2. Executive summary and outline of key review findings

Appendix 6, Inquiry into the Mangawhai community wastewater scheme

4. The Auditor‐General has commissioned this independent review to assess the sufficiency and appropriateness of the audit work undertaken by the Kaipara District Council’s auditor, Audit New Zealand. Specifically, my terms of reference require me to consider Audit New Zealand’s audits of the Council’s Annual Reports, Long Term Council Community Plans (LTCCP)1, Long‐Term Plan (LTP) and Annual Plans between 2003 and 2012. This review forms part of the Auditor‐General’s broader inquiry into the Council’s management of the Mangawhai community wastewater scheme (“the wastewater project”).

5. Given the emphasis of the Auditor‐General’s inquiry, I have focused my review on significant, or material, matters that are directly relevant to the broader inquiry. In particular, I have focused on those aspects of the audit engagement where the auditor considered (or would have been expected to consider) the risks and audit implications associated with the Council’s management and development of the wastewater project. In performing my review, I have also focused on the auditor’s understanding and consideration of:

  • Matters that impact the Council’s activities and operations;
  • The Council’s management control environment;
  • Key audit risks associated with matters reflected in the Council’s annual report or planning documents;
  • Council’s overall framework and system for ensuring compliance with applicable laws and regulations;
  • Those auditing, assurance and professional standards applicable to the planning and performance of particular audit engagements; and
  • Whether the overall objective of the audit has been met.

6. At the time this review was performed, there was significant public interest in the Council’s management and funding of the wastewater scheme. Numerous deficiencies and irregularities had become public knowledge, many extending back over multiple financial periods. Irregularities in the Council’s setting and assessment of rates, and other procedural matters, are now the subject of a Bill before Parliament. The community continues to express concerns about the funding and financial implications of the wastewater project.

7. It is therefore understandable that questions have been asked about why the Council’s auditor did not identify the irregularities. The high level of public interest and scrutiny have made completing this review especially challenging. In particular, there is a risk that heightened public scrutiny of the auditor’s performance may result in misplaced expectations, or a misunderstanding about the purpose of the audit, the audit process, and the role and responsibilities of the auditor – especially compared with the responsibilities of the Council or its independent advisors. This risk is commonly referred to as the audit expectation gap.

Understanding the purpose of the audit, and the auditor’s role and responsibilities

8. In preparing this report, I have been mindful of the need to carefully consider and clarify the role, purpose and responsibilities of the auditor; and to clearly establish the scope and objectives of the audit engagement. My aim has been two‐fold. First, doing so has helped me clearly identify the benchmarks and standards against which to assess the performance of the audit, and to determine the reasonable expectations that intended users of the annual report or planning document could have of the auditor. Second, it has ensured that those who read this report have a broader context of understanding about the audit process, its purpose and inherent limitations.

9. In the local government context, the purpose of an audit is to enhance the degree of confidence that intended users can have in a Council’s annual report or long‐term planning documents. In performing the audit, the auditor’s overall objective is to obtain reasonable assurance that these documents are:

  • free from any material misstatement; and
  • presented in a manner consistent with a recognised or prescribed reporting framework or in accordance with applicable legislative requirements.

10. Importantly, the concept of reasonable assurance does not mean that the auditor has obtained absolute assurance or that they have tested every transaction or disclosure in the annual report or long‐term planning document. Nor does it mean that the auditor has looked at and assessed whether every aspect of the Council’s operations and activities complies with applicable laws and regulations. It is recognised that most of the audit evidence from which the auditor draws conclusions, and bases their opinion on, is persuasive rather than conclusive.

11. In addition to understanding the objective of the audit, I have been careful to consider the scope of the audit engagement – the nature and extent of the matters on which the auditor is required to express an opinion, and also what matters the auditor’s opinion does not address. The scope of the audit engagement is determined by the requirements and provisions of the Local Government Act 2002 (the Act).

12. In the case of the Council’s annual report, the auditor is required to express an opinion on the presentation of the Council’s financial statements, group of activity statements and whether the Council’s annual report complies with the requirements set out in Schedule 10 of the Act. To the extent that an activity, project or transaction has a direct material impact on the annual report or on the presentation of the Council’s financial statements, then it is reasonable to expect that the auditor would take this matter into account when planning and performing the audit. If, however, a project or activity does not have a direct material impact on the Council’s financial statements, then, depending on its general nature or significance, the project or activity may have a limited role only in the auditor’s planning of the audit.

13. In the case of the Council’s planning documents2, the auditor is required to express an opinion on whether the planning document complies with the requirements of the Act, and to separately assess the quality of the information and assumptions underlying the forecast information. The Act explicitly prohibits the auditor from commenting on the merits of the plan’s policy content.

14. Finally, in the case of the audit of public entities, auditors are expected to take account of, or be alert to, matters that are of direct interest or concern to the Auditor‐General. These matters derive from the Public Audit Act 2001 and reflect public and parliamentary expectations of the Auditor‐General. In broad terms, the Auditor‐General is concerned with matters of performance, authority, waste and probity in public entities. Auditors are expected to bring the Auditor‐General’s attention to matters of interest in any one of these areas.

