Part 2: Our audit of the Government's 2013/14 financial statements
2.1
In this Part, we report the results of our audit of the Government's financial statements for 2013/14, and discuss the significant and other matters arising from this audit. The significant matters relate to:
- valuation of Solid Energy New Zealand Limited's assets and liabilities; and
- continuing uncertainties due to the Canterbury earthquakes, and associated accounting issues.
2.2
The other matters arising from our audit relate to:
- accounting for, and disclosure of, minority interests held in Crown companies;
- discount rates for long-term liabilities;
- valuation of the state highway network;
- the review of accounting policies for recognising tax revenue;
- assessing potential impairment of Crown assets;
- valuation of electricity generation assets;
- accounting for KiwiRail Holdings Limited;
- accounting for the Government's Treaty of Waitangi settlement obligations;
- accounting for public private partnerships; and
- the effect of new accounting standards.
Our audit report
2.3
We issued our audit report on the Government's financial statements on 30 September 2014.
2.4
The audit report appears on pages 24 to 26 of the Government's financial statements. It includes our 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 2014;
- the results of the Government's operations and cash flows for the year ended 30 June 2014; and
- the Government's borrowings as at 30 June 2014, and unappropriated expenditure, expenses, or capital expenditure incurred in emergencies, and trust monies managed by the Government, for the year ended on that date.
2.5
We issued a standard audit report, which included an unmodified audit opinion on the Government's financial statements for the year ended 30 June 2014.
Significant matters arising from the audit
Valuation of Solid Energy's assets and liabilities
2.6
We are satisfied that Solid Energy New Zealand Limited's assets and liabilities have been appropriately included in the Government's financial statements on the basis that Solid Energy is expected to continue to operate for the foreseeable future. This means that, where appropriate, Solid Energy's assets have been valued based on their value-in-use rather than their disposal value.
2.7
During 2012, it became apparent that Solid Energy was in some financial difficulty. Falling international coal prices, coupled with a strengthening New Zealand dollar, resulted in a significant reduction in revenue. As a result, there was a significant write-down in the value of Solid Energy's assets during the year to June 2013. There have been further significant write-downs in the value of Solid Energy's assets during the year to June 2014 as a result of lower coal prices and higher exchange rates than previously forecast.
2.8
The signing of a Deed of Indemnity and Bond Facility agreement with the Crown after 30 June 2014 enabled the Directors of Solid Energy to continue to assert that the company is a going concern.
2.9
The Deed creates an asset for Solid Energy and a liability for the Crown, recognised on signing, of $103 million. Under this Deed, the Crown will reimburse the mining rehabilitation expenses of Solid Energy for post-1987 mining activities. This transaction strengthens Solid Energy's balance sheet, but does not directly affect the Government's financial statements because the transaction is between entities within the Government reporting entity.
2.10
The Crown had previously indemnified Solid Energy for rehabilitation expenses arising from coal mining operations carried out by State Coal Mines before 1 April 1987.
Continuing uncertainties due to the Canterbury earthquakes, and associated accounting issues
2.11
We are satisfied that the effects of the Canterbury earthquakes have been appropriately accounted for in the Government's financial statements.
2.12
However, significant uncertainties remain in the valuation of liabilities and associated insurance recoveries.2 The uncertainties can be broadly categorised as follows:
- Uncertainties relating to estimating the earthquake-related outstanding claims liabilities and reinsurance receivables for the two insurance entities (the Earthquake Commission and Southern Response Earthquake Services Limited). The key sources of these uncertainties are:
- severe land damage and a complex land claims environment from both an engineering and legal perspective (this land aspect affects only the Earthquake Commission);
- the effect of multiple events on the Earthquake Commission's coverage and reinsurance coverage (with consequential effects on insurers, such as Southern Response); and
- estimations of the time to repair/rebuild and building cost inflation.
- Uncertainties relating to the Crown's obligations to provide a support package to local authorities for repairing damaged infrastructure.
- Uncertainties relating to the red zone, in particular the insurance receivables assumed by the Crown as part of the Crown's offer to acquire property in the red zone.
