Part 3: The Controller function and the appropriation audit

Central government: Results of the 2007/08 audits.

3.1
The Controller function and appropriation audit are important aspects of the Auditor-General’s work. They support the fundamental principle of Parliamentary control over government expenditure.

3.2
In this Part, we briefly outline the public finance principles underpinning this work and the work’s main features. We then discuss unappropriated expenditure in 2007/08, and report on some other matters we have had to consider in this area during the past year.

Summary

3.3
The circumstances for managing Parliament’s control over government expenditure change continually throughout the year. Therefore, several approval mechanisms are in place to provide some flexibility:

  • The primary authority for any expenditure comes from an Appropriation Act. The first Appropriation Bill, setting out the detailed Estimates of Appropriation, is introduced with the Budget in May and is usually passed into law in August each year. A second Appropriation Bill, containing supplementary Estimates of Appropriation that update the original estimates, is introduced with the next Budget, and is passed by the end of the financial year.
  • Section 26A of the Public Finance Act 1989 (the Act) enables the Governor-General to approve the transfer of small amounts between output expense appropriations within the same Vote during the year.
  • Section 26B of the Act enables the Minister of Finance to approve expenses or capital expenditure that exceed an existing appropriation in the last three months of the year. The expenses or capital expenditure need to be within the scope of the appropriation and below the greater of $10,000 or 2% of the total appropriation.
  • Imprest Supply Acts give conditional authority to the Crown to incur expenses or capital expenditure before an appropriation, up to a global maximum and subject to later incorporation in an Appropriation Act. In practice, the Crown controls the use of this authority by requiring Cabinet to approve any particular use of it.

3.4
We continue to see instances where departments incur expenditure without the authority of any of these mechanisms. Any expenses or capital expenditure incurred without authority is unauthorised expenditure, and is therefore unlawful. Any unappropriated and unlawful expenditure has to be separately reported and validated in the Appropriation (Financial Review) Act that is passed after each financial year, in keeping with section 26C of the Act.

3.5
In 2007/08, there were 32 instances of unauthorised expenditure, which added up to $567 million of expenditure. In most of these instances, the expenditure was within the scope but more than the amount of an appropriation. Some of these appropriations are for demand-driven expenditure. However, in some instances, the expenditure was outside the scope of an appropriation.

3.6
Departments need to understand the importance of appropriation and lawfulness, and the processes within the Act that support them. Departments should also have effective processes to ensure that all public expenditure is within the appropriate bounds.

3.7
We continue to emphasise the need for departments to improve their financial forecasting, and to seek authority or approval for expenditure promptly.

3.8
Departments should seek guidance and advice from the Treasury. We also encourage departments and appointed auditors to communicate about any potential issues.

Public finance principles

3.9
Two important principles govern public expenditure:

  • appropriation; and
  • lawfulness of purpose.

3.10
The Act defines the system of appropriation, which is the primary means by which Parliament authorises the Executive to use public resources. Under this system, expenses and capital expenditure should be incurred only in keeping with an appropriation or other statutory authority. Departments’ net assets should not exceed the limits for which they have authority from Parliament.

3.11
Lawfulness of purpose includes, but is wider than, the principle of appropriation. To be lawful, expenses or capital expenditure must be incurred not only in keeping with an appropriation but also within the legal authority or capacity that enables the department to carry out the activity concerned.

3.12
Departments must pay particular attention to ensuring that all expenses and capital expenditure are lawful on both counts. They must have effective systems and processes in place to support this aim.

3.13
The Treasury provides useful guidance on the system of appropriations on its website (www.treasury.govt.nz). This guidance includes:

  • Putting It Together: An Explanatory Guide to the New Zealand Public Sector Financial Management System;
  • A Guide to the Public Finance Act;
  • A Guide to Appropriations;
  • Treasury Circular 2007/05: Multi-Year, Revenue Dependent and Department to Department Appropriations; and
  • Treasury Circular 2006/04: Unappropriated Expenditure – Avoiding Unintended Breaches.

3.14
In May 2008, the Treasury issued Treasury Circular 2008/07: Unappropriated Expenses and Capital Expenditure 2007/08. The circular provided information and templates for the process that departments needed to follow in dealing with unappropriated expenditure in 2007/08. The Treasury has not yet issued the equivalent guidance for 2008/09.

Operating the Controller function

3.15
Sections 65Y to 65ZA of the Act set out the legislative provisions for the Controller function.

3.16
The main features of the Controller function are:

  • Departments provide information to the Treasury about the expenses and capital expenditure incurred against the authority available. The Treasury collates and monitors this information throughout the year.
  • The Treasury supplies monthly reports1 to enable the Controller to fulfil the role (section 65Y).
  • Throughout the financial year (usually each month), the Office of the Auditor-General and departments’ appointed auditors perform the Controller function using standard procedures. They carry out these procedures in keeping with the Auditor-General’s Auditing Standard 2: The Appropriation Audit and the Controller Function (AG-2) and a Memorandum of Understanding2 between the Treasury and the Office of the Auditor-General.
  • The Controller can direct a Minister to report to the House of Representatives if the Controller has reason to believe that expenditure has been incurred that is unlawful or not within the scope, amount, or period of any appropriation or other authority (section 65Z).
  • The Controller can stop payments from a Crown or departmental bank account, to prevent money being paid out if the Controller believes the payments may be applied for a purpose that is not lawful or outside the scope, amount, or period of appropriation or other authority (section 65ZA).

