Government. A timetable for transition has been set up that will require entities to provide their preliminary NZ IFRS opening balance sheets to the Treasury within 2 weeks of their 2006 statutory reporting deadline.

11.41
There has also been good progress towards the transition to NZ IFRS by many individual entities within the Government reporting entity, although the degree of progress is variable, particularly for smaller entities.

11.42
We have worked closely with the Treasury in its planning for the transition and will continue to do so. The Treasury has undertaken some useful initiatives to assist the sector in the transition. In our view, it is important that the Treasury continues to be proactive in providing guidance on issues affecting the sector.

11.43
The transition remains a significant challenge for us. There will be additional audit work required, particularly on NZ IFRS accounting policies, restated opening balance sheets, and comparative figures. We are confident that we will fully meet these challenges.

1: The term IFRS is used to refer to International Accounting Standards Board (IASB) standards. The standards comprise International Accounting Standards (IAS) inherited by the IASB from its predecessor body, the International Accounting Standards Committee, and the interpretations of those standards; and 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 IAS), and the interpretations of those standards; New Zealand International Financial Reporting Standards (NZ IFRS), and the interpretations of those standards; and New Zealand Financial Reporting Standards (FRS), where there is no equivalent IFRS.

3: Budget 2007 will set out the Estimates of Appropriations for the Government for the year ending 30 June 2008.

4: Financial Statements of the Government of New Zealand for the year ended 30 June 2005, parliamentary paper B.11, page 19.

5: FRS-41 uses the concept of an “issuer” as defined in section 4 of the Financial Reporting Act 1993.

6: Public benefit entities are entities whose primary objective is to provide goods or services for a community or a social benefit where equity has been provided to support that primary objective rather than for a financial return to equity holders. They include most public sector entities.

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

8: 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.

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

10: NZ IAS 1 Appendix: New Zealand Application Guidance: When is an Entity a Public Benefit Entity?

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