Part 5: My views on changes that are needed

5.1
At the end of 2002, I was not concerned about the decision to adopt IFRS. I was optimistic that IFRS would be suitably adapted for public benefit entities, resulting in relevant and appropriate changes to financial reporting standards for entities in the public sector. However, that optimism has been eroded.

5.2
Since 2002, I have become increasingly concerned about the credibility of NZ IFRS applied by public benefit entities in the public sector. My views, expressed in Parts 2 to 4 of this discussion paper, bear witness to those increasing concerns.

5.3
I am convinced that major changes are now needed to the standard setting arrangements in New Zealand. In this Part I explain why I advocate significant changes and outline the changes that I consider are needed.

Why I advocate significant changes

5.4
I noted in two of my reports to Parliament in 2008¹ that if the right changes were not made to NZ IFRS in the future, there would be an increasing risk that the set of standards would not be of high quality nor ultimately fit for purpose for most of the public sector. I also noted that I had communicated these views to the then chairman of the Accounting Standards Review Board, because I considered the current approach was not serving the best interests of the public sector.

5.5
I have now lost confidence in the current approach used for setting standards, as it affects the public sector. Because of that loss of confidence, I have withdrawn the resources of my Office from the process for setting financial reporting standards in New Zealand. In my view, standard setting during the past 6½ years has resulted in NZ IFRS and IFRS being substantially the same as each other. I consider that not enough regard has been given to differences that exist between the private and public sectors. As a result, not enough regard has been given to the interests of people who use financial statements to hold public sector entities to account.

5.6
Near the end of 2008, I wrote to the Accounting Standards Review Board noting my view that continuing to apply NZ IFRS was not in the long-term best interests of most entities in the public sector. I came to this view because I consider the process used for adapting IFRS has unduly inhibited the establishment of high-quality financial reporting standards for the public sector. From the outset of the adoption of IFRS in 2002, I have advocated relevant and appropriate financial reporting standards for the public sector that can be used to properly hold public sector entities to account.

5.7
However, my comments about NZ IFRS should not be taken as a criticism of IFRS. I continue to 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.

5.8
In my view, the approach for establishing financial reporting standards in New Zealand has meant that the standards needed by the public sector have not been delivered. My attempts to get reasonable changes to the approach, supported by a more balanced membership of the Financial Reporting Standards Board, have, to date, been unsuccessful. As a result, I am advocating significant changes to the broad approach for setting financial reporting standards for public benefit entities in the public sector. I am also advocating changes in the responsibilities for standard setting.

The changes that I consider are needed

5.9
First and foremost, I think it is now imperative that IFRS is applied by only those reporting entities that IFRS were designed for, that is, profit-oriented entities accessing capital markets and any other profit-oriented entities required to, or wishing to, state their compliance with IFRS. In my view, these entities should adopt pure IFRS as established by the International Accounting Standards Board. Adopting pure IFRS for these entities would separate their need to state compliance with IFRS from the need for the standard setter to make relevant and appropriate changes for public benefit entities.

5.10
The question then becomes what to do about the remaining reporting entities, most of which are in either the public sector or the not-for-profit sector. By separating those entities applying pure IFRS from the remaining reporting entities, the crucial issue is how the standards should be set for these remaining entities. In other words, putting those entities applying pure IFRS to one side, how does the standard setter go about creating New Zealand standards for the other reporting entities, which include public sector entities?

5.11
In my view, the overall objective for the standard setter in setting New Zealand standards should be to set high-quality standards designed to produce general purpose financial reports that are understandable and that meet the needs of the people using them.

5.12
However, I acknowledge there are different approaches that could be used in future for setting financial reporting standards for public benefit entities in the public sector. I outline four such approaches below. These approaches may not be the only approaches that could be used.

5.13
To avoid any doubt, I reiterate that I do not consider that continuing with the status quo is a realistic option.

5.14
I describe the approaches as:

• enhancing IFRS;
• adopting International Public Sector Accounting Standards (IPSAS);
• enhancing IPSAS; and
• creating New Zealand standards.

