Appendix 3: Report from the independent reviewer

25 August 2015

Mrs Lyn Provost
Controller and Auditor-General
PO Box 3928

Dear Mrs Provost


  1. You have retained me as an independent reviewer of the basis upon which auditors are appointed to act on your behalf, and the basis upon which appropriate levels of audit fees are determined.
  2. This is my report on those processes for the financial year ended 30 June 2015. I confirm that I am independent of the Office of the Auditor-General (OAG), Audit New Zealand and all private sector audit firms.
  3. My instructions require me to evaluate the processes involved and to report upon the probity and objectivity with which they are implemented. No limitation has been placed upon the manner in which I carry out my assignment. I have been free to inspect both paper and computer based files, documents and correspondence as I wished.
  4. There are four types of audit appointment
    1. an appointment made by the Auditor-General of an auditor for a given entity, usually for a term of 3 years, in accordance with the now well-established "audit allocation model";
    2. an appointment of an auditor for a given entity, following a contestable tender, if you consider that is an appropriate process in the circumstances;
    3. a re-appointment of an auditor for a further term, usually a further 3 years, to audit a particular entity;
    4. where an audit involves 150 or more budgeted hours, the individual auditor and senior personnel involved in the audits may not undertake the audit work for more than 6 consecutive years, thus a new auditor is required to be appointed, though that may be another person in the same firm.
  5. Allocations: In the past financial year, the Auditor-General appointed auditors for 32 new entities. That number includes 13 schools or school-related entities. Apart from schools, these new entities include, for example, newly established Crown entities, new subsidiaries of existing entities, and new entities resulting from mergers. There has been no evident dissatisfaction expressed by those entities either with the method or with the terms of any of the appointments effected during the year.
  6. Allocation model: The appointments just referred to were made under the "audit allocation model". This has been the principal method of appointment since 2003. There is an established and well-publicised set of criteria for those appointments. They are set out in a document entitled: "Appointing public sector auditors and setting audit fees" (ISBN-978-0-478-38310-2: online).
  7. The document has been widely deployed- it is available on the OAG website, and is referred to in correspondence or provided to entities and auditors whenever appropriate. In cases of doubt or difficulty- or where an entity or its auditors do not properly understand the nature of their respective roles or responsibilities - the representatives of the OAG direct them to this publication. The result is nearly always beneficial -a better and shared understanding of what is required generally ensues.
  8. The document was last reviewed and revised in 2011. I have reviewed it again, for the purposes of this present report. It is still a clear, succinct and useful expression of principle and practice. For my part, I see no evident need for further change at this stage.
  9. Contestable Tenders: Although no appointments were made by means of this process during the past year, a small tender of some school audits has been carried out since as a part of the process of putting in place new audits for schools (refer paragraph 13 below). The process of tendering remains available to the Auditor-General, if it suits the particular circumstances, but the reliability and practicality of the audit allocation model- and its cost- effectiveness- mean that the use of contestable tenders is unlikely to occur very often.
  10. Nonetheless, during the past year, two public entities have sought a change of auditor and a contestable tender. In one case, the issue was settled without a change. The other, more recent case is still being evaluated.
  11. However, the Auditor-General has expressed the view that, for large public entities- especially those with a commercial focus - a contestable tender process may, in some circumstances, appropriately be put in place.
  12. Re-appointments: generally: Leaving aside the position as to auditors for schools (see the following paragraph 13), existing auditors were re-appointed during the financial year to audit 199 public entities and their subsidiaries for a further term. In addition, in 2 instances a change was effected, with a different auditor being appointed in place of an existing one. The circumstances leading to these latter appointments involved auditor independence and auditor/entity relationship issues. Again, in the case of all 201 appointments covered by this paragraph 12, a careful process has been followed. There have been no unresolved issues arising from the method or the terms of appointment.
  13. Reappointments: schools: The term of appointment for the auditors of all schools came to an end once the audits of the financial year ended 31 December 2014 were completed. Auditors will need to be reappointed, or new auditors appointed, for most schools for the next 3 year contract period. (As most school audits involve fewer than 150 hours, auditors may, in many cases, carry out the audits for more than 6 consecutive years.) The task of effecting these reappointments and appointments is a large and complex exercise, covering approximately
    2,400 schools. But it has commenced well on this occasion, and there have been little evident dissatisfaction expressed as to the process that is being followed. Where dissatisfaction has been expressed, discussions are continuing.
  14. Overall, about 70 auditors for schools are appointed, nation-wide, from a variety of audit firms - ranging from small local firms through to the major international firms. All auditors must observe the Auditor-General's auditing standards and instructions. The OAG subjects the auditors to regular quality assurance reviews.
  15. Outside of the process of reappointing or appointing auditors for the next 3 year contract period, during the year, a change of auditor was effected in respect of 31 schools. And an auditor was appointed for 13 new schools or school related entities (these have previously been referred to in paragraph 5 above).