Professional expectations of the auditor in the planning and performance of the audit engagement

15. Auditors are required to plan and perform the audit in accordance with specific professional and ethical standards applicable to each audit engagement. In all cases the auditor is required to be independent of the public entity that they are auditing. They must plan and perform the audit with professional scepticism – an attitude that requires a questioning mind, alertness to conditions that may indicate a possible misstatement, and critical assessment of audit evidence (including avoiding the risk of over‐reliance on management’s explanations and representations). In discharging their professional obligations, the auditor must also exercise significant professional judgment – making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement. Furthermore, intended users of the auditor’s report are entitled to expect that the planning and performance of the audit meets the required quality standards and benchmarks.

16. Over the period covered by this review, certain auditing, assurance and ethical standards applicable to various audit engagements have changed, evolved or have been updated. I have been mindful of these changes when considering what was reasonable and appropriate at the time that the auditor planned and performed the engagement.

17. In addition, Audit New Zealand has suggested that in order to assess whether an auditor has demonstrated compliance with underlying standards of behaviour or performance, certain changes in general audit industry practice over the same period must be taken into account. For example, what may be considered sufficient documentation in 2012 may differ from that considered sufficient in 2003. Audit New Zealand contends that the underlying auditing standards, and the general industry approach to what is sufficient and appropriate to demonstrate compliance, collectively form the benchmark against which to assess whether the work planned and performed is that which could be expected of a reasonable auditor.

18. While there is no single verifiable body of evidence to benchmark general industry practice at a particular point in time, I have accepted Audit New Zealand’s arguments. I accept that it would be inappropriate, and unreasonable, to assess the performance of the 2003 audit on the basis of a higher standard or expectation applicable to the 2012 audit. I am satisfied that there is publicly available information corroborating Audit New Zealand’s assertion that the practices and expectations of auditors changed between 2003 and 2012. For example, reports from independent audit regulators, standard‐setting groups and oversight bodies reveal changes in expectations of auditors’ documentation practices and of the way they exercise professional judgment and scepticism. In addition, I note that Audit New Zealand’s own audit methodology also reflects changes in general industry practice, even in areas where the underlying requirements in the Auditing Standards may not have changed. I note also that during the period covered by my review Audit New Zealand has subjected its audit methodology and quality control practices to independent reviews by both the New Zealand Institute of Chartered Accountants and the Australasian Council of Auditors‐General, which identified no matters of concern.

19. Without limiting this conclusion, I have noted that while documentation on the audit file may be consistent with general industry practice, and therefore demonstrate the auditor’s compliance with the auditing and professional standards, there may be instances where it is not possible for me to assess the sufficiency and appropriateness of the work performed by the auditor – as there may be insufficient documentation from which I am able to undertake my assessment. I intend to clarify this in respect of the matters identified or reported through this report.

Key findings and observations from this review

General:

20. Audit quality varies significantly over the period covered by this review – although, overall, there has been a noticeable improvement in quality. There is evidence that the performance of audit test procedures has not always met the standards and expectations required of the auditor. Significant areas of deficiency or non‐compliance principally relate to:

  • the auditor’s planning of the audit engagement;
  • the identification and assessment of audit risks;
  • the sufficiency and appropriateness of audit documentation; and
  • the collection of sufficient appropriate audit evidence.

21. In addition, I have also identified deficiencies in the way the auditor considered the impact of the wastewater project on the annual report or planning documents – specifically, how the auditor applied their professional judgement or the nature and extent of scepticism exercised by the auditor in understanding the impact of the wastewater project on the Council’s financial statements.

22. In addition to this high‐level assessment of variable audit quality, I have also identified variability in the sufficiency and quality of the work performed at the level of specific components (for example, cash and bank, expenditure etc.). The standard of work varies depending on the nature of the component, the audit approach adopted for that component, and the knowledge and experience of the auditor performing the audit test procedures.

23. However, despite the deficiencies noted through this report, and with the exception of the auditor’s consideration of the wastewater project during the period of construction, audit work on rates and work performed in planning the audit and identifying audit risks, I have found that much of the audit work planned and performed at a component level within the audit had been sufficiently and appropriately planned and performed in accordance with the standards expected of that particular work.

24. Overall, I am satisfied that the audit methodology and approach developed by Audit New Zealand and/or the Office of the Auditor‐General (OAG) provided a reasonable and appropriate basis from which the auditor could plan and perform the audit engagements. The audit methodology is aligned to the requirements of the auditing and assurance standards applicable at the time each audit engagement was undertaken. Moreover, Audit 8 New Zealand’s audit methodology and its quality control systems, processes and procedures were subject to independent quality assurance review on at least three separate occasions during the period of this review. No significant issues or deficiencies were noted. In the case of the audit of the LTCCP/LTP, the OAG developed the audit methodology and approach for its appointed auditors.