Enhancing IFRS

5.15
By enhancing IFRS, I mean starting with IFRS but making appropriate changes for public benefit entities in the public sector. Such changes would include:

• removing standards that are not relevant to public benefit entities, and adding relevant standards from outside IFRS;
• altering language to make it relevant;
• removing unnecessary disclosure requirements;
• altering recognition, measurement, or presentation requirements where necessary; and
• adding guidance and relevant disclosure requirements.

5.16
In effect, I see enhancing IFRS as similar to the current approach where NZ IFRS can be applied by all reporting entities, but doing it a lot better. The approach would be better because it would remove the artificial constraints which currently exist when making changes for public benefit entities.

5.17
By separating those entities applying pure IFRS from the remaining entities, there should no longer be any concerns about the potential for changes in NZ IFRS to affect how profit-oriented entities apply IFRS. This is because the standards will no longer be packaged together as is the case now.

Adopting IPSAS

5.18
Adopting IPSAS for public benefit entities in the public sector, would, in my view, work along similar lines to adopting IFRS for the private sector. Adopting IPSAS would mean making minimal changes to those standards. Changes would be limited to:

• removing options where IPSAS contained alternative permissible treatments; and
• adding disclosure requirements.

5.19
Adopting IPSAS for public benefit entities in the public sector would create a need for standards for public benefit entities in the not-for-profit sector and those profit-oriented entities that are not adopting pure IFRS.

Enhancing IPSAS

5.20
Enhancing IPSAS would entail starting with IPSAS and making appropriate changes for application by public benefit entities in the public sector. Such changes would include:

• altering the language to make it relevant to the New Zealand situation;
• removing or adding disclosure requirements;
• altering recognition, measurement, or presentation requirements where necessary;
• adding relevant standards from outside IPSAS; and
• adding relevant guidance.

5.21
Enhancing IPSAS for public benefit entities in the public sector could readily be extended to include enhancements for public benefit entities in the not-for-profit sector. However, there would still be a need for standards for those profit-oriented entities that are not adopting pure IFRS.

Creating New Zealand standards

5.22
Creating New Zealand standards for all reporting entities, other than those adopting pure IFRS, would provide the standard setter with no defined starting point. Rather, the standard setter would be free to draw on principles, ideas, and requirements from various sources, including IPSAS and IFRS.

5.23
Each of the four approaches would have some benefits and drawbacks for the public sector. There would also be implications for other sectors. Figures 2 to 5 compare each of the four approaches in terms of what each would mean for the public and other sectors.

Figure 2
Enhancing IFRS

Figure 3
Adopting IPSAS

Figure 4
Enhancing IPSAS

Figure 5
Creating New Zealand standards

5.24
Essentially, I see that the preferred approach comes down to a trade-off between the quality of the standards sought (including the ability of entities to readily apply the standards), and the cost of setting standards to achieve that quality. Figure 6 shows my assessment of the quality versus cost trade-off, and what I see to be the likely trends associated with the first three approaches.

5.25
The transferability of accounting skills between the public, private and not-for-profit sectors is a factor to be considered also. On the face of it, similar standards between the sectors should help the transferability of accounting skills.

5.26
However, in my view, the transferability of accounting skills depends on the suitability of the standards. NZ IFRS may, in fact, have overstated the transferability of accounting skills because they give a false sense that the public sector is almost the same as the private sector. As a result, NZ IFRS may be applied to public sector circumstances and transactions as though they were the same as in the private sector, when in fact they can be quite different. Establishing the right standards for each sector should help to ensure the differences between the sectors are transparent.

Figure 6
Assessment of four new approaches for establishing financial reporting standards for the public sector

* My assessment of enhancing IFRS is on the basis that it is not simply a continuation of the status quo (that is, all relevant and appropriate changes are expected to be made between IFRS and NZ IFRS under this approach).

