Appendix 2 Report from the independent reviewer

Annual Report 2016/17.

John R Strahl
150 Riverside Drive
Lower Hutt

18 July 2017.

Controller and Auditor-General
PO Box 3928
Wellington 6140

ANNUAL REPORT OF THE INDEPENDENT REVIEWER OF AUDIT ALLOCATION PROCESSESS

Background and instructions

Pursuant to section 14 of the Public Audit Act 2001 (Public Audit Act), you are appointed as the auditor of all public entities. Under section 42 you are authorised to fix the fee payable for all such audits which must be reasonable.

Audit New Zealand, a business unit of your Office, has a large and competent staff. However with approximately 3,700 public entities in New Zealand which must be audited, it is impractical for Audit New Zealand itself carry out all these audits. You thus contract auditors from the private sector to carry out many of these on your behalf. The Office of the Auditor-General (OAG), sets strategy, policy, and standards, and appoints and oversees auditors, both from Audit New Zealand and auditors contracted from the private sector, who carry out audits on your behalf.

You have retained me as an independent party to review the basis upon which auditors, both from Audit New Zealand and the private sector, are appointed to act on your behalf, and to review the basis upon which the audit fees for these audits are determined.

This is my report on that review for the year ended 30 June 2017.

I am a former partner and chairman of law firm DLA Piper New Zealand. I chair a public entity which is audited by Audit New Zealand on your behalf. I confirm that I am independent of the Office of the Auditor-General, Audit New Zealand and all private sector audit firms.

My instructions are;

  • ' ..to review and confirm the probity and objectivity of the methods and systems used by the Office of the Auditor-General to;
  • Allocate and tender audits;
  • Monitor the reasonableness of audit fees; and
  • Anything else that impacts on those activities.

There has been no limitation placed on the manner in which I may carry out my work and I have been free to inspect any documents or files that I have considered appropriate to the review. I confirm that in the conduct of my review I have been given free access to all matters I have requested and have received full co-operation from your Office. I have also met with several of your staff, the Executive Director of Audit New Zealand and two private sector audit providers.

Types of Audit Appointments

In accordance with policies and practices adopted by your Office, there are four main types of audit appointments;

  1. an appointment made of an auditor to an entity, usually for a term of 3 years under the Audit Allocation Model (Allocation Model)
  2. an appointment of an auditor for an entity, following a contestable process, if you consider that is appropriate in the given circumstances
  3. a re-appointment of an auditor for a further term, usually 3 years, to audit that same entity
  4. where an audit involves 150 or more budgeted hours, the individual auditor and senior personnel may not undertake the audit work for more than 6 years, thus a new auditor must be appointed, though that may be another person in the same firm.

Appointments for new entities

In the last financial year, the Auditor-General appointed auditors for 30 new entities. That number includes 6 schools or school related entities. Apart from schools, these new entities are mainly subsidiary entities created or acquired by existing entities, but a few were completely new. All of these appointments were made following the principles set out in the 'Allocation Model' on which I will comment later. I observed no dissatisfaction by any of those entities to either the appointment made, the terms of appointment, or the proposed audit fee. I conducted a random review of the files relating to several appointments. All were well documented, showed appropriate consideration of the principles of the Allocation Model, good process and decision making using objective standards.

New entities which must be audited by you by virtue of the Public Audit Act, often are created without any specific consideration of that requirement. I was satisfied with the approach taken by your office to track these down and to manage the appointment process.

Re-appointments (other than for schools)

Existing auditors were re-appointed during the last financial year to audit 458 public entities and their subsidiaries for a further term. In respect of all the appointments covered by this paragraph, I observed no dissatisfaction from any of the entities and an appropriate process appeared to be followed and in accordance with the principles set out in the Allocation Model.

New appointments for existing entities (other than for schools)

There were 10 new appointments made for existing entities. Other than for 2, all were appointed pursuant to the principles of the Allocation Model. None were significant and no dissatisfaction in respect of the appointments made was evident.

Unusually 2 new appointments, both for substantial existing entities, were made following a contestable tender process. Both changes arose following some dissatisfaction between the entity and the previous auditor. As a result, neither existing auditor took part in the tender process.

A robust and thorough process was put in place and a panel, including an independent chair, was involved in assessing the tenders and making a recommendation to the Auditor-General. A representative of the entity took part in the panel. As required the final decision was made by the Auditor-General.

I considered that this process adopted for these entities in the particular circumstances was both appropriate and reasonable and that the tender itself was well conducted.

It was also reassuring to note that as a result of this contestable process, the audit fee determined in respect of the entity with no material change to the scope of the audit was entirely consistent with the historical audit fee for that entity.

Appointment of school auditors

The appointment of auditors of all schools and school related entities arises on a 3 year cycle and that was completed in 2015. As a result, other than for the appointments to 6 new schools, no re­ appointments took place this year. However, there were changes made to 53 schools (involving 2 auditors) due to quality concerns. For 35 of those schools, new auditors were appointed following a small tender, and the balance were directly appointed in accordance with the Allocation Model. I saw no material dissatisfaction with any of these new appointments.

