Part 8: The financial reporting environment

Central government: Results of the 2010/11 audits (Volume 1).

In this Part, we comment on:

Changes in New Zealand's financial reporting environment

We have expressed concerns in the past about the ongoing suitability of New Zealand equivalents to International Financial Reporting Standards (NZ IFRS) for many entities in the public sector. Our concerns were prompted, in part, by expected changes to NZ IFRS (because of proposed changes to the underlying International Financial Reporting Standards, IFRS) that would make their application by many public sector entities increasingly more difficult. Some of those changes are occurring, although at a slower pace than we expected, and more changes are envisaged.

The concerns resulted in the then Auditor-General withdrawing staff from the standard-setting process at the end of 2008, and publishing a discussion paper entitled The Auditor-General's views on setting financial reporting standards for the public sector,29 in June 2009. In the two and a half years since that paper was published, we have seen meaningful debate about the changes needed to set financial reporting standards in New Zealand and change is now under way.

We hope that by raising concerns we have helped to influence legislative changes to the Financial Reporting Act 1993 about the External Reporting Board (XRB), which was previously the Accounting Standards Review Board (ASRB). Those changes have, with effect from 1 July 2011, resulted in the XRB being given responsibility for both preparing and issuing financial reporting standards, among other responsibilities. The XRB has established two sub-boards including the New Zealand Accounting Standards Board (NZASB), which is tasked with preparing and issuing financial reporting standards.

We see the changes as a positive step. They position the XRB to make changes to the financial reporting standards to be applied by different types of reporting entities, including all entities in the public sector. As a result of these changes, the Auditor-General has once again made staff available to the new standard-setting process and a staff member has been appointed to the recently formed NZASB.

The legislative changes require the XRB to draft a strategy for establishing different tiers of financial reporting for different classes of entities, and to submit the strategy for Ministerial approval by 31 March 2012. The purpose of this requirement is to ensure that the financial reporting requirements that apply to different classes of entities are appropriate.

The XRB started consulting on proposals for its draft strategy in September 2011, at which time the XRB published three papers:30

  • Accounting Standards Framework: A Multi Standards Approach, a position paper;
  • Accounting Standards Framework for General Purpose Financial Reporting by Public Benefit Entities, a consultation paper; and
  • Accounting Standards Framework for General Purpose Financial Reporting by For-Profit Entities, a further consultation paper.

The position paper sets out the XRB's view that a multi-standards approach to financial reporting should be adopted in New Zealand because such an approach is likely to best meet the information needs of users of financial statements. We fully support an approach that focuses on the information needs of users.

The paper explains the process the XRB went through, and the matters it took into account, in forming the view that there should be a multi-standards approach. The view is based on feedback from consultation on a discussion document issued by the ASRB in September 2009 about a proposed new accounting and assurance standards framework for general purpose financial reporting in New Zealand.

The multi-standards approach sets a broad strategic shape to the new accounting standards framework. However, the NZASB needs to establish what that means at a detailed level to different categories of reporting entity, to ensure an appropriate level of reporting by all entities. The XRB's two consultation papers set out proposals for different tiers of reporting entities and the broad proposals for the financial reporting requirements for those different tiers. We comment below on the proposals as they relate to entities in the public sector.

Implications for entities in the public sector

The consultation paper about accounting by public benefit entities proposes three tiers. Public benefit entities in the public sector would be allocated to tiers depending on the amount of their operating expenditure and also the nature of their accountability. The operating expenditure thresholds would be:

  • tier 1, operating expenditure of more than $30 million;
  • tier 2, operating expenditure between $2 million and $30 million; and
  • tier 3, operating expenditure of less than $2 million.

Tier 1 would also include some public benefit entities in the public sector based on the nature of their accountability, regardless of the amount of their operating expenditure. Those entities include leviers of coercive revenue (such as the Crown) and issuers (such as Kiwibank Limited).

The financial reporting requirements for public benefit entities would depend on the tier to which an entity was allocated:

  • Tier 1 entities would be required to apply a suite of New Zealand public benefit entity (NZ PBE) standards based on International Public Sector Accounting Standards (IPSAS) modified for New Zealand circumstances, together with relevant domestic standards where there is no equivalent IPSAS.
  • Tier 2 entities would apply the NZ PBE standards but with reduced disclosure requirements.
  • Tier 3 entities would have simple format template reporting.

The expectation is that all three tiers would measure and recognise transactions consistently. However, there may be some measurement and recognition differences for tier 3 entities.

The proposed approach is likely to be more suitable than standards based on international financial reporting standards (IFRS). However, those requirements will be significantly influenced by IPSAS, which is a reasonably comprehensive set of standards with a level of underlying complexity and significant disclosure requirements. Therefore, although NZ PBE standards will be more appropriate and some modifications can be made to IPSAS in creating those standards, they will not be a "silver bullet" that will immediately resolve all the concerns that we have previously raised.

The consultation paper about accounting by for-profit entities proposes only two tiers. Large for-profit entities in the public sector would be in tier 1 and all other for-profit entities in the public sector would be in tier 2. To qualify as large, a for-profit entity in the public sector would need to have revenue of more than $30 million or assets of more than $60 million.

The financial reporting requirements for those tier 1 entities would be NZ IFRS, which basically consists of IFRS supplemented by relevant domestic standards. Tier 2 entities would apply NZ IFRS but with reduced disclosure requirements.