The auditor’s knowledge and understanding of the wastewater project

25. By any measure, the wastewater project was a significant undertaking for the Council. Its funding and financial implications were of significant interest to the community. From discussions with each auditor, and my review of the documentation and evidence available on the audit files, I find that that the auditor was generally aware of the progress and development of the wastewater project.

26. As the wastewater project progressed, its potential impact on the Council’s annual reports and planning documents changed significantly. The auditor needs to have a sufficient understanding of the wastewater project, and its impact on the annual report or planning document, in order to effectively plan and perform the audit engagement. It therefore follows that as the scope and management of the project changes the auditor would need to update their assessment and understanding of the project.

27. In my view, the auditor did not have a sufficiently complete understanding of the wastewater project – once the final contract had been signed and construction was underway – in order to properly plan and perform the audit. The wastewater project should have been a significant and increasing area of focus throughout the 2006 – 2009 audits, but it was not. Importantly, through this period the auditor did not identify the wastewater project as a significant audit risk or area of audit focus and there is no evidence that the auditor independently considered the nature of the contract entered into by the Council, and the impact that this had on the accounting for the wastewater project in the financial statements. I consider this to be a significant deficiency. As was subsequently discovered the Council did not correctly account for the wastewater project. In the case of the 2009 annual report, the effect of these errors is that the financial statements are materially misstated.

28. I have looked closely at this issue during my review. The auditor notes that their understanding was that the wastewater project should be accounted for off‐balance sheet. This understanding was formed through discussion and reliance on the advice from Council management. It was also influenced by the auditor’s continued reliance on the 2005 assessment of the overall project management. There is no evidence that the auditor ever independently reviewed or considered the wastewater project, once the final contract had been signed, or tested/confirmed whether the Council’s accounting treatment of the wastewater project was consistent with the substance of the arrangement or that it complied with generally accepted accounting practice.

29. In my view the auditor was over‐reliant on advice from, and discussions with, management. It is reasonable to have expected that the auditor should have independently developed their understanding of the wastewater project and assessed the impact on the annual report, including whether the Council had adopted the most appropriate accounting treatment. Further, the auditor inappropriately placed reliance on work performed in 2005 without sufficiently updating this assessment to take account of changes in the nature and scope of the project during 2006 – 2009. Both of these matters are significant deficiencies in the auditor’s planning and performance of the audit. As a consequence of these deficiencies the auditor has failed to detect that the accounting treatment adopted by the Council was incorrect and that the result of this would be errors and omissions in the Council’s financial statements. In the case of the 2009 annual report, these errors and omissions were material. As a consequence, the auditor has not satisfied the overall audit objective – they have not obtained reasonable assurance that the financial statements are free from material misstatement – and has incorrectly issued an unqualified audit opinion.

30. Given the significance of this finding, and for the sake of completeness, I briefly summarise the extent of the auditor’s understanding during critical periods of the review.

2003‐2005

31. Audit New Zealand suggests in this period, the wastewater project was at a stage of development that meant it was unlikely to have a material or significant impact on the Council’s annual report. As a result, Audit New Zealand contends that the testing required to be performed by a reasonable auditor at that time would have been limited in its nature and extent, and certainly less than was required in subsequent periods. After carefully considering the stages of development of the wastewater project over this period, I accept that the nature and extent of audit testing performed between 2003 and 2005 was reasonable: it put the auditor in a position to properly express an opinion on the Council’s annual report.

32. However, I consider that the judgment exercised by the auditor in reaching their position on the impact of the wastewater project on the annual report is not clearly or sufficiently documented on the audit files. Between 2003 and 2005 there is evidence that the auditor completed an annual assessment of the management of the wastewater project. This assisted the auditor’s understanding, enabling the auditor to effectively plan the audit engagement. However, it is noticeable that this assessment was narrowly focused and did not specifically consider amongst other matters:

  • the nature and extent of the Council’s oversight, governance and management of the project;
  • the Council’s overall risk management strategy, framework and risk identification for the project;
  • the project’s funding and financial implications, including the accounting treatment of the project;
  • the robustness or quality of project budgets and financial projections; or
  • the project’s impact on the Council’s funding and financial policies and financial strategy.

33. It is reasonable to suggest that the auditor’s knowledge and understanding of the wastewater project, and its impact on audit risk, would have initially developed during 2003‐2005. As the development of the wastewater project progressed and changes were made to scope and financial impact of the project, it is reasonable to expect that the auditor would have updated their understanding and assessment of the impact of the project on the annual report or planning document.

