Appendix: Our audit report on the Government's financial statements

Central government: Results of the 2015/16 audits.

To the Readers of the Financial Statements of the Government of New Zealand for the Year Ended 30 June 2016

Opinion

I have audited the financial statements of the Government of New Zealand (the financial statements of the Government) for the year ended 30 June 2016 using my staff, resources and appointed auditors and their staff. The financial statements of the Government on pages 34 to 151 comprise:

the annual financial statements that include the statement of financial position as at 30 June 2016, the statement of financial performance, analysis of expenses by functional classification, statement of comprehensive revenue and expense, statement of changes in net worth, and statement of cash flows for the year ended on that date, a statement of segments, and notes to the financial statements that include accounting policies, borrowings as at 30 June 2016, and other explanatory information;
a statement of unappropriated expenditure for the year ended 30 June 2016;
a statement of expenses or capital expenditure incurred in emergencies for the year ended 30 June 2016; and
a statement of trust money, administered by departments, for the year ended 30 June 2016.

In my opinion, the financial statements of the Government on pages 34 to 151:

present fairly, in all material respects the Government's:
- financial position as at 30 June 2016;
- financial performance and cash flows for the year ended on that date;
- borrowings as at 30 June 2016;
- unappropriated expenditure for the year ended 30 June 2016;
- emergency expenses and capital expenditure for the year ended 30 June 2016; and
- trust money administered by departments for the year ended 30 June 2016.
comply with generally accepted accounting practice in New Zealand, in accordance with Public Sector Public Benefit Entity Accounting Standards.

Basis for Opinion

The audit has been carried out in accordance with the Auditor-General's Auditing Standards, which incorporate the International Standards on Auditing (New Zealand) (ISAs (NZ)). My responsibilities under those standards are further described in the Auditor's responsibilities for the audit of the financial statements of the Government section of this report.

While carrying out this audit, my staff, and appointed auditors and their staff followed my independence requirements, which incorporate the independence requirements of Professional and Ethical Standard 1 (Revised) Code of Ethics for Assurance Practitioners issued by the New Zealand Auditing and Assurance Standards Board and the International Ethics Standards Board for Accountants' Code of Ethics for Professional Accountants (IESBA Code), and we have fulfilled our other ethical responsibilities in accordance with my independence requirements.

As an Officer of Parliament, I am constitutionally and operationally independent of the Government and, in exercising my functions and powers under the Public Audit Act 2001 as the auditor of public entities, I have no relationship with or interests in the Government.

I believe that the audit evidence I have obtained is sufficient and appropriate to provide a basis for my opinion.

Key Audit Matters

Key audit matters are those matters that, in my professional judgement, were of most significance in my audit of the financial statements of the Government of the current period. In applying my professional judgement to determine key audit matters, I considered those matters that could be complex, have a high degree of uncertainty, or are important to the public.

Because of the nature of the Government's activities, I recognise that key audit matters may be long-standing, and therefore, may not change significantly from one year to the next. These matters were addressed in my audit of the financial statements of the Government as a whole, and in forming my opinion thereon.

