Part 2: Matters arising from the audit of the Government's 2009/10 financial statements
2.1
In this Part, we report the results of our audit of the Financial Statements of the Government of New Zealand for the year ended 30 June 2010 (the Government's financial statements) and discuss the significant matters arising from the audit.
Unqualified audit opinion
2.2
The Auditor-General issued the audit report on the Government's financial statements on 30 September 2010.
2.3
The audit report appears on pages 24 and 25 of the Government's financial statements. It includes our unqualified audit opinion that those statements:
- comply with generally accepted accounting practice in New Zealand; and
- fairly reflect:
- the Government's financial position as at 30 June 2010; and
- the results of the Government's operations and cashflows for the year ended 30 June 2010.
Summary of significant matters arising from the 2009/10 audit
2.4
We discuss in more detail in the rest of this Part the significant matters arising from the audit, including:
- The Treasury's performance – The Treasury managed the process for preparing the Government's financial statements well. See paragraphs 2.7-2.8.
- Retail Deposit Guarantee Scheme – We are satisfied that the liability recognised for payments under the Scheme is based on reasonable analysis and assumptions. See paragraphs 2.11-2.17.
- Canterbury earthquake – The earthquake in the Canterbury region on 4 September 2010 was a significant event that occurred after balance date but before the Government's financial statements were completed. We are satisfied that the earthquake was a non-adjusting event and that the subsequent events' note disclosure in the Government's financial statements is appropriate and fairly reflects the Treasury's knowledge at 30 September 2010. See paragraphs 2.18-2.20.
- Discount rates – Last year, we reported our concerns about the use of different discount rates for valuing significant liabilities of the Government. We are satisfied that the valuations of the significant liabilities as at 30 June 2010 (in particular, those of the Accident Compensation Corporation and the Government Superannuation Fund) are based on robust, consistent, risk-free discount rates and Consumer Price Index (CPI) assumptions. See paragraphs 2.21-2.26.
- Related parties – Last year, we reported that there was no process to collect all the information about transactions between the Government reporting entity and key management personnel to ensure that disclosures required under NZ IAS 24: Related Party Disclosures could be made. We accepted that it was appropriate for the Treasury to wait for the standard-setter's revision to the standard before putting in place such a process. A good process has been implemented, and we are satisfied that adequate related party disclosures have been made in the Government's financial statements for the year ended 30 June 2010. However, there are two aspects that will need further consideration. See paragraphs 2.27-2.30.
- Land managed by the Department of Conservation – A significant project was carried out in 2009/10 to update the Department's financial records for land. We are satisfied that the Government's financial statements at 30 June 2010 fairly reflect the value of Crown land managed by the Department, after adjustments that were made to reflect the updated financial records. The adjustments were large, and the quality of the previous financial records was of concern. It will be important to ensure that the Department maintains accurate financial records for land in the future. See paragraphs 2.31-2.34.
2.5
We have also commented on:
- the review of accounting policies for tax revenue recognition (see paragraphs 2.35-2.37);
- accounting for the Emissions Trading Scheme (see paragraphs 2.38-2.42);
- accounting for the Government's proposal for repairing leaky homes (see paragraphs 2.43-2.45);
- accounting for Treaty of Waitangi settlements that include relativity clauses (see paragraphs 2.46-2.47);
- future enhancements to the state highways valuation methodology (see paragraphs 2.48-2.51); and
- accounting for the Kyoto Protocol (see paragraphs 2.52-2.57).
2.6
The Treasury has accepted the recommendations we have made, and will be working on them, along with other agencies, in 2010/11.
The consolidation audit
The Treasury's performance
2.7
The Treasury proactively dealt with several matters throughout 2009/10, including developing robust, risk-free discount rates and inflation assumptions to use in valuing the significant liabilities of the Government and establishing a process for collecting the information needed for related party disclosures.
2.8
The Treasury also proactively managed the consolidation reporting by significant public entities in 2009/10 and prepared the draft financial statements to an excellent standard by the statutory deadline.