34. Audit New Zealand suggests that much of the information required to undertake a comprehensive assessment of the matters identified in paragraph 32 above did not exist at the time of the 2003 – 2005 audits – as the contract was not signed until October 2005. Between 2006 – 2009, Audit New Zealand agrees that the assessment should have been updated subsequently to reflect the different stages of the wastewater project once the final contract had been signed. I concur with Audit New Zealand’s general position on this matter. However, I remain concerned over the sufficiency of documentation on the file to support this. In my view, there is insufficient documentation on the file to indicate whether the work performed by the auditor was a preliminary assessment only. Second, in the context of the work performed, if in the auditor’s professional judgement the matters identified above were not matters that needed to be acted upon until after the contract was signed then it is reasonable to expect that this judgement would be documented. Third, with respect to the auditor’s consideration of the governance and oversight arrangements that the Council had in place, in my view, these are equally relevant to both the Council’s planning and set up of the project (pre‐contract signing) and during the period of development or construction (post‐contract signing) and therefore were matters that should have been considered by the auditor and documented on the file. Notwithstanding these limitations, I accept Audit New Zealand’s assertion that, based on the current stage of development, this would not have influenced the auditor’s planning and performance of the audit.

2006‐2009

35. Between 2006 and 2009, the auditor continued to rely on work undertaken as part of the 2005 review. There is no evidence or documentation indicating that the auditor ever updated their understanding of the project, or addressed the gaps and deficiencies noted during the 2005 review.

36. Also between 2006 and 2009, the auditor failed to identify any significant audit risks associated with the wastewater project and did not adequately assess its potential on the Council’s annual report or planning documents. Nor is there evidence or documentation showing the auditor sufficiently assessed or considered the implications of changes in the project’s scope, or the funding and financial implications of these changes. Critically, the auditor did not independently consider or assess whether the Council’s proposed accounting treatment of the wastewater project was consistent with the substance of the arrangement, or that it complied with generally accepted accounting practice. Continued reliance on management’s understanding as the primary source of audit evidence, without independently corroborating this understanding, was inappropriate.

37. As a result of these deficiencies, between 2006 and 2009, the auditor’s planning and assessment of audit risk provided an insufficient basis from which to effectively plan and perform the audit of Council’s annual report and planning documents. It is reasonable to expect that the wastewater project would have been an increasingly significant consideration in the audit during this period.

38. Based on my review of the audit files during this period, I also found that limited testing and consideration was given to the wastewater project during the actual performance of the audit. Errors, omissions and deficiencies related to the wastewater project were never identified or detected – either because they were not tested or considered, or because test procedures were performed incompletely or inadequately. The significance of the wastewater project on the forecast financial and funding information, as set out in the planning documents was also not sufficiently reflected in the auditor’s planning and performance of these audits. These deficiencies also meant that the auditor was not sufficiently aware of matters of performance, authority, probity and waste, as required by the OAG’s standard.

39. Of particular concern is the fact that the Council’s financial commitments under the contract, the treatment of expenditure and the recognition of the resulting assets and liabilities were not appropriately accounted for in the Council’s financial statements. The fact the auditor never identified this deficiency was due to a lack of understanding of the wastewater project and how it should have been accounted for in the Council’s financial statements.

40. In the case of the 2009 annual report, these errors and omissions meant the Council’s financial statements are materially misstated and therefore the auditor’s opinion on these financial statements is incorrect. In my view, it is reasonable to have expected the auditor to have identified these errors and omissions in the planning and performance of the audit.

2010‐2012

41. Commercial acceptance of the wastewater project took place in July 2009. In 2010–2012, the auditor became aware of deficiencies in the way that the Council had accounted for the wastewater project in the financial statements during the period of construction. There is evidence that the auditor sufficiently considered this issue, and the impact on prior period financial statements, and in respect to the audit opinions issued previously by the auditor. The 2011 annual report discloses the nature and extent of the errors and omissions. There is extensive disclosure of the restatement of comparative financial information to reflect the impact on the 2008 – 2010 financial statements if the wastewater project had been appropriately accounted for. These disclosures highlight the potential material misstatement of the 2009 financial statements. Throughout this period there is evidence that the auditor discussed and liaised with the OAG to understand and address the implications of the errors and omissions.

The auditing of Council’s rates

42. At the time this review was undertaken, irregularities in the Council’s setting and assessment of rates were the subject of a local Bill3 before Parliament. These are therefore matters of considerable concern to the community, and there is a strong public interest in understanding why the irregularities were not identified by the auditor.

43. Accordingly, my review specifically examines the sufficiency and appropriateness of the work performed by the auditor on rates. I have focused primarily on the period covered by the Bill, and reached the following conclusions and findings:

43.1. The Council is responsible for setting and assessing rates, and for ensuring compliance with appropriate legislative requirements – in the case of rates, this means setting and assessing rates in accordance with the Local Government Rating Act 2002 (LGRA). The auditor is responsible for planning and performing the audit to ensure the overall audit objectives are satisfied. The auditor’s work on rates cannot be relied upon as a legal review of the Council’s compliance with the applicable legislative requirements. In circumstances where the Council requires some form of legal sign‐off or assurance, then it is reasonable to expect it to seek such assurance directly from appropriate independent legal counsel. Evidence on the audit files indicates that, during the period of this review, the Council did seek and obtain independent legal advice on its setting of rates.