Recognition of tax revenue
Key audit matter	What we did
The Government recognised tax revenue of $63.1 billion for the year ended 30 June 2016. Tax revenue is the main source of revenue for the Government. As outlined in note 2, it is necessary to estimate some components of tax revenue at 30 June 2016 because of timing differences between the reporting date for the financial statements of the Government and when taxpayers file tax returns. At 30 June 2016, the most significant estimates were those about companies' and other persons' income tax revenue totalling $14.4 billion (net of refunds). Estimating income tax revenue is complex and relies on judgement. The recognition of income tax revenue is a key audit matter because it is a significant source of the Government's revenue, and is subject to significant uncertainties, complexities, and judgements.	We obtained an understanding of the systems, processes, and controls in place over the receipt of tax revenue, and assessed significant reconciliation processes. We carried out audit procedures to confirm the value of tax revenue as at 30 June 2016. This involved testing the data used in the estimation models to ensure that it was relevant and was used appropriately, checking the evidence to support the reasonableness of underlying assumptions applied in the models, and testing the sensitivity of the underlying assumptions used in the models. We also reviewed the historical accuracy of the estimation models to ensure that they had previously provided reasonably accurate estimates, and we checked receipts after year end to confirm the validity of some estimates. I am satisfied that the estimates included in tax revenue at 30 June 2016 are reasonable, and that the disclosures about the key estimates and judgements are appropriate.
Valuing property, plant and equipment
Key audit matter	What we did
The Government owns a number of significant assets that can be difficult to value because of the nature of the assets. I have identified the following specific asset types where such difficulties are considered key audit matters because of the significance of those assets, and the uncertainties inherent in making the valuations.
*State highway network* As outlined in note 18, the state highway network has been valued at $22.3 billion at 30 June 2016 by an independent external valuer. The valuation is based on information from a number of databases that identify the asset components that make up the network (roads, bridges, culverts, etc.), and their expected useful lives. These asset components exclude land which is separately recorded, as set out in note 18. It is possible that some of the information in the databases could be incomplete or has been indexed using assumptions that cannot be easily verified. This includes additional brownfields costs, such as traffic management, that cannot be applied to historic road construction because of incomplete records about these costs. As a result, there are uncertainties about the valuation of the state highway network.	We obtained an understanding of how the state highway network is valued. This involved confirming the competence, capabilities, and objectivity of the valuer, testing the valuer's valuation procedures, including the information they extracted from databases, and challenging the valuer's critical assumptions and judgements. We also carried out audit procedures to confirm that key controls were operating over the state highway network systems. This involved testing a sample of asset components to check whether appropriate approval had been obtained for expenditure on the components and whether there was adequate supporting documentation. We also reviewed the valuer's estimates of known brownfields costs, and in particular brownfields costs associated with roading components constructed or acquired during the year. I am satisfied that the value of the state highway network is reasonable and consistent with valuation practices, and that the disclosures appropriately outline the uncertainties about the valuation of the state highway network.
*Electricity generation assets* As outlined in note 18, the electricity generation assets, which are at least 51% owned by the Government, are valued at $15.7 billion at 30 June 2016. The valuation of these assets is carried out by specialist valuers because of the complexity and significance of the assumptions about the future prices of electricity, the generation costs, and the generation volumes that these assets will create. As a result, small changes to these assumptions, in particular the forecast prices of electricity and the discount rates used to determine the present value of these prices, could significantly change the value of these assets.	We obtained an understanding of how electricity generation assets are valued. This involved confirming the competence, capabilities, and objectivity of the valuers, testing the valuer's procedures for carrying out the valuations, including the information they used to carry them out, and challenging the valuer's critical assumptions and judgements. We also used our own valuation specialists to assess the valuer's procedures. We tested the sensitivity of the key underlying assumptions used by the valuers to ensure that they were reasonable, and we compared the forecast prices of electricity to the expected longer-term wholesale prices and market data where it was available. We also confirmed the underlying information held about assets by verifying asset purchases and disposals in the current period. This included testing whether there was adequate supporting documentation for those purchases and disposals. It also involved confirming the opening assets balances, and evaluating the related financial statement disclosures. I am satisfied that the valuation of electricity generation assets is reasonable and the disclosures appropriately outline the sensitivity and the complexity of the valuation of electricity generation assets.
*Rail network* As outlined in note 18, the rail network has been valued at $959 million at 30 June 2016. In arriving at this value the freight and the metro transport parts of the network have been valued on different bases, reflecting the commercial nature of the freight part of the network and public benefit nature of the metro transport part of the network. The extent to which the freight part of the network is commercial is open to debate, given the expected government funding required in future years. If it was not considered commercial, the basis for valuing the freight part of the network would change to reflect a public benefit nature. As outlined in note 18, if the freight part of the network had been valued based on a public benefit value rather than a commercial value, the rail network would increase in value by $4.2 billion.	We considered the evidence around the commercial nature versus the public benefit nature of the freight part of the rail network. The evidence included reviewing: the State owned Enterprises Act 1986; strategy documents; forecast results; correspondence setting out the Minister's expectations; and minutes from Board meetings. As in past years, the evidence showed mixed results for the commercial nature versus the public benefit nature of the freight part of the rail network. It is a finely balanced judgement whether to value the freight part of the network on a commercial basis. On balance, I am satisfied that the judgement to value the freight part of the network on a commercial basis is once again marginal but reasonable, and that the disclosures are appropriate.