Audit Allocation Model

As can be seen from the appointments above, the vast majority have been made using the Allocation Model with only a few by the use of a contestable basis. The Allocation Model has been the principal method used for appointments since it was first adopted in 2003 and later revised in 2010. This is now a well established and publicised set of principles are set out in a document entitled; "Appointing public sector auditors and setting audit fees.' The principles are summarised in that document as comprising:

  • auditor independence;
  • auditor knowledge about public entities and public sector audits;
  • the particular audit skills required; the audit's quality and cost; and
  • the need for the Auditor-General to always have access to enough audit capacity and capability.

The full guide is available on the OAG website (ISBN-978-0-478-38310-2) and is provided to any entity and auditor when appropriate. It is consistently followed and referred to when issues arise.

I have again considered the Allocation Model and whether it remains fit for purpose. Prior to its adoption most audit appointments were made following a contestable tender process. The conduct of audits in the public sector requires specialist expertise, and a careful balance to ensure good quality and consistent auditing at reasonable cost. I remain of the view that that these objectives and the balancing required to retain a consistent level of quality and reasonable cost, is best achieved by use of the Allocation Model as opposed to a pure contestable process in the vast majority of cases. The contestable process was successfully and appropriately used this year for 2 substantial entities. However while I expect it will continue to be used in individual cases when appropriate, I doubt this will happen very often.

By making appointments in accordance with such a model, given the inherent discretion available, this requires a disciplined and consistent application of the principles of the model when decisions are made. From my review of appointments made during the last year, a careful and consistent process has been followed.

Auditor Independence

This year I also reviewed whether the commitment to 'auditor independence', one of the key allocation principles and a requirement of the Audit Standards, is adequately monitored. I observed a strong commitment to this and found both reasonable and appropriate systems in place to both monitor and reinforce compliance.

Audit fees

Section 42 of the Public Audit Act 2001 authorises the Auditor-General to set the fee for all audits which must be reasonable. In the event of a dispute, either party may refer any fee dispute to arbitration.

In practice, at the commencement of every individual audit appointment, the proposed fee is first referred to OAG by the auditor for review to ensure its reasonableness and it is then provided to the entity for the auditor and entity to agree. The OAG will assist in that process and has available a comprehensive data base of fees in the sector. It is the strong preference of the Auditor-General for the entity and the appointed auditor to then reach agreement, and that is almost always the case.

In the year under review there are no outstanding disputes over audit fees, although it is always possible that a dispute might be raised again at a later date.

In no case over the last year has the Auditor-General had to exercise the power to fix a fee and not since 2009 has there been a reference to arbitration.

The OAG has strong and consistent guidelines as to what level of fee is regarded as reasonable. Apart from limited permitted changes due to unexpected additional time requirements or change of scope, increases in hourly rates or overall increases are carefully and strictly monitored. A twice yearly review of overall movement in audit fees is conducted and reported to the Auditor-General and OAG leadership team.

Most issues which arise over fees are during or at the end of an audit. Some arise due to the constrained financial position of particularly small entities. Some arise due to misunderstandings about what is required and sometimes the quality of information provided by the entity and rework by the auditor as a result leads to tension. In all cases reviewed, the OAG has shown consistent care and patience in helping to resolve these issues.

I am entirely satisfied that the approach of the Auditor-General has been consistent and reasonable in the process of setting and resolving issues over audit fees.

Issues arising after appointment

While I have observed virtually no disputes over the initial appointment of auditors or the first setting of the audit fee, there continue to be some limited cases of subsequent dissatisfaction. This is most commonly raised by a few entities and only in a very limited number of cases by an auditor. They almost always involve the entity thinking they have to pay too much or that the performance or relationship between the entity and the auditor is not good. It is sometimes both.

The number involved remains very small. I have reviewed several of the disputed cases. In all cases the Auditor-General has taken a consistent and objective position and has sought to assist the parties resolve the issue. In a few exceptional cases, the Auditor-General has changed the auditor for the following year.

Other issues

There are no other material issues which arose in the previous year which in my view warrant comment in this report.

Conclusions

I have been provided full access to all relevant material and free access to the relevant files and personnel of the OAG. I have met with and obtained full explanations to all my queries by OAG personnel and have observed the relevant internal process of the OAG including as to disclosure of interests and the monitoring of auditor independence. On the basis of that review and the explanations provided I consider that the policies currently adopted for the allocation of audits and the setting of fees are appropriate and that:

  1. the process and methods used to allocate audits has been conducted fairly, reasonably, and with suitable probity and objectivity
  2. the approach and process taken to fix and monitor the reasonableness of audit fees has been reasonable, having regard to the interests of all parties, and has been conducted with suitable probity and objectivity
  3. the subsequent issues that have arisen for both appointments and fees have been dealt with objectively, fairly and patiently

Yours sincerely

John Strahl

John R Strahl.