2.13
The Crown's obligations relating to the above at 30 June 2014 total $6.4 billion, which represents about 4% of the Crown's total liabilities. This level of provisioning means these earthquake-related amounts are considerably less material to the whole-of-government position than they are to the individual entities that manage the liabilities.
2.14
There also continues to be uncertainty about measuring the Crown's obligation to fund a portion of the cost of damage to local authority infrastructure.
2.15
After the Canterbury earthquakes of 2010 and 2011, under the Civil Defence Emergency Management Plan and Guide (the CDEM Plan and Guide), the Government had an obligation to provide financial support for response and recovery costs. This included 60% of the repair (recovery) cost for water infrastructure assets (water, storm water and wastewater) owned by local authorities. In May 2011, a permanent legislative authority was put in place to replace the obligation under the CDEM Plan and Guide. This committed the Crown to funding 60% of the water infrastructure costs for Christchurch City Council, Waimakariri District Council, Selwyn District Council, and Environment Canterbury.
2.16
After this, the Crown entered into cost-sharing agreements with Christchurch City Council on 26 June 2013 and Waimakariri District Council on 2 December 2013. The purpose of the cost-sharing agreements was to establish a total value to which the Crown can commit, so the previous permanent legislative authority was able to be removed.
2.17
The most significant is the Christchurch City Council agreement and the Crown's associated obligation. A total value of $1.8 billion was agreed as the total Crown obligation. This obligation includes not only the obligation of the Canterbury Earthquake Recovery Authority (CERA) for the recovery of horizontal infrastructure (water infrastructure assets), but also the initial response costs under the CDEM Plan and Guide (which have been settled with the Department of Internal Affairs) and the repair costs for roading to be funded by the New Zealand Transport Agency.
2.18
The $1.8 billion is based on estimates from Christchurch City Council's three-year plan. The amount is subject to review, and could change after December 2014.
Treatment of roading costs from the Canterbury earthquakes
2.19
In accounting terms, repairs to local roads are recognised in the year of repair. Unlike the estimated costs to repair the water infrastructure assets, there is no provision in the Government's financial statements for costs associated with the future repair of local roads. Future roading costs will be met through road user charges, fuel excise duties, and registration fees paid in the future to the National Land Transport Fund.
2.20
Although the Government is committed to repairing local roads in Canterbury, the Canterbury earthquakes have increased the priority of the roading work in the Canterbury region, rather than created an additional liability to be recognised in the Government's financial statements. The broader context is that the Government has an ongoing programme of funding the repair and development of local roads throughout New Zealand.
2.21
If the Government's share of the costs associated with the future repair of local roads exceeds the amount available from the usual roading revenue sources, then the Government can allocate more revenue. The Crown has agreed to meet its share of the cost of the Christchurch roading recovery if that cost exceeds the $50 million each year that the New Zealand Transport Agency has agreed to fund from the National Land Transport Fund.
2.22
The main development in 2013/14 was that the New Zealand Transport Agency entered into a loan agreement with the Government to fund the Agency's contribution above this amount during the next three years. This has no effect on the Government's financial statements because it is an agreement between entities within the Government reporting entity.
2.23
Based on information known about the Government's funding decisions to date, we are satisfied that it is appropriate to continue to not recognise the cost of repairing roads as a liability in the Government's financial statements.
Accounting treatment of development costs for Anchor Projects
2.24
As part of the Christchurch Central Recovery Plan, CERA is leading the construction of significant "Anchor Projects" within the Christchurch central business district. We considered whether the costs associated with these projects should be treated as capital or operating in nature.
2.25
Although spending in 2013/14 is not significant in the context of the Government's financial statements, clarity about the correct accounting treatment is important to ensure consistency as the level of spending increases. The two significant projects that began construction during 2013/14 were:
- Avon River Precinct: This development is being funded by CERA. It is on land owned by Christchurch City Council and Canterbury District Health Board. Any improvements constructed by CERA will pass to these parties under the cost-sharing agreement referred to in paragraphs 2.16-2.18. We agreed that these improvement costs should be treated as an operating expense in the Government's financial statements.