43.2. Considering the overall objectives of the audit engagement, I found that the auditor’s methodology and approach to auditing rates – including the performance of test procedures to assess compliance with applicable legislative requirements – provided a reasonable and appropriate basis from which to plan and perform the audit engagement. However, my review of the audit files reveals significant deficiencies in:

  • the actual performance and documentation of the audit test procedures;
  • the collection and evaluation of appropriate audit evidence;
  • the manner in which the auditor exercised professional judgment to form a conclusion from the audit work on rates.

43.3. Of particular concern is the auditor’s failure to adequately document the performance of audit test procedures so as to support their conclusions about legislative compliance. In most instances, the auditor simply noted on the audit file that the Council had complied with the requirements of the LGRA, despite contrary evidence now before Parliament in the form of the Bill. The files I have reviewed neither demonstrate nor provide any evidence for how the auditor reached their conclusions.

43.4. I found the auditor did not adequately consider or assess the Council’s systems, processes and procedures for ensuring compliance with legislative requirements for setting and assessing rates. The auditor was over‐reliant on the Council’s control environment and underlying systems of control, and did not sufficiently test whether the Council’s systems, processes and controls were operating as described or understood, or whether they were effective. Documentation on the audit file indicates the auditor was unduly reliant on discussions and enquiries with management. As a consequence, the auditor was not sufficiently alert to the potential risk of non‐compliance.

43.5. In 2009 the Council introduced a new targeted rate to fund the wastewater scheme. There is no evidence that the auditor ever considered or assessed whether the basis of this targeted rate complied with the LGRA. Audit test procedures required the auditor to adopt a sampling approach when selecting and testing targeted rates, and when checking whether the basis for these rates complies with the LGRA. I accept that this is a reasonable approach and that it would be unreasonable to expect the auditor to consider and test all targeted rates, in every audit, in order to satisfy the audit objectives. However, in my view, given the significance of the wastewater project, the impact of the Council’s funding decisions on the community and the fact that the targeted rate had been introduced for the first time in 2009, I consider it reasonable that the auditor should have selected this targeted rate for testing. The auditor did not, and there is insufficient documentation to understand the basis for this decision. I queried this matter with Audit New Zealand, who responded that … “The contention that the Mangawhai targeted rate should have been tested can be supported given the significance of the rate both financially and in the context of the Council’s environment”. Had the auditor selected this rate, there is a reasonable expectation, based on the test procedures specified in the audit file, that the irregularities in the setting of the rate would have been identified by the auditor.

43.6. Audit test procedures required the auditor to ensure that all rates set out in the rates resolution were as set out in the Council’s Funding Impact Statement (FIS). In addition, the auditor was required to assess whether the Council’s rates assessment notice contained all the elements and requirements set out in the LGRA. Irregularities subsequently identified in the Bill show that the Council had not complied fully with either legislative requirement.

Over the period covered by the Bill (2006/2007 – 2009/2010) the audit files indicate that the auditor has performed the test procedures prescribed. No instances of non‐compliance, and no errors or omissions, were identified in any period.

In the majority of the audits performed during the period covered by the Bill, the documentation and evidence on file makes it difficult to determine with sufficient certainty what work was carried out in accordance with the audit test procedures or why the irregularities were not identified.

Given the nature of the test procedures the auditor was required to perform, it is reasonable to expect the auditor to have identified the irregularities and deficiencies subsequently identified in the Bill. Had they been, they would have been brought to the attention of the Council and the OAG.

43.7. The auditor did review and consider the independent legal advice the Council obtained on various rating matters. The first such advice was provided when the Council became aware of potential irregularities in the setting of rates for the wastewater scheme during the 2010 audit. There is sufficient evidence to indicate that the auditor appropriately considered this advice, discussed the issues it raised with the Council, and considered and assessed the consequences for the auditor’s report on the Council’s annual report.

Notwithstanding these actions, the way the auditor documented the results of their audit test procedures and formed conclusions were at odds with the matters identified in the Council’s independent legal advice. And, after considering that advice, the auditor did not review and update the work they had already performed as might reasonably have been expected.

43.8. Once aware of the potential irregularities, the auditor brought the matter to the attention of the OAG in a reasonable and timely manner. Evidence and documentation supports this, and also shows that the auditor and the OAG carefully considered how the irregularities might affect the audit report. The Council disclosed the irregularities in its 2010 annual report, which it did by way of a note to the financial statements. No adjustment was considered necessary to the recognition of rates revenue. In light of the disclosures made by the Council, and based on the information and understanding available at that time, the auditor concluded that an unqualified audit report was appropriate. This judgement is supported by sufficient appropriate evidence on the audit file.

By the time the 2011 and 2012 annual reports were audited, the Council had carried out more detailed analysis of the nature, extent and impact of the irregularities. The Council provided more detailed disclosure of these matters in the notes to the financial statements. Based on the disclosures made by Council and after considering the further analysis undertaken by management since 2010 the auditor concluded that an unqualified audit report was still appropriate, but that audit report should include additional commentary to draw users’ attention to the irregularities and matters disclosed by the Council. Again, the judgement exercised by the auditor is supported by sufficient appropriate evidence on the audit file.