  16. A change of auditors for schools may be effected for a variety of reasons. For example, where the previous auditor no longer meets the Auditor-General's independence or quality requirements; where an audit firm has withdrawn from auditing schools; where the auditor or the school request a change for specific and valid reasons; or where the portfolio of school audits of an auditor needs to be increased to improve the auditor's critical mass of school audits.
  17. The circumstances under which audit fee increases are allowed are generally limited. However, this year (as in the two previous years) these circumstances are discussed with the Ministry of Education before being discussed with the auditors concerned. Notably, Novopay issues have continued to affect and complicate audits, with consequent delays and complexities. Additional audit fees, to take account of the costs arising from these factors in the year just past, are in the course of being negotiated with the Ministry of Education. (See also paragraph 29 (a).)
  18. Issues about fees and performance: During the course of the past year, a number of entities raised questions or made complaints about the level of their audit fees or, occasionally, about auditor performance. Some of these have been informal in nature (and have been readily and promptly resolved). A few, 11 in number, have been more formalin nature (with well articulated letters expressing the grounds for an entity's concern).
  19. The basis for these claims about fees is, sometimes, that in times when an entity's revenue is constrained, it is neither appropriate nor fair that an audit fee should remain at what is perceived to be a high level - or should increase. There is sometimes a perception held by an entity that an alternative auditor could do the task for less than the current fee without affecting audit quality.
  20. The OAG has a sophisticated and detailed data-base. It enables an analysis of audit fees for all public entities. The contributing components (audit hours, average hourly charge-out rates, and levels of experience within the audit team) of the fees for all types and sizes of entities, year by year, individually and sector by sector, may be compared and contrasted. In particular, the movement in hourly rates and the time expended on an audit, or a range of audits, can be accurately identified.
  21. The OAG uses this material, constructively, to help respond to enquiries or complaints received. The response is usually given by the OAG direct to the entity, though sometimes the auditor responds, using information supplied by the OAG. In either case, the comparative data which is relevant to a particular entity is recorded in an explanatory letter, along with a description of the various factors lying behind the audit costs. While the analysis performed by the OAG often indicates that the audit fee is well substantiated and within an appropriate range,it also indicates where audit fees are outside that range- either higher than expected, or lower. In either case, the auditor and the entity are informed of those findings and expected to negotiate further in order to reach agreement.
  22. In some cases, it is apparent that the actions of the entity itself have contributed to the increase in fees. For example, in some cases the materials that will require audit are poorly prepared or checked, are incomplete, or require several iterations before they are correct and complete. Those factors tend to result in an increase in the auditor's time, with a consequent claim for an increase in fees.
  23. But in most cases where the issue of fees has been raised, the detailed explanation given to entities by the OAG (or,in some cases,by an auditor using data supplied by the OAG) has led to a resolution, or to a withdrawal of the complaint, or to no further action being taken by the entity. In the year under review I inspected the records relating to 11 entities which had expressed particular concern about the level of fees or auditor performance- or both. In all but one of those cases a resolution has either been achieved between the OAG and the entity, or can be seen to be likely. In that one case, further steps are planned to bring additional objectivity to the matter.
  24. My review of the materials for the financial year to 30 June 2015 has again shown that where, occasionally, there is some dissatisfaction expressed by entities or auditors, it tends to centre on two particular issues.
  25. The first is related to auditor performance or to the auditor/entity relationship. This arises very infrequently, but when it does, it has consistently been resolved. The resolution occassionally entails a well-considered change in the appointed auditor. That was required for a small number of school audits in the year under review.
  26. The second relates to the level of fees - either initially or upon a subsequent claim for increase. Viewed broadly, the role of the Auditor-General, acting through the OAG, is to ensure that audit fees are fair and reasonable. The OAG provides detailed information, when needed, with a view to assisting the entity and the auditor to come to an accord about this.
  27. Generally, agreement is reached between entity and auditor. The Auditor-General's clear preference is that it is desirable that the audit fee should be the result of an accord between those two parties - often within a range expected by the OAG (using its data base) and acceptable to her.
  28. In practice, that approach can be seen to work very well. The Auditor-General has the statutory power to set audit fees, if needed. But since 2003 that power has been exercised on only three occasions, most recently in 2009.
  29. Other issues: I have observed a number of other issues affecting audits that have evolved during the past year:
    1. Novopay- effect on school audits: The two most recent reports by Independent Reviewers have referred to the complex issues, affecting the payment of teachers and staff, arising from the Ministry of Education's payroll system known as "Novopay." Put simply, the difficulty has been the additional time and effort required by schools, the Ministry, school auditors and the OAG to gain certainty about payroll reports, and to complete- and then audit- accurate financial statements in a timely way.