- Bus interchange: This development is being constructed on land acquired for the purpose. CERA is leading the project and there is currently construction on the site. We agreed that costs to date for site preparation should be treated as capital expenditure. This conclusion differs from the Avon River Precinct because CERA retains legal ownership of these assets during construction. At this stage, the ultimate owner of the bus interchange has yet to be determined.
Other matters arising from the audit
Accounting for, and disclosure of, minority interests
2.26
We are satisfied that the minority interest disclosures in the Government's financial statements are materially correct, and that the effect of the sale during the year of part of the Government's shareholding in Meridian Energy Limited, Genesis Energy Limited, and Air New Zealand Limited has been adequately explained.
2.27
The share of the Crown's net worth that is attributable to minority interests has increased significantly after the partial sale of shares in Mighty River Power Limited in May 2013 and the abovementioned partial sales of shares. This is because an increased percentage of shares in these entities is now held by minority interests. However, the Crown retains the majority shareholding and therefore control over these entities, so it continues to consolidate them within the Government's financial statements.
2.28
Although the Treasury made some improvements in the presentation of minority interests in the Government's financial statements, we continue to have concerns about some aspects of the presentation in the Statement of Financial Performance. These concerns relate to the extent to which the current presentation in the Statement of Financial Performance fully complies with generally accepted accounting practice. We will discuss this further with the Treasury during the 2014/15 audit of the Government's financial statements.
2.29
For 2015, we have recommended that the Treasury review the presentation of minority interests in the Government's financial statements, with a view to better aligning the presentation with generally accepted accounting practice.
Discount rates for long-term liabilities
2.30
We are satisfied with the reasonableness of the discount rates and consumer price index (CPI) assumptions used to value the significant long-term liabilities of the Government. The risk-free rates are also used to derive a market interest rate for discounting student loan advances.
2.31
We reviewed the Treasury's table of risk-free discount rates and CPI assumptions as at 30 June 2014. We concluded that they had been determined in keeping with the Methodology for Risk-free Discount Rates and CPI Assumptions for Accounting Valuation Purposes (the methodology), and that they were appropriate for the Government to use.
2.32
The long-term interest rate remained at 5.5% (in the previous year it had been reduced from 6%). The long-term CPI inflation rate of 2.5% was also retained. However, there was a small increase in short-term discount rates, which has contributed to a reduction in the liabilities of the Government.
2.33
We also followed up on matters raised in our reviews in previous years, and we were satisfied with the Treasury's responses. We will review the Treasury's responses again next year, because these matters could be subject to future technical developments or affected by different market conditions.
2.34
We have recommended that the Treasury continue to monitor long-term rates in the intervening two years, when these long-term rates are not subject to review in keeping with the methodology.
Valuation of the state highway network
2.35
We are satisfied that the valuation of the state highway network is based on the best information available to the New Zealand Transport Agency at the time of the valuation. However, we note that "brownfield" costs, such as the cost of traffic management, are not fully incorporated as part of the valuation.3 Also, we note that there are uncertainties with the quality of some of the underlying data used in the valuation.
2.36
In 2010, we recommended that the New Zealand Transport Agency review the reasonableness and validity of the assumptions used to value state highways, and that brownfield costs be incorporated into the valuation. The New Zealand Transport Agency is now estimating brownfield costs and they will, over time, be progressively recognised in the Government's financial statements in future years. For 2013/14, the brownfield costs included in the state highways valuation of $28.6 billion was $250 million.
2.37
The valuation of the state highway network is based on valuing each of its components, such as land, formation, and bridges, and adding these together. As in previous years, there are uncertainties about whether the underlying data includes the right quantity of some components, accounts for all the costs of some components, and records the right life of some components based on their condition.
2.38
We understand that the New Zealand Transport Agency has a plan to improve the accuracy of the asset data, and to identify other costs that should be included in the valuation in the future. The plan includes carrying out a stocktake of all state highway assets during the three years to 30 June 2016. This work will help improve future valuations.
