Part 1: Auditor-General's introduction

The Auditor-General’s views on setting financial reporting standards for the public sector.

1.1
The purpose of this discussion paper is to set out:

  • my views on setting financial reporting standards for the New Zealand public sector;
  • my views on setting financial reporting standards internationally;
  • my concerns about financial reporting standards for the New Zealand public sector (including concerns about specific standards applying to most public sector entities and expected future changes to standards); and
  • my views on changes that are needed to provide a better basis for public sector financial reporting standards in New Zealand.

1.2
In setting out my views, I want to make Parliament aware of my concerns and what it can do to help bring about change. I also hope the discussion paper will promote constructive debate about the changes needed to the approach to setting financial reporting standards, particularly for the public sector.

A summary of my views

1.3
I am disappointed with the overall quality of financial reporting standards applying to most entities in the public sector. In my view, the approach to setting financial reporting standards needs to change to ensure that appropriate standards apply to public sector entities, so that those entities' financial statements will meet the needs of people using them.

1.4
For the past 6½ years, most financial reporting standards issued in New Zealand have been based on International Financial Reporting Standards (IFRS).1 IFRS have been put in place by the International Accounting Standards Board for application by large profit-oriented entities accessing capital markets. The Financial Reporting Standards Board, a committee of the New Zealand Institute of Chartered Accountants, has established New Zealand equivalents to IFRS (NZ IFRS)2 for application by reporting entities whether profit-oriented or not. The Accounting Standards Review Board, an independent Crown entity, has approved NZ IFRS for application by certain reporting entities, which includes most entities in the public sector.

1.5
Taking standards created by the International Accounting Standards Board for one purpose and using them for another purpose relies on relevant and appropriate changes being made to IFRS. Unfortunately, there have been few changes and little guidance included in NZ IFRS to assist public sector entities to apply the new standards.

1.6
I am concerned about the lack of changes and the lack of guidance for the public sector, particularly given IFRS contain a lot of guidance and examples for circumstances and transactions common to profit-oriented entities. I am concerned because of the adverse effect that deficiencies in financial reporting standards can have both on the quality of financial reports prepared by public sector entities, and on the costs of doing so.

1.7
My comments about NZ IFRS should not be taken as a criticism of IFRS. I support the adoption of IFRS by listed issuers in New Zealand and any other profit-oriented entities required to, or wishing to, state their compliance with IFRS. Adopting IFRS makes sense for those entities, because IFRS are designed primarily for profit-oriented entities accessing capital markets.

1.8
During the past few years, I have been calling for sensible changes to be made to IFRS when creating NZ IFRS. I am disappointed that my calls have, mostly, not resulted in the changes I consider are needed. This lack of change has resulted in some instances where NZ IFRS are difficult to apply in the public sector, and where information in financial statements is of questionable relevance to those people using it.

1.9
I am also aware of impending changes to IFRS by the International Accounting Standards Board that are likely to make IFRS even more difficult to apply by most public sector entities. These impending changes also raise more questions about the relevance of information for people using public sector entities' financial statements.

1.10
At the end of 2008, I decided that the best action I could take was to withdraw my staff from the process for setting financial reporting standards and report my concerns to Parliament. My regret at withdrawing staff was outweighed by a concern that continuing to involve my staff would add credibility to a process that, in my view, should not be given. I was also concerned that continued involvement was not a good use of the scarce resources of my Office.

1.11
I do not want my disappointment with the quality of standards to imply that there is generally poor quality financial reporting by public sector entities in New Zealand. In my view, despite the quality of the standards, public sector entities mostly report meaningful financial information. Also, despite the quality of the standards, financial reporting by entities in the New Zealand public sector is still well regarded internationally. I am advocating change now to ensure that the New Zealand public sector does not lose its reputation.

1.12
It is important that Parliament is aware of my concerns and the changes that I think are needed to ensure that relevant and appropriate financial reporting standards are put in place for the public sector. If Parliament shares my concerns, it can help to bring about some of the changes.

1.13
I consider there now needs to be a significant change to the way financial reporting standards are set for the public sector. This is likely to include taking more account of the work of the International Public Sector Accounting Standards Board.3 The focus for change needs to be on relevant and appropriate financial reporting standards that are designed to produce financial reports that are understandable and can be used by people to properly hold public sector entities to account.

Why financial reporting standards are important

1.14
Financial reporting standards are important because they set the requirements for preparing financial statements. These requirements are collectively referred to as generally accepted accounting practice. Financial statements are an important part of the accountability documents prepared by entities in the public sector. Therefore, financial reporting standards play a crucial role in the accountability of entities in the public sector.