3.17
The audit work carried out on appropriations supports the formal operation of the Controller function. Section 15(2) of the Public Audit Act 2001 now explicitly recognises this work as part of the basic functions of the Auditor-General. The Auditor-General’s appointed auditors must carry out an appropriation audit as part of the annual audit of each department, to confirm that:

  • expenses and capital expenditure have been incurred within the amount, scope, and period of an appropriation or other statutory authority;
  • expenses incurred have been for lawful purposes; and
  • any unappropriated expenditure is reported in the financial statements.

Unappropriated expenditure in 2007/08

3.18
Most of the government expenditure during 2007/08 was authorised by appropriations in the usual way.

3.19
There were a few transfers in keeping with section 26A of the Act, and a few approvals under section 26B. There were 32 instances of expenditure (adding up to $567 million) that were not authorised through any of the processes provided by the Act.

3.20
In 26 of the 32 instances, expenditure was within the scope of an appropriation but more than the amount authorised by Parliament.3 Some of these expenditures are heavily demand-driven. The total expenditure in excess of authority was $330 million.

3.21
The remaining six instances4 were expenditure that was outside the scope of any appropriation. The total expenditure in these cases was $237 million.

3.22
This is a relatively small amount of unauthorised expenditure compared to total government expenditure. However, it is always a concern when government agencies incur expenditure without the necessary authority from Parliament.

3.23
Some common factors that have contributed to unappropriated expenditure include:

  • poor forecasting by departments;
  • departments not making timely requests for authority to spend; and
  • departments not specifying requests for authority clearly enough to accommodate the actual expenditure.

3.24
Some departments also delayed seeking appropriate corrective action once they had identified a breach.

3.25
We continue to encourage departments to pay closer attention to ensuring that they have authority before incurring any expenditure. We also work with the Treasury to provide better guidance and support through the administrative systems that support the Crown’s financial management.

Net asset holdings

3.26
Nine departments breached their net asset limits during 2007/08.5 This is a significant increase from the two instances in the previous year.

3.27
The Act sets a limit on the net assets that departments may hold. Section 22(3) states:

The amount of net asset holding in a department must not exceed the most recent projected balance of net assets for that department at the end of the financial year, as set out in an Appropriation Act in accordance with section 23(1)(c).

3.28
We continue to see similar problems arising in this area in the current financial year. It is a complex area, from both a legal and an accounting perspective.

3.29
Therefore, departments should take care in projecting net assets, and in monitoring the actual net asset levels throughout the year.

Remeasurements

3.30
The Act provides for remeasurements. These are financial transactions that are defined to be excluded from the meaning of expenses used in the Act. Therefore, they do not, unlike other expenses, require an appropriation. The Act also provides authority for a department’s net asset level to increase beyond its authorised limit, after the remeasurement of an asset or liability. In these cases, the excess will not be treated as a breach of appropriation. An example of a remeasurement is the revaluation of land and buildings.

3.31
Section 2 of the Act defines remeasurements as “revisions of prices or estimates that result from revised expectations of future economic benefits or obligations that change the carrying amount of assets or liabilities”. Section 2 also sets out what remeasurements do not include. They do not include, for example, revisions that result from transactions or events directly attributable to the Crown’s actions or decisions. For example, the revaluation of student loan receivables after a policy decision to change the applicable interest rate is not a remeasurement. Therefore, it is subject to appropriation limits in the usual way.

3.32
In July 2006, the Treasury issued a paper entitled Measuring Remeasurements to provide guidance in this area.

3.33
In our Controller function and appropriation audit work, we frequently have to consider whether transactions or events result in a remeasurement. We regularly find that deciding whether transactions result in remeasurements requires careful judgement. The legal and accounting issues are not straightforward.

3.34
Therefore, departments need to take care when assessing transactions as remeasurements, and refer to the guidance available from the Treasury in doing so. We also encourage early discussion between departments and appointed auditors, where appropriate.

The significance of appropriation scope

3.35
The authority provided by an appropriation is limited to the scope of the appropriation. Departments may not use it for any other purpose.

3.36
Departments should take care that they clearly specify the scope of appropriations they administer to provide an effective basis for this authority. Scope specification will meet this objective where it:

  • acts as an effective constraint against non-authorised activity; and
  • does not inappropriately constrain activity intended to be authorised.

3.37
Conversely, a poorly defined appropriation scope undermines the effectiveness of Parliamentary approval and scrutiny of expenditure.

3.38
The Treasury has an ongoing programme of providing guidance and improving the quality of appropriation scope statements. In September 2005, the Treasury issued a paper entitled Scoping the Scope of Appropriations to provide guidance for departments in preparing appropriate descriptions, before they include them in the Estimates of Appropriation.

3.39
The Treasury promoted clearer and more robust appropriation scope specifications as part of its Review of Accountability Documents work programme. The Treasury also plans to continue to issue relevant guidance.

1: Monthly reporting is not required for July and August.

2: The joint understanding and expectations about the role and procedures associated with the Controller function are set out in the Memorandum of Understanding between the Treasury and the Office of the Auditor-General.

3: These are listed on pages 148-150 of the Financial Statements of the Government of New Zealand for the Year Ended 30 June 2008.

4: These are listed on page 151 of the Financial Statements of the Government of New Zealand for the Year Ended 30 June 2008.

5: These are listed on page 152 of the Financial Statements of the Government of New Zealand for the Year Ended 30 June 2008.

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