Valuing long-term liabilities
Key audit matter	What we did
The valuation of the Government's long-term liabilities is complex and requires actuaries to estimate the value, based on assumptions about the future. I have identified the following specific liabilities where such complexities are considered key audit matters because of the significance of the value of those liabilities, and the uncertainties inherent in making those valuations.
*ACC's outstanding claims liability* As outlined in note 22, ACC's outstanding claims liability has been valued at $36.6 billion at 30 June 2016 by an independent actuary. The assumptions used to calculate the value of the outstanding claims liability include estimating the length of rehabilitation from injuries, estimating amounts of cash payments and when they will occur, and estimating inflation and discount rates. The sensitivities are demonstrated in note 2, which indicates that changes in the assumptions can have a large effect on the amount of the liability, which also effects the amount of the actuarial gain or loss on the liability.	We obtained an understanding of how ACC's outstanding claims liability is valued, which included considering the appropriateness of the assumptions adopted by ACC for each significant claim type. We tested the underlying process for recording claims, used our own actuarial specialists to assess the approach taken to valuing the liability, and assessed the significant assumptions used in the valuation by evaluating them against past claims. We also tested the reconciliations of the underlying claims data to ACC's systems, examined the sensitivity analysis for movements in key assumptions, and evaluated the related financial statement disclosures. I am satisfied that ACC's outstanding claims liability is reasonable, and that the disclosures appropriately outline the sensitivities of the valuation to changes in assumptions.
*Valuing Government employees superannuation liability* As outlined in note 23, the Government's liability for public servants superannuation entitlements for past and current members under the Government Superannuation Fund has been valued at $12.4 billion at 30 June 2016 by an independent actuary. The assumptions used to calculate the value of the liability include estimating the return on assets owned by the Fund, estimating expected rates of salary increases for public servants who are members of the Fund, and estimating inflation and discount rates. As demonstrated in note 2, changes in the assumptions can have a large effect on the amount of the liability.	We obtained an understanding of how the Government's liability for public servants superannuation entitlements is valued. This involved, confirming the competence, capabilities, and objectivity of the actuary, as well as testing the actuary's valuation procedures. We used our own valuation specialists to assess the actuary's procedures, and we challenged the actuary's critical assumptions and judgements. We also tested key controls over the completeness and accuracy of membership data, which was used in the actuary's valuation and we evaluated the appropriateness of key assumptions on the return on assets and expected rates of salary increases, against external benchmarks. I am satisfied that the Government's liability for public servants superannuation entitlements is reasonable, and that the disclosures appropriately outline the sensitivities of the valuation to changes in assumptions.
Valuing financial assets and liabilities at their fair value
Key audit matter	What we did
As outlined in note 29, the Government has financial assets of $125.8 billion, of which $71.8 billion are valued at their fair value, and financial liabilities of $127.2 billion, of which $12.3 billion are valued at their fair value. The financial assets and liabilities measured at fair value include derivatives (which have a principal value of $221.5 billion), marketable securities, and share investments. Where quoted market prices are not available to determine the value of financial assets and liabilities, fair value must be estimated. This is done by applying a valuation approach that is most appropriate for the asset or liability, such as using valuation models. Inputs into the models will use market data when available, otherwise inputs are derived from non-market data, which requires judgement. We consider that valuing financial assets and financial liabilities at their fair value is a key audit matter, given their significance, including the principal value of derivatives, and the estimations required.	We obtained an understanding of the valuation processes used by entities to determine the fair value of financial assets and liabilities. Where a fund manager carries out the valuation, we obtained an understanding of the controls and valuation approaches applied. We also carried out a range of audit procedures which reflected the nature of the financial assets and liabilities being valued and the uncertainties associated in determining their fair value. These audit procedures included a mixture of: testing the internal controls over data relating to financial assets and liabilities that has been entered into systems; confirming the fair value of financial assets and liabilities to independently sourced valuations, and investigating any significant variances; confirming the value of financial assets and liabilities to independent pricing sources; and evaluating the appropriateness of the inputs used for valuing financial assets and liabilities where the fair value was dependent on significant non-market inputs. I am satisfied that the fair values for financial assets and liabilities are reasonable and that the disclosures are appropriate.
Accounting for the effects of the Canterbury earthquakes
Key audit matter	What we did
The outstanding earthquake insurance liabilities for the Canterbury earthquakes, as outlined in note 31, are $2.1 billion at 30 June 2016. The calculation of these liabilities is complex and is carried out by independent actuaries. The calculations have to take into account estimates of the extent of the damage, which is often not clearly known, uncertainties arising from changing land policies and engineering requirements in response to issues such as liquefaction and flooding, and associated legal claims. I have included the outstanding Canterbury earthquakes liabilities as a key audit matter because of the public interest in these liabilities.	We obtained an understanding of how the outstanding earthquake insurance liabilities for the Canterbury earthquakes were valued. This involved confirming the competence, capabilities, and objectivity of the actuaries, testing the actuaries' valuation procedures, including the information they used, and challenging the actuaries' critical assumptions and judgements. We evaluated whether the latest information about the effects of the earthquakes, including the damage, claims paid out, and repairs undertaken, had been used by the actuaries. We also used our own actuarial specialists to assess the actuaries' procedures. We tested a sample of claims and payments of claims during the year to ensure that appropriate controls were in place, they had been appropriately approved, they had supporting evidence, and they had been correctly incorporated into the information used by the actuaries. I am satisfied that the earthquake insurance liabilities are reasonable and that the disclosures appropriately outline the uncertainties over the valuation of the earthquake insurance liabilities.