43.9. In my view, the deficiencies identified in the previous paragraphs 43.1 – 43.8 are significant. A root cause analysis does not sufficiently explain why the auditor did not identify the irregularities through the performance of the audit test procedures. Based on the audit test procedures the auditor was required to perform, it is reasonable to expect the auditor to have detected the following rates‐related irregularities subsequently identified in the Bill:

  • differences between the FIS and the Council’s rates resolution;
  • uncertainties over whether the rates assessment notice correctly contained all matters required by the LGRA;
  • uncertainties over the basis for “key” targeted rates selected by the auditor during the 2006/2007 and 2007/2008 audits;
  • uncertainties over the basis for the targeted sewerage rates selected by the auditor for testing in the 2007/2008 and 2008/2009 financial periods; and
  • uncertainties over the basis for the targeted rate to fund the wastewater scheme in 2009 (on the basis that the auditor could have been reasonably expected to select this particular rate as part of their sample testing). It is reasonable to have expected that the auditor’s performance of the test procedures would have identified most of the irregularities relating to the setting and assessment of rates subsequently identified in the Bill.

43.10. Following discussions with the auditor, I have determined that the primary reasons for the deficiencies outlined above were:

  • a lack of understanding of the requirements of the LGRA;
  • a lack of understanding of the objective or purposes of the audit test procedure; and
  • a failure to adequately identify the risks and significance of non‐compliance.

These lapses meant the auditor was not in a position to apply sufficient appropriate professional judgement when performing the audit test procedures, or to identifying potential material non‐compliance, or irregularities, should they be present. The deficiencies noted in the auditor’s work were not identified or addressed through the engagement quality review processes.

43.11. Cumulatively, these deficiencies mean the auditor’s performance of test procedures on rates did not comply with the auditing and professional standards applicable to the audit engagement. They have also influenced my view on whether the auditor has satisfied the objectives of the audit during the period covered by the Bill.

Other significant matters arising from the auditor’s work

Documentation:

44. The standard of the auditor’s documentation varies across the period and/or between individual components of the audit engagement. Between 2003‐2009, I have found deficiencies relating to sufficiency and appropriateness of documentation that:

  • supports the performance of test procedures and other audit work;
  • recorded meetings and discussions with Council management and staff;
  • showed the professional judgment exercised by the auditor – whether it provided an adequate basis from which the auditor could rely on work performed in previous audits, and to show compliance with the necessary auditing and professional standards.

I have carefully considered what impact deficiencies in audit documentation may have on whether the audit file contains sufficient audit evidence to support the audit opinion. I note that auditor oversight regulators, and the quality review programs of most audit firms, generally take the approach that if audit work is not documented, the presumption is that the work has not been performed – in the absence of evidence to the contrary. Based on my review I have identified instances where there is no documentation to support the performance of a test procedure or the professional judgement exercised by the auditor, and instances where the documentation is insufficient.

Understanding of relevant laws and regulations

45. I consider that the auditor was sufficiently aware of those laws and regulations that the Council was required to comply with, including those that had a material impact on the recognition and disclosure of items in the annual report and planning document. There is evidence on file to indicate that the auditor has considered and assessed category 1 legislation (which includes significant legislation such as the Local Government Act 2002, Local Government Rating Act 2002). However, except for 2006, I found no evidence that the auditor ever tested, or considered the possible impact of non‐compliance, with other category 2 or 3 legislation – legislation that may have a fundamental effect on the Council’s operations or that may result in significant financial, operational or political exposure (such as, the Resource Management Act 1991, Building Act 1991, Goods and Services Tax Act 1985 etc.).

46. I found that although the auditor has assessed the overall legislative control environment, and the systems and controls for ensuring compliance with applicable laws and regulations, the documentation to support the auditor’s performance of test procedures, or as evidence of the auditor’s professional judgement has not always sufficiently allowed me to form a view on whether the auditor has obtained sufficient appropriate audit evidence.

47. I have found significant deficiencies in the work performed by the auditor to assess the Council’s compliance with the LGRA when setting and assessing rates. I have separately commented on this matter above.

48. My discussion with the auditors has highlighted the subjective nature of the auditor’s work in the legislative compliance area. Audit New Zealand provides guidance and training to auditors to assist the auditors’ understanding of what the auditing standards 16 expect of the auditors. Auditors identified the professional judgement that is required in determining whether they have obtained reasonable assurance as a particular area of subjectivity. Confusion on the part of the auditor as to what constitutes sufficient appropriate audit evidence could affect the auditor’s conclusion. Audit New Zealand acknowledges this is an area that may need further attention.

49. I found that the auditor has appropriately communicated to the Council their responsibility for ensuring compliance with applicable laws and regulations. I also found that the auditor clearly understood their responsibilities in the context of the overall objective of the audit.

