Part 1: Financial results and trends
1.1
In this Part, we consider local authorities' financial results for 2015/16.1 We were particularly interested in how local authorities performed compared to what they planned and budgeted for in the first year of their 2015-25 long-term plans.
1.2
In completing our analysis, we wanted to answer the following questions:
- Did local authorities spend what they planned to on their operations?
- Are local authorities maintaining their budget commitments to invest in their assets?
- Are local authorities adequately reinvesting in their assets?
- What are the revenue trends?
- Did local authorities prudently manage their debt?
1.3
We do not expect local authorities to achieve their budgets exactly, and there can be many reasons why an entity might not do what it plans to. For the purposes of our analysis, we consider a local authority to have reasonably achieved its budget if the performance was between 80% and 125% of the budget.
1.4
Unless otherwise noted, we have used the parent-only results of local authorities except Auckland Council. For Auckland Council, we analysed the group results because Auckland Council produces a group budget in its long-term plan and we wanted to compare the actual 2015/16 information with the budget.
Did local authorities spend what they planned to on their operations?
1.5
In 2015/16, local authorities' total operating expenditure was $10.5 billion. This was 10.3% more than the $9.5 billion that was budgeted. Sixty local authorities spent more than they had budgeted on operational expenses, including two local authorities that spent 25% more than they had budgeted. Although operational expenses were more than anticipated when setting the budget, the variances can be reasonably explained.
1.6
Higher-than-budgeted expenditure related to items that local authorities cannot easily budget for or control. These items include:
- gains or losses on assets sold;
- fair value movements on investment property and derivative financial instruments;
- foreign exchange movements; and
- impairment of assets (for example, reduced value from damage arising from earthquakes or storm events).
1.7
Factors outside of a local authority's control, such as changes to interest rates or the property market, can significantly influence what assets are sold for, which can affect a local authority's expenditure or revenue.
1.8
Auckland Council had the largest variance to budget, with operating expenditure that was $561 million more than the $3.4 billion budgeted. Of this variance, $552 million related to the items noted in paragraph 1.6.
1.9
Figure 1 compares the actual amount spent and the budget for 2015/16 by type of operating expenditure. Local authorities spent 7.2% less than budgeted on finance costs. This is primarily because local authorities borrowed less than planned (see paragraphs 1.36 to 1.47).
Figure 1
Local authorities' operating expenditure, by type
| Operating expenditure item | 2015/16 actual amount $million | 2015/16 budgeted amount $million | Percentage over/(under) budget |
|---|---|---|---|
| Depreciation and amortisation | 2,204 | 2,151 | 2.4% |
| Finance costs | 758 | 816 | (7.2%) |
| Other operating expenditure | 7,511 | 6,531 | 15.0% |
Are local authorities maintaining their budget commitments to invest in their assets?
1.10
Most local authorities did not spend as much on their assets as they had planned. Local authorities' capital expenditure in 2015/16 was $3.4 billion, about 70% of the $4.9 billion budgeted.2,3
1.11
The two largest variances were for Auckland Council ($462 million) and Christchurch City Council ($472 million). These two local authorities spent 74% and 51% of their respective capital expenditure budgets. They reported that this was because of delays in the timing of individual projects.
1.12
It is not unusual for local authorities to spend less than in the budget. In 2015/16, 45 local authorities, including Auckland Council and Christchurch City Council, spent less than 80% of their capital expenditure budgets. Twenty-three local authorities spent between 80% and 125% of their budgets, and nine local authorities spent more than 125% of their budgets.4
1.13
Spending less than has been budgeted is a trend we have seen in previous years. From 2012/13, local authorities have spent, on average, a maximum of 77% of their capital expenditure budget in any one year. Figure 2 shows the performance of local authorities against their budget from 2012/13 to 2015/16.
Figure 2
Local authorities' actual capital expenditure as a percentage of their budgeted capital expenditure, 2012/13 to 2015/16
| Less than 80% | Between 80% and 125% | More than 125% | |
|---|---|---|---|
| 2012/13 | 46 | 29 | 2 |
| 2013/14 | 43 | 28 | 6 |
| 2014/15 | 45 | 28 | 4 |
| 2015/16 | 45 | 23 | 9 |
1.14
From the financial information, we cannot assess what effect the underspending has on the service potential of local authorities' property, plant, and equipment.
1.15
However, local authorities that are consistently underspending on their capital expenditure budgets do need to understand the effect this has on their assets. For example, underinvestment could compromise the long-term ability of local authorities to deliver services to their communities.