Responsibilities of the Treasury and the Minister of Finance for the financial statements of the Government

The Treasury is responsible for preparing financial statements of the Government that:

comply with generally accepted accounting practice in New Zealand in accordance with Public Sector Public Benefit Entity Accounting Standards;
present fairly, in all material respects the Government's financial position, financial performance, and cash flows; and
presents fairly, in all material respects the Government's:
- borrowings;
- unappropriated expenditure;
- expenses or capital expenditure incurred in emergencies; and
- trust money administered by departments.

The Minister of Finance is responsible for forming an opinion that the financial statements of the Government present fairly in all material respects the financial position and financial performance of the Government.

The responsibilities of the Treasury and the Minister of Finance arise from the Public Finance Act 1989.

The Treasury is also responsible for such internal control as it determines is necessary to enable the preparation of the financial statements of the Government that are free from material misstatement, whether due to fraud or error. The Treasury is also responsible for the publication of the financial statements of the Government, whether in printed or electronic form.

In preparing the financial statements of the Government, the Treasury is responsible for assessing the Government's ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting.

Auditor's responsibilities for the audit of the financial statements of the Government

I am responsible for expressing an independent opinion on the financial statements of the Government and reporting that opinion to you based on my audit. My responsibility arises from section 15 of the Public Audit Act 2001.

My objectives are to obtain reasonable assurance about whether the financial statements of the Government as a whole are free from material misstatement, whether due to fraud or error, and to issue an audit report that includes my opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs (NZ) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the decisions users take on the basis of the financial statements of the Government. If material misstatements had been found that were not corrected, I would have referred to them in my opinion.

As part of an audit in accordance with ISAs (NZ), I exercised professional judgement and maintained professional scepticism throughout the audit. Also:

I identified and assessed the risks of material misstatement of the financial statements of the Government, whether due to fraud or error, designed and performed audit procedures responsive to those risks, and obtained audit evidence that is sufficient and appropriate to provide a basis for my opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
I obtained an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the internal control used by the Treasury to prepare the financial statements of the Government.
I evaluated the appropriateness of accounting policies used, and the reasonableness of accounting estimates and related disclosures made by the Treasury.
I concluded on the appropriateness of the use of the going concern basis of accounting that has been used by the Treasury to prepare the financial statements of the Government, up to the date of my auditor's report based on the audit evidence I have obtained.
I evaluated the overall presentation, structure, and content of the financial statements of the Government, including the disclosures, and whether the financial statements of the Government represent the underlying transactions and events in a manner that achieves fair presentation.

For the budget information reported in the financial statements of the Government, my procedures were limited to checking that the amounts agree to the Government's most recent forecast.

As part of my audit, I obtained information from my staff, and appointed auditors of the organisations that are consolidated into the financial statements of the Government, including information about:

eliminations of transactions between the organisations that are consolidated into the financial statements of the Government;
application by those organisations of appropriate accounting policies and Treasury instructions to prepare the financial statements of the Government; and
relevant risks of material misstatement of the financial statements of those organisations that may affect the financial statements of the Government.

I have communicated with the Treasury, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that I identified during my audit.

From the matters communicated with the Treasury, I determined those matters that were of most significance in the audit of the financial statements of the Government of the current period and are therefore the key audit matters described in this report.

I did not evaluate the security and controls over the publication, whether in printed or electronic form, of the financial statements of the Government.

Other information

In addition to preparing the financial statements of the Government, the Treasury is also responsible for preparing the other information on pages 3 to 24 and 153 to 162.

My opinion on the financial statements of the Government does not cover the other information. As a result, I do not express any form of audit opinion or assurance conclusion on that information.

In connection with my audit of the financial statements of the Government, my responsibility is to read the other information, and, in doing so, consider whether this information is materially inconsistent with the financial statements of the Government, or my knowledge obtained in the audit, or otherwise appears to be materially misstated. If, based on the work I have performed, I conclude that there is a material misstatement of this other information, I am required to report that fact. I have nothing to report in this regard.

Signature - LP

Lyn Provost
Controller and Auditor-General Wellington, New Zealand

30 September 2016