Understanding of the Council’s management control environment

50. The onus is on the auditor to understand the Council’s business, activities and operations to the extent necessary to effectively plan and perform the audit. Moreover, the methodology and audit approach developed by Audit New Zealand requires the auditor to consider and assess the effectiveness of the Council’s management control environment: this includes the financial management control environment, and its internal control systems.

51. Between 2003 and 2009 the auditor assessed the Council’s management control environment as good, or effective. I found that there was often insufficient documentation available to demonstrate the auditor’s professional judgement in reaching this conclusion. In addition, I found that the auditor’s consideration of the Council’s financial management environment was based on a narrow assessment of the budgeting and performance monitoring practice at an entity wide level, supplemented by an assessment and testing of underlying control systems. The auditor placed reliance on their current knowledge of the Council’s business and discussions with management as the primary source of evidence for the entity wide assessment.

52. In 2011 an independent financial health check was commissioned by the Council. That review identified significant deficiencies in the Council’s financial and budgeting management practices, and highlighted significant financial challenges faced by the Council in managing the current forecast debt levels. The auditor was aware of the review, but noted that the scope differed from the assessment that the auditor completed in planning the audit.

53. In 2011 and 2012, the emergence of significant issues and irregularities (including those matters identified in the financial health check) was persuasive in the auditor’s reassessment of the Council’s control environment – which the auditor now assessed as ineffective. I found that the auditor’s assessment in 2011 and 2012 to be more complete and comprehensive. There was good documentation of the auditor’s professional judgement on the audit file.

Quality control

54. The auditor’s work was subject to quality control review procedures, both at the level of the individual audit engagement and within Audit New Zealand’s overall system of quality control. Over the period covered by this review, Audit New Zealand sought three independent reviews of its quality control system and its engagement performance. One review was conducted by the Australasian Council of Auditors General (ACAG) on invitation by the then Auditor‐General. There were also two independent reviews conducted by the New Zealand Institute of Chartered Accountants (NZICA). These reviews were similar in scope to those performed on other chartered accounting practices. In all three cases, the independent reviewers issued reports. No adverse findings were made.

55. At an engagement level, the audit has been subjected to Audit New Zealand’s engagement quality control review (EQCR) processes. There is evidence of the performance of these review processes. In 2009 the auditor inappropriately requested dispensation from an EQCR after the initial planning of the audit. The auditor’s request was approved. I have found that Audit New Zealand was contractually obliged to provide an EQCR reviewer for the 2009 audit. This was set out in the Council’s letter of undertaking. EQCR was performed over the planning stage of the 2009 audit but not on the fieldwork and finalisation components. I have noted that the full cost of the EQCR review was incorporated into the audit fees paid by the Council. The contractual obligation was not brought to the attention of Audit New Zealand’s professional practices group at the time that the request for dispensation was being considered.

How did these deficiencies affect the objectives of the audit and the audit opinion?

56. Having completed my review, and having identified my key findings and observations, I am now in a position to consider and assess the impact of these on whether:

  • the auditor has satisfied the overall objective of the audit;
  • there is sufficient appropriate audit evidence to support the conclusions reached by the auditor; and the audit report and opinion issued by the auditor were appropriate.

57. I have set out below my overall analysis and conclusion as they apply to the following clusters of audit:

  • Audits performed 2003‐2005
  • Audits performed 2006‐2009
  • Audits performed 2010‐2012.

Audits performed 2003‐2005

58. My principal concern throughout this period is that the audit file does not always contain sufficient documentation for me to assess whether the auditor:

  • had adequate audit evidence to support the conclusions they reached;
  • appropriately carried out the audit test procedures required; and
  • documented their professional judgement.

59. Audit New Zealand asserts that the nature and extent of documentation on the audit file was consistent with industry practice at that time. It is difficult for me to fully assess this now, although I accept that industry views on what constitutes sufficient appropriate audit documentation has increased since 2003.

60. With respect to the auditor’s consideration and assessment of the wastewater project, I found that this was a specific area of audit focus throughout the planning of these audits. There is documentation and evidence showing the auditor reviewed the project management annually. While this assessment of the overall project management was, in my view, overly narrow in scope and consideration of the most relevant aspects of the Council’s governance and management of the project, it is unlikely to have influenced the auditor’s planning and performance of the audit – given the current state of the project at that time. In my view the auditor’s level of knowledge, understanding and testing was sufficient to enable them to understand the impact of the wastewater project on the Council’s annual report or planning document, and thereby satisfy the objective of the audit.

61. Notwithstanding these comments, in my view the audit files generally provide sufficient appropriate evidence to support the overall conclusions the auditor reached. The auditor has satisfied the overall audit objective, and there is no evidence or documentation on the audit file to indicate that at the time that they issued their audit report that the opinion should be qualified.

Audits performed 2006‐2009

62. Based on my review of the audit files, I found that the auditor’s understanding of the wastewater project – once its final scope and contract arrangement had been agreed – was insufficient to properly plan and perform the audit of the Council’s annual reports/planning document. The potential impact of this failing is significant: it affected the auditor’s overall conclusion and the audit report issued, and is therefore crucial to my determination of whether the objectives of these audits were satisfied.