We support the long-term strategy to separate the reporting requirements of public benefit entities and for-profit entities. Although there is currently a reasonable alignment between IFRS and IPSAS, they are likely to diverge in future. This is because IFRS are focusing more on the needs of a narrow set of users (essentially investors in international capital markets), whereas IPSAS are focusing on the needs of resource providers (such as taxpayers) and recipients of public goods and services (such as students, hospital patients, and those receiving social welfare payments).

Some financial reporting challenges

Although the changes in the financial reporting environment are a positive step, there are some significant financial reporting challenges facing the XRB and the NZASB.

Reducing complexity

Since the introduction of NZ IFRS, most public entities' financial statements have become larger and more complex with increased disclosures. We continue to question whether the volume of information contained in financial statements properly meets the information needs of those who typically read the financial statements. There remains a real risk that readers are being presented with too much information, which makes it increasingly difficult to "see the wood for the trees".

The tier structure will go part of the way to addressing the issue about complexity of information, particularly for smaller entities, given that the NZASB can determine the disclosure requirements for tiers 2 and 3. However, tier 1 entities will still have extensive disclosures as required by IFRS and IPSAS.

In October 2010, the International Accounting Standards Board (IASB) invited the New Zealand Institute of Chartered Accountants and the Institute of Chartered Accountants of Scotland to carry out a project to review the levels of disclosure requirements in existing IFRS and to recommend deletions and changes to the disclosure requirements. Those Institutes issued a report in July 2011 entitled Losing the excess baggage – reducing the disclosures in financial statements to what's important.31 The report recommended deleting specific requirements and enhancing the use of materiality in financial reporting disclosures.

If disclosure requirements were reduced in line with the recommendations in the July 2011 report, financial statements prepared in keeping with IFRS could be reduced by up to 30% without losing important information for users. In our view, that would be a positive step. We consider that if changes were made to reduce the level of disclosure requirements in IFRS, it would be difficult for the International Public Sector Accounting Standards Board (IPSASB) not to make a similar level of reduction to the disclosure requirements of IPSAS. Any changes to IFRS and IPSAS would be expected to be reflected in New Zealand standards in due course.

Conceptual frameworks for financial reporting in the public sector

There are currently conceptual frameworks for both for-profit entities and public benefit entities in New Zealand. However, the New Zealand framework for for-profit entities developed by the IASB is more than 20 years old, and the New Zealand framework for public benefit entities is based on the IASB private sector framework and includes only a few changes that focus on the public sector.

Conceptual frameworks are important because they provide a high-level "roadmap" to standard setters, and a point of reference to preparers and auditors of financial statements for transactions not addressed by a particular standard.

The IASB is currently working on changing its conceptual framework to one that is more narrowly focused on the needs of those people accessing international capital markets. This is a long-term project that has been under way for several years already.

During the last few years, the IPSASB has also been working on its first conceptual framework for public benefit entities in the public sector. The work that the IPSASB is doing does consider the work being done by the IASB but is not constrained by it. That work already looks to be focused on the needs of both resource providers (such as taxpayers) and recipients of public goods and services (such as students, hospital patients, and those receiving social welfare payments).

In our view, both conceptual framework projects are important to New Zealand. The NZASB has a role in appropriately influencing the work being done internationally. Also, as changes are made to conceptual frameworks, it will be important to the New Zealand public sector that the NZASB considers the interaction between the conceptual frameworks, given the public sector includes both for-profit entities and public benefit entities.

Standards for reporting non-financial performance information

On many occasions, we have commented about how crucial non-financial performance information is to the accountability of many entities in the public sector. Also, we have noted that such information needs to work in conjunction with financial information to convey a coherent and understandable picture about the performance of entities.

Currently within NZ IFRS, there are only a few paragraphs that deal with statements of service performance, which is a particular form of reporting on non-financial performance information. Supplementing those paragraphs is a document entitled: Technical Practice Aid No. 9: Service Performance Reporting (TPA-9). TPA-9 contains application guidance based on practice at the time the material was first published in 2002. However, it is arguably too detailed and not sufficiently focused on the main principles of what constitutes good reporting of non-financial performance information.

In our view, it is important that the NZASB develops an appropriate standard for the preparation of non-financial performance information because of the need for that information to integrate with financial information and present a complete performance picture.

Determining which entities combine to form a group

The issue of which entities combine to form a group is important in the public sector. Group financial statements affect the transparency of reporting and accountability, because they show the combined resources, and use of resources, by a "parent" entity.

"Control" is the accounting concept used to determine which entities are combined to form a group. Current financial reporting standards provide a lot of guidance about what "control" is in a financial reporting sense. This guidance focuses on the underlying substance of arrangements, not on the meaning of the word "control".

Notwithstanding the guidance provided in current financial reporting standards, assessing whether an entity controls another in the public sector can be difficult. This is particularly so for entities with no formal ownership instruments such as trusts. Determining whether entities such as trusts are "controlled" for financial reporting purposes remains a challenging area that would benefit from greater clarity.

In our view, the NZASB needs to clarify what control means for entities with no formal ownership instruments. We consider it important that the entities combined to form a group continue to focus on the substance of arrangements and present useful information to readers.

29: Available on our website (

30: See "Accounting Standards Framework Documents Released" on the XRB's website (

31: Available on the website of the New Zealand Institute of Chartered Accountants (

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