      The problems for the 2012 and 2013 years were severe, but for the year to 31 December 2014 there has been significant improvement. School audits are required by statute to be completed by 31 May. For the period to this past 31 May 2015, around 86% of the approximately 2,400 school audits had been completed. But delays in obtaining audit comfort from the Ministry and the payroll provider have again meant that some school audits have been unable to be completed by that date. While there has been a significant improvement in the accuracy of the data, the main remaining concern is about timeliness of issue of the year-end payroll reports. For the year ended 31 December 2014, year-end payroll reports were not available to schools and auditors until 27 February
      2015, which is about 3 weeks later than under the previous payroll system. That resulted in a compressed time frame for preparation and audit of schools financial statements, resulting in some not meeting the statutory timeframe for their completion.
    2. Timeliness: In June of this year the Auditor-General issued a report entitled "Being accountable to the public: Timeliness of reporting by public entities." It took a snapshot of how well public entities met their reporting deadlines for the 2013/2014 year. Most entities did meet their deadlines,but some entities (which were named) fell behind. In my current review of the 2014/2015 year, I have noticed that many entities are still not managing to meet their reporting obligations in a timely way. Notably, these include some schools and entities such as the smaller licensing trusts. In many, if not all of those cases, those entities will have limited capability or capacity to complete their financial and performance reports, so as to comply with generally accepted accounting standards. For many of them, a lack of financial resources will exacerbate the problem.