2.39
We will continue to monitor the New Zealand Transport Agency's work in these areas as part of our audit to ensure that, as better information becomes available, it is used in future valuations of the state highway network.
The review of accounting policies for tax revenue recognition
2.40
In previous years, we have recommended that a thorough review of taxation revenue recognition policies be carried out with a view to improving the recognition of taxation revenue, where appropriate. This is an important project because of the complexities involved and the potential effect on the way the Government recognises its tax revenue. The PAYE and GST components of the review were concluded in 2012.
2.41
The Inland Revenue Department has proposed amending its revenue recognition policy after it completes the income tax component of the project. Under this proposal, Inland Revenue will recognise income tax based on taxpayer balance dates and provisional tax assessments from 1 July 2015. This differs from the existing policy, which uses payment due dates. This primarily affects how tax revenue is recognised during the year, rather than at the end of the financial year.
2.42
A pilot project, due to be completed by the end of 2014, is being run to assess the effect of the proposed change against the current revenue recognition policy.
2.43
It is intended that any changes will not be applied to Inland Revenue's financial statements (and thus the Government's financial statements) until 2015/16.
Impairment assessments
2.44
For most assets, entities are required to annually assess whether there are indicators that the asset might be impaired, and if there are such indicators, carry out an impairment test. For other assets, like goodwill, an impairment test is required to be carried out annually, regardless of any indicators. An impairment loss must be recognised if the recoverable amount of an asset (the higher of value-in-use and fair value less costs to sell) is less than its carrying amount.
2.45
We reviewed, and were satisfied with, the work carried out by the Treasury and other entities to consider the assessments of recoverable amount for significant assets, including:
- the Government's student loan portfolio;
- Solid Energy's assets and liabilities (see paragraphs 2.6-2.10);
- valuations of significant portfolios of buildings to ensure that they appropriately reflect the assets' level of compliance with the building code, as a result of the increased focus on compliance levels after the Canterbury earthquakes; and
- the Crown's goodwill arising from the acquisition of Air New Zealand, when the Government regained control of the company.
Valuation of electricity generation assets
2.46
We were pleased that the additional disclosures in the Government's financial statements show sensitivities in the valuations of electricity generation assets. The disclosures are based on disclosures by the Government's three key electricity generators (Genesis, Meridian, and Mighty River Power).
2.47
We will continue to discuss with the Treasury whether it is feasible to move towards more of a centralised approach (such as with discount rates) for some or all of the main assumptions used in valuing electricity generation assets.
Accounting for KiwiRail
2.48
We are satisfied that it is still appropriate for KiwiRail Holdings Limited to be designated as a for-profit entity for financial reporting purposes. We are also satisfied with the resulting accounting treatment and disclosures, noting the different treatment of non-freight rail infrastructure at a whole-of-government level (as outlined below).
2.49
Two of the main factors in determining whether it is appropriate to designate the company as a for-profit entity include whether the company is a financially sustainable business, and whether it continues to behave commercially, consistent with being a for-profit entity.
2.50
We note that both KiwiRail and the Government appear to be committed to developing a sustainable business, and the company continues to behave commercially, consistent with being a for-profit entity for financial reporting purposes.
2.51
However, given the group's financial performance in the past few years and its projected financial performance, we will continue to monitor the financial sustainability of the business.
2.52
We understand that KiwiRail is of the view that a commercial turnaround requires a review of the funding mechanism, to provide KiwiRail with the necessary certainty about investment. To achieve this, KiwiRail has recently carried out a major 30-year strategic review.
Valuation of railway network assets not required for freight services
2.53
We are satisfied with the valuation and disclosure in the Government's financial statements of railway network assets not required for freight services (including rail infrastructure assets used solely for metropolitan passenger services).
2.54
The non-freight portion of the network continues to be accounted for on a different basis in the Government's financial statements and KiwiRail's financial statements. KiwiRail accounts for this part of the network on a purely commercial basis because that is consistent with the Government's expectations of the company (that is, to generate a commercial return from the use of the rail network).