1.16
We will continue to focus on underspending, especially during our audits of local authorities' 2018-28 long-term plans.
Does this capital expenditure trend differ for major infrastructural assets?
1.17
Local authorities are responsible for owning and managing the following main groups of infrastructure assets:
- water supply;
- sewerage;
- stormwater drainage;
- flood protection; and
- roading and footpaths.
1.18
As in previous years, in 2015/16, we collected and analysed the capital expenditure disclosed in the funding impact statements for these activities. Capital expenditure has to be disclosed in three categories:
- expenditure for new assets to meet additional demand;
- expenditure to improve levels of service; and
- expenditure to replace or renew existing assets.
1.19
As shown in Figure 3, spending against each type of capital expenditure other than renewals and replacement of sewerage assets was, for all local authorities, generally well below budget. Of the core activities, there are no categories where the amount spent was within 10% of budget.
1.20
As we reported last year, this low level of capital expenditure calls into question the accuracy of budgets. It also highlights the risk that, if underinvestment continues, local authorities might not be able to maintain service levels in the future. We expect that some local authorities might have to make difficult decisions about future service levels if they are not able to maintain them at the current levels.
Figure 3
Core activity funding impact statements – total actual capital expenditure and comparison with budgeted capital expenditure
| Capital expenditure types | Additional demand | Improve level of service | Renewal and replacement | |
|---|---|---|---|---|
| Water supply | Actual capital expenditure | $113.6m | $100.3m | $148.2m |
| Actual against budget | 82% | 65% | 78% | |
| Sewerage | Actual capital expenditure | $132.5m | $98.6m | $408.9m |
| Actual against budget | 59% | 65% | 126% | |
| Stormwater drainage | Actual capital expenditure | $43.3m | $67.2m | $87.9m |
| Actual against budget | 60% | 87% | 81% | |
| Flood protection | Actual capital expenditure | $8.8m | $37.1m | $13.2m |
| Actual against budget | 65% | 71% | 29% | |
| Roading and footpaths | Actual capital expenditure | $139.7m | $252.6m | $715.1m |
| Actual against budget | 83% | 73% | 88% | |
1.21
We encourage all local authorities to carefully assess how accurate their budgets are and to remain aware of other factors that could result in substantial differences between the delivery of capital expenditure work and what was planned.
Are local authorities adequately reinvesting in their assets?
1.22
In previous years,5 we outlined concerns that local authorities might not be adequately reinvesting in their assets.
1.23
To consider how local authorities are investing in their assets, we compared renewal capital expenditure to depreciation (depreciation is the best estimate of what portion of the asset was used during the period) (see Figure 4).
1.24
The comparison of renewal capital expenditure to depreciation shows that, for most local authorities, renewals were less than 100% of depreciation. Such results are likely to indicate that the quality of the assets is deteriorating. If nothing changes, the cost of improving the quality of the assets might fall on future generations.
1.25
There appears to be an increase in 2014/15 and 2015/16 in the number of local authorities whose expenditure on renewals is more than 100% of depreciation. This increase is largely because some local authorities are completing large, one-off renewal projects.
Figure 4
Renewal capital expenditure compared to depreciation, 2012/13 to 2015/16
1.26
This calculation is only an indication of whether the expenditure is enough to maintain existing assets. We urge individual local authorities to continue considering whether they are adequately maintaining their assets, taking into account their unique circumstances.
1.27
A comprehensive understanding of the age and condition of critical assets, as well as of future demand (for example, increases or decreases depending on demographic changes or changes to environmental standards), is important in assessing whether the actual and planned expenditure is sustainably maintaining assets.
1.28
Once local authorities have a comprehensive understanding of their critical assets and the cost of adequately maintaining them, elected members can make informed decisions about managing their assets and have well-informed conversations with their communities about how to fund that cost or the consequences of not doing so.
1.29
We will continue to focus on this, especially during the audits of local authorities' 2018-28 long-term plans.
What are the revenue trends?
1.30
Our analysis shows that there are no unusual or unexpected revenue trends. As in previous years, local authorities' revenue was in line with their budgets.
1.31
In 2015/16, local authorities recorded revenue of $11.1 billion. This was 4.3% more than the $10.7 billion that was budgeted. Fifty-five local authorities recorded more revenue than budgeted. Five of those local authorities recorded 25% more revenue than budgeted.
1.32
Auckland Council had the largest dollar variance to budget, receiving $68 million more than the $3.7 billion that was budgeted.6 However, this is only 1.8% more than what Auckland Council budgeted.