Public entity performance
2.9
In recent years, we have raised significant concerns about the performance of some public entities in preparing timely and accurate financial information for consolidation. This year, we have seen an improvement in the receipt and accuracy of the returns. However, we continue to be disappointed in the number of "except for" audit clearances received (in other words, clearance of most but not all of the information provided for consolidation) and the number of late audit clearances because of entity non-performance.
2.10
We will work with the Treasury to ensure that entities that have not performed or met the required deadlines this year work with us actively to meet the deadline next year, with no "except for" audit clearances. In particular, we and the Treasury will work with those entities that had significant adjustments to their returns.
Significant matters arising from the 2009/10 audit
Retail Deposit Guarantee Scheme – liability based on reasonable analysis/assumptions
2.11
We are satisfied that the liability recognised for payments under the Retail Deposit Guarantee Scheme (the Scheme) is based on reasonable analysis and assumptions.
2.12
In October 2008, the Government introduced the Scheme. In August 2009, the Government announced that the Scheme would continue until 31 December 2011 with tightened eligibility criteria and additional limitations on its coverage. As at 30 June 2010, 73 financial institutions (2009: 73) had joined the Scheme and the amount of funds subject to the guarantee totalled $133 billion (2009: $124 billion). Note 30 of the Government's financial statements discloses detailed information about the Scheme.
2.13
As at 30 June 2010, the Government has recorded a liability of $791 million (2009: $831 million) for:
- future payments of $43 million to claimants of entities already in default (2009: $15 million); and
- net expected losses of $748 million for future payments under the Scheme (2009: $816 million).
2.14
The provision for net expected losses has been determined based on the likelihood of default actions triggering the guarantee and the expected loss given default (amounts payable to depositors less assets realised). The Treasury assessed which non-bank financial institutions are likely to call on the Scheme by using financial information from the Reserve Bank of New Zealand and external inspectors engaged to carry out detailed reviews of the financial institutions' loan books, funding arrangements, and operational structures.
2.15
After 30 June 2010, receivers have been appointed for three companies within the Scheme – Mutual Finance Limited, Allied Nationwide Finance, and South Canterbury Finance Limited. The inherent risk, and therefore the cost to the Scheme, of these receiverships of $745 million was recognised in the $748 million provision for future payments under the Scheme. Of the $745 million, $728 million was recognised in 2008/09 and the additional $17 million in 2009/10.
2.16
Last year, we recommended that the high-level approach that had been taken to determining the liability needed to be tested by a fuller analysis of each institution, and further work be done to establish the integrity of the financial information used to determine the provision. We are satisfied that our recommendations have been addressed.
2.17
Our Office is currently planning a performance audit examining selected aspects of how the Treasury implemented and managed the Scheme. This work will cover the original, revised, and extended Scheme. We anticipate reporting our findings to Parliament by 30 June 2011.
Canterbury earthquake subsequent event disclosures
2.18
The earthquake in the Canterbury region on 4 September 2010 was a significant event that occurred after balance date but before the Government's financial statements were completed. We are satisfied that the earthquake was a non-adjusting event and that the subsequent events' note disclosure in the Government's financial statements is appropriate and fairly reflects the Treasury's knowledge at 30 September 2010.
2.19
The Government is likely to incur significant costs because of this earthquake. However, the amount of those costs was not reliably quantifiable at the date of signing the Government's financial statements. We are satisfied that the Treasury is putting in place systems and processes to ensure that the costs to the Government can be monitored and reported accurately in the future.
2.20
Given the significance of the earthquake to New Zealand and the Government's financial statements, we expect the Treasury to consider specific disclosures in the Government's financial statements for 30 June 2011, and we will work with the Treasury to ensure that the disclosures (as required) are agreed early.
Significant long-term liabilities – risk-free discount rates and Consumer Price Index assumptions
2.21
Last year, we reported our concerns about the initial use of different discount rates for valuing significant liabilities of the Government. We are pleased that the Treasury completed a substantial project during the year to establish an acceptable methodology for deriving risk-free discount rates and inflation assumptions for use in certain accounting valuations in the Government's financial statements.