      Nonetheless, those entities,because they are wholly or partly publicly funded, do have a legal obligation to comply with their reporting requirements. Recent amendments to the Crown Entities Act 2004 and to the Companies Act 1993 now mean that some subsidiaries will no longer be required to report separately, but only as a part of the group reporting of their shareholders. In addition, the introduction of tiered reporting standards should simplify reporting for the smaller entities. Those changes will lighten the burden for many smaller entities. Nonetheless, the issue of lapses in timeliness is one to which the Auditor-General and the OAG are giving increased emphasis.
    3. Local authorities: long term plans: Every three years all localauthorities are required to complete a long term plan for areas within their jurisdiction. A change to the Local Government Act in 2014 introduced a requirement for a consultation document, covering the key issues affecting the community, followed then by a long term plan. The Auditor-General is the auditor of all local authorities, and auditors appointed by her must conduct an audit of both the consultation document and long term plan.The most recent long term plans were required to be approved by councils, and the respective audits completed, by 30 June. Most plans were finalised and audits completed by those dates. And most consultation documents and long term plans were of a reasonable standard considering this was the first time the changed requirements needed to be met. However 3 out of 78 long term plans were not completed on time. This is an area that will require continuing scrutiny.
    4. Audit New Zealand's position: Audit New Zealand carries out audits of public entities at the direction of the Auditor-General and is directly answerable to her. In November 2013 an inquiry was completed for the Auditor-General into the Mangawhai community wastewater scheme. The local authority which had commissioned that scheme was the Kaipara District Council. The inquiry concluded that the audits of the Council, conducted by Audit New Zealand between 2006 and 2009, were substandard in significant respects. In the interest of ensuring audit quality, the Auditor-General then decided not to allocate any new audits to Audit New Zealand until Audit New Zealand can assure the Auditor-General that it has reached the objective of delivering consistent audit quality throughout the whole of its current audit portfolio.

      Since that decision was taken, Audit New Zealand has reviewed all its operations and processes, with a view to demonstrating t at it merits a lifting of that restriction. Substantial progress has been made towards that end, but the Auditor-General has yet to conclude that the restriction may safely be removed (and if so, upon what terms and conditions).
    5. Legislative and regulatory prov1s1ons: For the purpose  of this report, I have considered a variety of such provisions,insofar as they have a bearing on the conduct of public sector audits.Examples include the provisions of the Financial Markets Conduct Act 2013 and the Companies Act 1993, especially as they relate to the reporting obligations of an "issuer"; the Crown Entities Amendment Act 2013 and its requirements as to which subsidiaries need- or need not- report separately; the new Accounting Standards Framework,promulgated by the External Reporting Board (established under the Financial Reporting Act 1993), which has recently set out a four tier framework for public entities that are required to prepare financial statements. In my view, the OAG is well aware of how these differing requirements are to be applied. To date, there have been no apparent difficulties with their application. (The OAG has pointed out to me, however, an inconsistency in the practical implementation of the reporting requirements for subsidiaries that are linked in a chain. But that small issue has no adverse impact on the OAG's own operations or on its surveillance obligations.)
    6. Auditor-General's and OAG's publications: For the purposes of this report, I have kept a watchful eye on the regular reports and publications issued throughout the year by the Auditor-General herself.Ihave also considered the papers issued by the OAG for the guidance of entities with which it deals.In that latter regard, I am thinking particularly of documents issued with a view towards assisting schools and their auditors in the estimation of time and costs in relation to school audits. Overall, the reports and publications that I have seen have been of a consistent and commendably high quality.
  30. Conclusions:I now state my overall conclusions. These follow from what I have said in the preceding paragraphs of this letter. My conclusions are:
    1. On the basis of the written material I have seen and the explanations I have been given by OAG personnel, I consider that the processes adopted by the Auditor-General and by the OAG in relation to the allocation and appointment of auditors for audits falling within the Auditor-General's mandate, during the financial year to 30 June 2015:
      1. have been appropriate for their purpose; and
      2. have been applied in a way which is fair and responsible, having regard to the respective interests of the parties concerned;
    2. That observation applies both to the way in which auditors have been appointed or re-appointed, and to the way in which questions as to the appropriateness of an audit fee have been dealt with;
    3. In cases where issues have been raised by entities as to fee levels or as to auditor performance, those issues have been, or are being, dealt with fairly and professionally;
    4. Other issues which I have examined (such as those referred to in paragraph 29) which touch upon the Auditor-General's mandate and the operations of the OAG have, in my view, been evolved reasonably and responsibly.
  31. Taking everything into account,my conclusion is that the processes by which audits in the public sector have been allocated and fees have been set, in the financial year to 30 June 2015, have been carried out with due probity and objectivity.

Yours sincerely

Sir David Gascoigne, KNZM, CBE