5.27
As Figure 6 shows, I see the cost of enhancing IFRS increasing over time as IFRS, on which this approach is based, become increasingly unsuitable for public benefit entities and requires more change. I see the quality of the standards resulting from adopting IPSAS improving over time as the International Public Sector Accounting Standards Board continues to gain credibility as an international standard setter for the public sector. For the same reason, I also see the quality of the standards resulting from enhancing IPSAS improving over time, while I also see a reduction over time in the cost of the process for enhancing the standards. I do not see any trends associated with creating New Zealand standards.

5.28
As well as a decision on how a set of New Zealand financial reporting standards will be created in future, there will need to be a decision about appropriate differential requirements for small entities. In my view, irrespective of the approach adopted, it is important to ensure that the reporting requirements for small entities broadly reflect their size and complexity, and the needs of people using the information reported.

5.29
The current differential reporting framework is designed to ease the compliance burden on smaller entities. Following the deferral of mandatory adoption of NZ IFRS (as outlined in Part 2, starting at paragraph 2.59), fewer small entities in the private sector reported in accordance with NZ IFRS. However, most smaller entities in the public sector were unable to defer NZ IFRS. Therefore, the standard setter now needs to review the differential reporting concessions available to small entities, particularly for the public sector.

5.30
In my view, more concessions should be available to smaller entities in the public sector. This would ensure that the accountability obligations of such entities are not disproportionate to their size while still meeting the needs of people using their financial statements. It may be that a simplified set of requirements can be established for certain homogenous sub-sectors within the public sector (for example, the schools sector).

5.31
Associated with any change in the approach to setting standards would be a need to review the way standard setting is carried out.

5.32
For the past 16 years, there have been two parties involved in setting financial reporting standards: the Financial Reporting Standards Board that writes standards, and the Accounting Standards Review Board that reviews and approves those standards. Therefore, setting financial reporting standards has required the co-operation of both boards.

5.33
Having two separate parties involved in setting financial reporting standards is different from what happens in other jurisdictions such as Australia, the United Kingdom, Canada, and the United States. In those jurisdictions the body that writes the standards sets the standards.

5.34
In my view, the writing and approving of financial reporting standards needs to be the responsibility of one board, a statutory board. I acknowledge that there would need to be changes to the Accounting Standards Review Board’s powers for it to be that statutory board. This would require legislative change.

5.35
The members of the statutory board would need to be selected from appropriately skilled people, so that collectively the board had experience in dealing with issues across the range of reporting entities for which standards are set.

Concluding comments

5.36
In my view, the Accounting Standards Review Board needs to be given the power to create financial reporting standards (as opposed to only approving or not approving standards submitted to it). If the Board had that power, it could then decide the best way forward and implement it so that standard setting for the public sector could be put “back on track”.

5.37
In my view, significant change rather than fine tuning is required. Such changes would include requiring, at least, listed issuers to adopt pure IFRS, and allowing any other profit-oriented entities wishing to state their compliance with IFRS to also adopt pure IFRS. In this way, these entities would be using standards designed for them.

5.38
The challenge for the Accounting Standards Review Board would then be to decide the most appropriate approach to setting standards for all other reporting entities. I have outlined four broad approaches the Accounting Standards Review Board could think about. The underlying premise of these four approaches is that continuing the status quo is not an option.

5.39
All four approaches have advantages and disadvantages. In my view, any assessment of these various approaches essentially comes down to a trade-off between quality of financial reporting standards (including the ability of entities to readily apply the standards) and the cost of setting standards to achieve that quality. I would strongly prefer an approach that emphasises the quality of financial reporting standards for the public sector.

1: The reports were Central government: Results of the 2006/07 audits, Part 2: Transition to New Zealand equivalents to International Financial Reporting Standards, pages 19-26 and Local government: Results of the 2006/07 audits, Part 7: Transition to New Zealand equivalents to International Financial Reporting Standards, pages 49-56, which were presented on 21 May 2008 and 24 June 2008 respectively.