2.22
We are satisfied that the valuations of the significant liabilities as at 30 June 2010 (in particular, those of the Accident Compensation Corporation and the Government Superannuation Fund) are based on robust, consistent, risk-free discount rates and CPI assumptions. These assumptions were also used to build a risk-adjusted discount rate for use in valuing student loans.
2.23
In 2010/11, the Treasury will need to ensure that there is a wider application of these risk-free discount rates and CPI assumptions in the valuations of similar liabilities (such as long service leave and retiring leave liabilities) by other entities within the Government reporting entity.
2.24
We considered the appropriateness of the Treasury publication, Methodology for Risk-free Discount Rates and CPI Assumptions for Accounting Valuation Purposes (the Methodology), published in July 2010. The Methodology outlines how to determine the risk-free discount rates and CPI assumptions for use in certain accounting valuations.
2.25
We considered the table of risk-free discount rates and CPI assumptions as at 30 June 2010 and the associated methodology to be appropriate for the Government to use in valuing insurance claim liabilities (under NZ IFRS 4: Insurance Contracts); in valuing employee benefits such as pension obligations, long service leave, and retiring leave (under NZ IAS 19: Employee Benefits); and in building a risk-adjusted discount rate for use in valuing student loans (under NZ IAS 39: Financial Instruments: Recognition and Measurement).
2.26
However, we have highlighted to the Treasury some matters that may be subject to future technical developments and/or different market conditions that the Treasury will need to consider in future revisions of the Methodology. We will continue to monitor these matters in future years.
Collecting information about related party transactions
2.27
Last year, we reported that there was no process to collect the information about transactions between the Government reporting entity and key management personnel to ensure that disclosures required under NZ IAS 24: Related Party Disclosures could be made. We accepted that it was appropriate for the Treasury to wait for the standard-setter's revision to NZ IAS 24 before putting in place such a process.
2.28
During the past year, changes were made to NZ IAS 24 that dealt with the disclosure of transactions with Ministers of the Crown. The only related parties for the Government are key management personnel – being the 28 Ministers of the Crown, their close family members, and entities controlled or jointly controlled by those people.
2.29
A good process has now been implemented, and all 28 Ministers of the Crown completed a related parties disclosure form and declaration in September 2010.
2.30
We are satisfied that adequate related party disclosures have been made in the Government's financial statements for the year ended 30 June 2010. We note that no disclosures were required to be made based on the declarations made by Ministers. There are some areas that we have recommended the Treasury consider further for the Government's 2010/11 financial statements.
Adjustments to the value of land managed by the Department of Conservation
2.31
At 30 June 2009, discrepancies were identified in the financial records of the Crown land managed by the Department of Conservation (the Department). The Department has a comprehensive land register. However, it was maintaining financial and valuation records separately without rigorous processes to reconcile these records with the land register. The Department carried out a project to review its financial records for land to ensure that the records are accurate. This included an improved methodology and process for the revaluation of Crown land.
2.32
We are satisfied that the Government's financial statements at 30 June 2010 fairly reflect the value of Crown land managed by the Department, after adjustments that were made to reflect the updated financial records.
2.33
The quality of the Department's previous financial reconciliation process for land records was of concern. The review project identified that the value of the Crown land managed by the Department needed to be reduced by a net amount of $304 million. The size of the underlying adjustments, noted below, was concerning when compared to the 30 June 2010 Crown land value of $5,910 million. Those adjustments were:
- a $1,698 million reduction for valuations previously included that did not relate to Crown land managed by the Department; and
- a $1,460 million increase for land not previously included in the Department's financial records.
2.34
The review project has resulted in the Department implementing improved business processes. It will be important to ensure that the Department maintains accurate financial records for land in the future.
Review of accounting policies for tax revenue recognition
2.35
We are comfortable that the recognition of taxation revenue under current policies materially complies with generally accepted accounting practice. However, in previous years, we have suggested that the Inland Revenue Department thoroughly review taxation revenue recognition policies with a view to fine-tuning the recognition of taxation revenue, where appropriate. The Inland Revenue Department expects to complete its revenue recognition project by the end of December 2011, and intends to apply any changes to revenue recognition in 2012.