63. The wastewater project should have been a major focus for the auditor during this period. While the auditor was generally aware of the project’s progress, I consider that level of awareness was not a sufficient basis on which to effectively plan and perform the audit. The auditor’s understanding of the project’s nature and scope did not allow a proper appreciation of its impact on the annual report. In contrast to 2003‐2005, in this period the auditor identified no significant audit risks relating to the project.

64. I have heard from the auditor that they relied on the project management assessment performed by the previous auditor in 2005, and on management’s general understanding of the project. I find the fact that the auditor regarded these sources as appropriate audit evidence during the 2006 – 2009 period a major concern. In my view, the auditor should have been independently updating their understanding and assessment of the project as its scope was finalised, the construction contract was awarded, and construction got underway. The fact that the auditor identified no significant audit risks is also a concern, as it meant there was no assessment or testing of the contract arrangement and its impact on the Council’s annual report during 2006 – 2009.

65. During the 2006 – 2009 period I have noted significant deficiencies in the auditor’s work on rates, and have found that many of the irregularities since identified in the Bill before Parliament should have been detected by the auditor through their test procedures. While these shortcomings may not have changed the decision to issue an unqualified audit opinion, they are nonetheless significant concerns that mean the overall performance of the audit was sub‐standard.

66. Finally, there were a number of more general deficiencies – for example, the sufficiency of audit documentation, that were apparent during this period – as they were in other periods. Again, I have taken these into account in my assessment of whether the auditor has met the standards expected and satisfied the overall audit objective.

67. Overall, after reviewing the 2006‐2009 audit files and carefully considering the issues and deficiencies identified, I have concluded that there are reasonable grounds to question whether the auditor has satisfied the overall audit objective in this period. In addition, as there is evidence to indicate that the Council’s 2009 annual report was materially misstated, I also conclude that the auditor incorrectly issued an unqualified audit opinion on that annual report: it should have been qualified.

68. The nature, extent and impact of the misstatement of the 2009 annual report is brought to light in the Council’s 2011 annual report. The notes to the financial statements in the 2011 annual report provides additional disclosure by outlining the impact on comparative information had the Council correctly accounted for the wastewater project in the 2009 financial statements. This shows that for 2009, total Council expenditure was understated by $12.412m, property plant and equipment was understated by $27.273m and Council borrowings understated by $36.120m. These figures highlight the size of the errors in the 2009 financial statements which, I find, exceeds the materiality levels set by the auditor.

69. There is no evidence to suggest that an unqualified opinion was incorrectly issued for the other audits performed during this period, despite the fact that the auditor did not satisfy the objectives of these audits. However, a significant body of evidence from 2011 suggests that, had the auditor detected irregularities in the setting and assessment of rates, they would have asked the Council to make additional disclosures in the annual report and would have referred to these disclosures in the audit report.

Audits performed 2010‐2012

70. In general, the quality of audit planning and performance significantly increased in this period. The sufficiency and appropriateness of audit documentation and evidence improved markedly, showing extra effort and resources were applied to auditing the Council’s annual reports/planning document once the irregularities I have referred to came to light.

71. Apart from the initial planning of the 2010 audit, where the auditor did not initially identify any significant audit risks associated with the wastewater project, I find only minor deficiencies in audit quality over this period. Those I have identified were unlikely to affect the auditor’s conclusion or whether the auditor had satisfied the objective of the audit.

72. It was during 2010‐2012 that significant irregularities in the management and funding of the project came to light, including irregularities in the setting and assessment of Council rates. From my review of audit files, I am satisfied that the auditor sufficiently and appropriately considered these matters when planning and performing audits in this period, and in forming an overall conclusion on the audit evidence available.

73. After completion and commercial acceptance of the wastewater project in 2009, the infrastructure asset and related borrowings were brought into the Council’s financial statements for the first time as part of the 2010 audit. As noted, the Council did not fully comply with generally accepted accounting practice in its accounting treatment of the project during construction. It addressed this issue as part of the 2011 annual report. The impact of the incorrect accounting treatment on the 2010 annual report was not material.

74. In my view, the audit files for this period generally provide sufficient evidence to support the auditor’s overall conclusion. There is no reason to suggest that the auditor did not satisfy the overall audit objective at the time that they issued their unqualified audit 20 report. Moreover, the auditor’s 2011 and 2012 reports provide additional explanatory information that draws attention to the Council’s disclosure of the irregularities, and their effect on the annual report.

1 Throughout this report I have referred to the LTCCP and LTP, collectively, as Council’s planning documents.

2 The local Government Act 2002 requires that the Council’s LTCCP and LTP be audited. There is no separate requirement for the Council’s annual plan to be audited.

3 The Kaipara District Council (Validation of Rates and Other Matters) Bill (the Bill), introduced to Parliament in June 2013