1.15
Parliament has decided, through legislation, that most entities in the public sector must prepare financial statements that comply with generally accepted accounting practice. Financial statements usually cover a period of one year and provide information about past transactions and events. Typically, entities in the public sector compare historical financial information about past transactions and events with the financial information budgeted at the beginning of the year.

1.16
The financial statements required by generally accepted accounting practice need to be relevant and appropriate for financial accountability purposes. Financial statements are made publicly available to partly fulfil an entity's accountability responsibilities.

1.17
Non-financial performance information is also a crucial part of the accountability documents prepared by many entities in the public sector. Non-financial performance information needs to work in conjunction with financial information to convey a coherent and consistent picture about each public sector entity's performance.

1.18
It is important that financial reporting standards result in financial information that can be readily integrated with non-financial performance information. Financial and non-financial performance information needs to be integrated, because true accountability requires transparency about financial and non-financial performance and an appropriate relationship between the two.

1.19
If there are deficiencies in financial reporting standards for the public sector, the likely consequences include:

  • The information in financial statements may be unduly complex, both for those preparing the financial statements and for those using them. Undue complexity is particularly a problem for smaller public sector entities with limited resources and for those without a high degree of financial literacy.
  • Transactions and events may be accounted for inappropriately or differently by different entities. Inappropriate or different accounting can adversely affect both the ability of people to understand financial statements and their ability to compare information between periods and, where relevant, across entities. The adverse effects could ultimately lead people to question the reliability and usefulness of financial statements.
  • The information in financial statements may not be readily integrated with non-financial performance reporting. If this happens, people will not have a meaningful picture of an entity's performance with which to hold it to account.

Scope of this discussion paper

1.20
My views and concerns in this discussion paper are based on:

  • many and varied dealings my staff and I have had relating to financial reporting standards, particularly during the past 6½ years; and
  • documents my staff and I have read relating to financial reporting standards during that time.

1.21
The dealings my staff and I have had include:

  • involvement in setting financial reporting standards in New Zealand and internationally through membership of various boards and working groups;
  • correspondence and discussions with the Financial Reporting Standards Board and the Accounting Standards Review Board;
  • liaison with audit offices in Australia; and
  • the audit of public sector entities' financial statements based on NZ IFRS.

1.22
The documents my staff and I have read include:

  • draft proposals,4 discussion papers, and other documents published by the Financial Reporting Standards Board, the International Accounting Standards Board, and the International Public Sector Accounting Standards Board;
  • NZ IFRS;
  • public sector entities' financial reports; and
  • articles in accounting journals and academic papers.

1.23
This discussion paper is focused primarily on financial reporting standards for public benefit entities in the public sector. The definition of public benefit entities includes most entities in the public sector.5 Public sector entities that are not public benefit entities are generally companies, such as state-owned enterprises, port companies, energy companies, and company subsidiaries of public sector entities.

1.24
Although the discussion paper focuses on public benefit entities in the public sector, some of the matters discussed may have implications for profit-oriented entities in both the public and the private sectors, and public benefit entities in the not-for-profit sector. Such implications are unavoidable given there are currently common financial reporting standards affecting the financial reporting by entities in all sectors.

1: IFRS refers to standards and interpretations issued by the International Accounting Standards Board. The standards and interpretations comprise:

  • International Accounting Standards (IAS), adopted by the International Accounting Standards Board from its predecessor body, the International Accounting Standards Committee, and interpretations of those standards established by the former Standards Interpretations Committee; and
  • International Financial Reporting Standards (IFRS), which are the new standards created by the International Accounting Standards Board, and interpretations of those standards established by the International Financial Reporting Interpretations Committee.

2: NZ IFRS refers to standards and interpretations issued by the Financial Reporting Standards Board and approved by the Accounting Standards Review Board. The standards and interpretations comprise:

  • The New Zealand equivalents to IFRS (that is, the New Zealand equivalents to the standards and interpretations issued by the International Accounting Standards Board); and
  • New Zealand-created standards on topics not addressed by the International Accounting Standards Board.

3: The International Public Sector Accounting Standards Board is a part-time international standard-setting board that serves the public interest by creating financial reporting standards known as International Public Sector Accounting Standards (IPSAS) for use by public sector entities around the world.

4: A draft proposal is usually issued for public comment as an "exposure draft".

5: Public benefit entities are defined as reporting entities whose primary objective is to provide goods or services for community or social benefit, and where any equity has been provided with a view to supporting that primary objective rather than for a financial return to equity holders. Public benefit entities in the public sector include such entities as government departments, district health boards, tertiary education institutions, schools, fish and game councils, other Crown entities, local authorities, licensing trusts, cemeteries, administering bodies, and Māori trust boards.

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