2.36
This is an important project because of the complexities involved and the potential effect on the way the Government recognises its tax revenue.
2.37
We have recommended that the Inland Revenue Department remain focused on achieving the completion date of its revenue recognition project, and that the Treasury closely monitor the progress of the project. Should there be changes to revenue recognition policies, we will consider the financial reporting impact and disclosure requirements (if any) of the changes in the Government's financial statements. Early consideration of any potential changes will be important.
Accounting for the Emissions Trading Scheme
2.38
As the Emissions Trading Scheme (ETS) is extended into new sectors, accounting for the ETS will become significant for the Government's financial statements in the future. There are also a number of refinements and developments required next year, including more regular updates of the carbon price and developing an accounting policy for revenue recognition.
2.39
Since the ETS began, 5.1 million New Zealand Units (NZUs) have been issued to participating foresters. The Crown recognises a liability and expense for these issued NZUs, which represents an obligation to swap the NZUs for internationally tradable Assigned Amount Units if requested by the participant. Once the scheme is fully operational, there will be units surrendered by participants that will be recognised as revenue and reduce this liability.
2.40
We have assessed the systems and the transactions relating to the allocation of units to foresters and have not identified any issues with the reported balances.
2.41
We have recommended that:
- A more regular, such as monthly, update of the carbon price be carried out. Currently, the carbon price is updated every six months based on the value of Certified Emission Reduction units that are traded on the European carbon market. However, NZUs issued to, or received from, ETS participants should be valued at fair value at the time of issue. Depending on the volatility of carbon prices, it is unlikely that a six-monthly price update will be a reasonable approximation to the requirement for fair value at the time of issue of NZUs.
- The Treasury and the Ministry for the Environment work together to develop a suitable accounting policy for the recognition of revenue from units surrendered by participants in the ETS. In particular, this should consider the timing of revenue recognition. At 30 June 2010, no units had been surrendered.
- The Treasury ensure that revenue recognition policies are consistent across the Government's financial statements. In particular, we note that there are parallels between the collection of NZUs under the ETS and the collection of taxation by the Inland Revenue Department. There is currently no authoritative guidance on accounting for the ETS, although the International Accounting Standards Board has an active project on the issue. Therefore, any accounting policy may be subject to change.
- The Ministry for the Environment complete its planned review of the carbon pricing methodology in time for it to be implemented by 30 June 2011 (see paragraph 2.55).
2.42
The dates for introducing various sectors into the ETS are shown in Figure 1.
Figure 1
Dates for introducing various sectors into the Emissions Trading Scheme
Sector
|
Date of introduction into the ETS
|
---|---|
Forestry | 1 January 2008 |
Stationary energy, industrial processes, liquid fossil fuels | 1 July 2010 |
Synthetic gases, waste | 1 January 2013 |
Agriculture | 1 January 2015 |
Accounting for the Government's proposal for repairing leaky homes
2.43
During the year, the Minister for Building and Construction announced the Government's proposal to assist homeowners in getting leaky homes repaired faster by contributing 25% of the agreed repair costs (with affected local authorities also contributing the same amount). The Government proposed that it would provide assistance to homeowners to access bank finance for the remaining agreed repair costs by way of loan guarantees to banks. The Department of Building and Housing is working on the details of how these proposals could work and on obtaining agreement between the Government, local authorities, and banks.
2.44
We are satisfied that the proposal has been appropriately disclosed as an unquantifiable contingent liability in the Government's financial statements. We consider it appropriate that no liability be recognised as at 30 June 2010.
2.45
We are currently working with the Treasury and the Department of Building and Housing on future accounting for the Government's leaky home proposal.
Accounting for Treaty of Waitangi settlements that include relativity clauses
2.46
Because of the uncertainties surrounding measurement of liabilities that may arise under relativity clauses in some Treaty of Waitangi settlements, we agreed with the Treasury that a liability for any relativity payments should not be recognised at 30 June 2010 and that an unquantifiable contingent liability be disclosed in the Government's financial statements. We are satisfied with the contingent liability disclosures.