2.55
However, in the Government's financial statements, the portion of the network not necessary to run the freight operation is accounted for on the basis of the service potential provided by those assets, rather than the net cash flows they are forecast to generate. This is because, despite the Government's expectations of KiwiRail generally, the primary purpose for the non-freight portion of the network at a whole-of-government level is a public benefit purpose, such as reduced congestion on roads and therefore reduced travel times, rather than the Government generating a commercial return from those assets.
2.56
The different accounting treatment of the non-freight portion of the network in the Government's financial statements has resulted in this portion being valued $0.7 billion higher at 30 June 2014 than in KiwiRail's financial statements.
Accounting for the Government's Treaty settlement obligations
2.57
We are satisfied that the Crown's obligations as a result of relativity clauses in two previous Treaty of Waitangi settlements have been appropriately accounted for and disclosed in the Government's financial statements. That includes disclosure of an unquantifiable contingent liability for payments that may be required in future under the relativity clauses.
2.58
The deeds of settlement negotiated with Waikato-Tainui and Ngāi Tahu included relativity clauses. Those clauses mean the Crown is liable to make payments to maintain the value in real terms of Waikato-Tainui's and Ngāi Tahu's settlements at 17% and 16.1% respectively, of all Treaty settlements.
2.59
In October 2012, the Crown advised that the relativity mechanism had been triggered. Both Waikato-Tainui and Ngāi Tahu made claims under the relativity mechanism and received an initial payment. We expect that the reliability of the estimate of the claims under the relativity mechanism will continue to increase as disputed items between the parties are progressively settled.
2.60
We will continue to liaise with the Ministry of Justice and the Treasury on this issue.
Accounting for public private partnerships
2.61
We have advised the Treasury that, in our view, the disclosure of public private partnership assets4 provides useful information. We are comfortable with the current treatment of disaggregating public private partnership assets within existing asset classes in the Government's financial statements, on the basis of materiality.
2.62
However, the Government's financial statements do not currently disclose these assets as a separate class of assets. Doing so is required by one of the accounting standards.
2.63
The Treasury's view is that there is a conflict between two different standards, making it difficult to fully comply with both. We agree.
2.64
We do not expect the matter to have a material effect for a number of years because it becomes an issue only after the public private partnership assets are first recognised in the Government's financial statements. We intend to support the Treasury in approaching the standard-setter (the External Reporting Board) to try to get the relevant standard changed.
New accounting standards
2.65
The External Reporting Board has put into effect a new financial reporting framework that has resulted in new standards and requirements for all public benefit entities in the public sector. The new public benefit entity standards were issued in May 2013 and apply for reporting periods beginning on or after 1 July 2014.
2.66
From 1 July 2014, the Government's financial statements need to be prepared in keeping with these new public benefit entity accounting standards.
2.67
The Treasury's project team to help plan for the transition has identified some issues that will need to be appropriately dealt with on transition to the new standards. Other issues have been identified which need to be drawn to the attention of the External Reporting Board.
2.68
Unresolved issues currently include:
- An apparent conflict between two different standards about whether service concession assets need to be accounted for as a separate class of assets (see paragraph 2.63).
- The presentation of revenue from sovereign receivables for outstanding taxes and fines, which are currently presented at their face value and then impaired. The standards require tax revenue and revenue from fines to be initially recognised at fair value.
2.69
We also note that the Treasury continues to monitor changes to accounting standards, which could increase the challenges associated with consolidation of a mixture of for-profit and public benefit entities.
2.70
We will continue to liaise with the Treasury on transition issues during 2014/15. We will also agree an audit timetable with the Treasury for auditing the updated accounting policies, opening statement of financial position, comparatives, and related disclosures. We note that the Treasury does not expect significant changes to arise from the transition to the new accounting standards.
2: As explained in note 30 of the Government's financial statements.
3: Brownfield costs is a generic term for the additional costs of construction in an already developed location.
4: Note 20 of the Government's financial statements.