1.33
Local authorities receive revenue through many sources. In 2015/16, rates remained the main source of income (49.6% of local authorities' total revenue). Other significant revenue sources were:
- development and financial contributions, which local authorities charge to help fund extra infrastructure as a result of development projects;
- grants and subsidies – for example, grants from the New Zealand Transport Agency, which helps to fund the roading work done by local authorities;
- investments, such as interest and dividend income;
- user charges, which are fees local authorities charge for a variety of activities, including building and resource consenting processes, dog licensing, and food premises licensing; and
- vested assets, which represent the value of assets donated by others to local authorities. This is a non-cash revenue source.
1.34
Many local authorities received more revenue from investments and vested assets in 2015/16 than they expected. Many of the local authorities reported that the increase over budgeted revenue was from these revenue sources.
1.35
Conversely, local authorities received proportionately less revenue from grants and subsidies. A significant proportion of the grants that local authorities received was to fund capital expenditure work. As we noted above, most local authorities did not spend all of their capital expenditure budgets in 2015/16 and so missed out on grants.
Did local authorities prudently manage their debt?
1.36
Local authorities as a whole appear to be managing debt prudently.
1.37
Local authorities had $13.6 billion of debt at 30 June 2016, which was $1.1 billion less than budgeted and $667 million more than at 30 June 2015. This continues a trend since 2012/13 of local authorities having less debt than budgeted for.7
1.38
Many local authorities use debt to fund long-life assets. As a general principle, debt should not be used to fund operations because it is like borrowing to pay for the groceries. Furthermore, local authorities usually use debt to fund new assets to meet demand or to increase levels of service, rather than to fund renewals.
1.39
However, local authorities can choose to use debt to fund any type of capital expenditure. Because many local authorities do not spend all of their capital expenditure budgets, we are not surprised that local authority debt was less than budgeted.
1.40
Not all local authorities carry debt. At 30 June 2016, 12 local authorities had no debt.
1.41
Auckland Council recorded the most debt at 30 June 2016 and made up about 56% of total local authority debt.
1.42
The effect of debt on local authorities is best assessed by considering the cost of servicing debt. In our view, managing financing costs that are more than 15% of rates revenue is likely to be difficult and will reduce a local authority's flexibility to respond to unexpected changes.
1.43
However, there is no specific rule on the appropriate level of such costs. It is up to individual local authorities to determine limits they are comfortable with based on their circumstances and to disclose these in their financial strategies. Local authorities that borrow through the New Zealand Local Government Funding Agency must also comply with a set of financial covenants.
1.44
The proportion of rates revenue used to meet financing costs was 13.7% for 2015/16, which was 1.1% less than budgeted.8 Importantly, the proportion was also less than for 2014/15 (by 1.2%). This indicates that local authorities should be in a better position to meet financing obligations compared with prior years. This is partly a result of low interest rates.
1.45
Seven local authorities had financing costs as a proportion of rates revenue at or above 15% in 2015/16. These local authorities had budgeted for this position.
1.46
Local authorities report against prudence benchmarks in accordance with the Local Government (Financial Reporting and Prudence) Regulations 2014. These include three types of benchmarks related to debt:
- debt affordability benchmark;
- debt servicing benchmark; and
- debt control benchmark.
1.47
The seven local authorities that had higher financing costs as a proportion of rates revenue all reported that they met their debt affordability benchmarks in 2015/16. However, not all local authorities met the debt servicing benchmark or the debt control benchmark. Those local authorities need to carefully monitor and manage this position.
1: The information excludes the results of Carterton District Council. The annual report of this local authority was not publicly available when we prepared this report.
2: This information has been extracted from the statement of cash flows of local authorities. It includes only the cash that the local authority spent on purchasing property, plant, and equipment and intangible assets.
3: When capital expenditure, as reflected in all local authorities' whole-of-council funding impact statements, is compared to budget in those statements, 73% of budgeted capital expenditure has been incurred. We consider that the difference between the 70% and the 73% relates to the level of year-end accruals between years.
4: That is, these local authorities spent an extra 25% or more than they had budgeted for.
5: See, for example, Office of the Auditor-General (2016), Local government: Results of the 2014/15 audits, pages 14 and 15.
6: We have included the share of surplus in associates and joint ventures recognised by Auckland Council in our revenue analysis.
7: From 2012/13, local authorities as a whole have between 90% and 100% of the budgeted debt as at 30 June.
8: Finance costs have been drawn from the Statement of Comprehensive Income. It is possible that these figures could include non-cash items. This calculation is only an indication of the pressure debt can place on a local authority. Other sources of revenue, such as development contributions and user charges, also contribute to meeting the cost of debt.