2.47
This matter will need to be monitored closely because the mechanism is expected to be triggered within the next two years, depending on the progress of settlements. When this occurs, and is able to be reliably measured, our view is that an additional liability will need to be recognised in the Government's financial statements. We will continue to work with the Ministry of Justice and the Treasury on this.
Future enhancements to the state highways valuation methodology
2.48
We are satisfied that the state highways valuation of $24.8 billion as at 30 June 2010 is materially correct. However, the methodology used for valuation of the state highways network has remained largely unchanged for 20 years (with acknowledged enhancements to the process). We have previously raised the need for the New Zealand Transport Authority (NZTA) to review the methodology to ensure that it remains consistent with internationally accepted valuation methodology.
2.49
NZTA's independent valuer has previously raised a number of issues with the methodology used for the state highways valuation. The most significant issue is that some of the actual project costs incurred in recent urban projects have been excluded from the valuation. This includes costs such as traffic management, environmental compliance, utilities, a generic increase in construction costs as a result of the restrictions imposed by an urban built-up environment, and the significant costs associated with re-establishing the interface with adjacent properties ("Brownfields"). This has potentially undervalued the network.
2.50
NZTA has reviewed the appropriateness of including "Brownfields" costs. The review concluded that it is appropriate to include these costs in future valuations. This approach is applied internationally and to other large infrastructure assets such as the rail network. We understand that NZTA and its valuer are now considering how to incorporate this into future valuations.
2.51
We have recommended that NZTA update its valuation methodology to incorporate "Brownfields" costs and complete a review of the reasonableness and validity of the assumptions used in the valuation methodology. These should be done in time to incorporate any methodology changes into the 30 June 2011 valuation.
Accounting for the Kyoto Protocol
2.52
We have concluded that the Kyoto asset is materially correct based on the current assumptions and information available.
2.53
By its nature, this asset is more uncertain than most other items in the statement of financial position. Fluctuations in the value of the estimate may occur through changes in the assumptions underlying the net carbon emissions, movements in the price of carbon, and exchange rate movements between the market currency (EURO) and the New Zealand dollar. These assumptions are particularly prone to uncertainty.
2.54
New Zealand ratified the Kyoto Protocol in December 2002. This international agreement commits New Zealand to reducing its average net emissions of greenhouse gases between 2008 and 2012 (the first commitment period of the Kyoto Protocol or CP1) to 1990 levels or to take responsibility for the difference.
2.55
New Zealand's projected balance of Kyoto Protocol units during the first commitment period has increased by 1.6 million tonnes (from a surplus of 9.6 million tonnes in 2009). The two largest factors underlying the increase are:
- Emissions from the agricultural sector are now projected to be 6.4 million tonnes lower than projected in 2009 (a drop of 3.5%). This is attributable to the slower than anticipated recovery from a nationwide drought, and some regions experiencing further drought. The slower than predicted recovery is because of the economic slowdown.
- This fall in emissions has been largely offset by a fall in net removals from forestry of five million tonnes. Land-use mapping data has shown that the area of eligible Kyoto forests is smaller than previously estimated. This mapping also shows some deforestation of natural forests that had not previously been included in the net position, and this has increased the estimation for deforestation emissions.
2.56
We have recommended that the Ministry for the Environment complete its planned review of the carbon pricing methodology in time for it to be implemented by 30 June 2011. The current carbon pricing methodology is based on the value of Certified Emission Reduction units that are traded on the European carbon market. This has previously been agreed as the most appropriate methodology. However, as there have been changes in the carbon market in New Zealand, including the implementation of an ETS, it is appropriate for this methodology to be reviewed.
2.57
During 2009/10, an Australian-based firm completed an independent review of the methodology and processes used to determine the projected Kyoto net position. The review found that the projected net emissions are a reasonable estimate of how New Zealand is tracking towards its Kyoto Protocol commitment, and a practical system has been developed for estimating future levels of emissions that reflects New Zealand's national circumstances.