Appendix 2: Report from the independent reviewer

Annual report 2017/18.

18 July 2018.

John R Strahl
P O Box 33141 Petone Pst Shop
Lower Hutt

John Ryan
Controller and Auditor-General
PO Box 3928
Wellington 6140

Dear Mr Ryan


Background and instructions

Pursuant to section 14 of the Public Audit Act 2001 (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 3,545 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 2018.

I am a former partner and chairman of law firm DLA Piper New Zealand. 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 discussed matters with 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 24 new entities. That number includes 7 schools or school related entities. Apart from schools, these new entities are mainly subsidiary entities created or acquired by existing entities (13), but 4 were completely new. All of these appointments were made following the principles set out in the ‘Allocation Mode’' 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 review of the files relating to the 4 completely new 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 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 142 public entities and their subsidiaries for a further term. Most were PFA 4th Schedule Administering Bodies and Cemetery Trusts. 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

There were 75 new appointments made for existing entities, 14 of which were late changes for school audits for the 2016 year due to non-completion by the previous auditor. 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.

Appointment of school auditors

The appointment of auditors of all schools and school related entities arises on a 3 year cycle and this has commenced this year so that the audits for the year ending 31 December 2018 may be completed with the appointments to be for the 2018-2020 years.

This is a very major exercise with 2466 schools and related entities involved.

I reviewed the process that is currently underway.

As part of that process every school is advised and has the opportunity for some input. About 30 schools have requested a change for the 2018-2020 period. While all such requests are considered, I understand that it is unlikely that all will be agreed to. All existing audit service providers are also consulted. At the time of my review, eight audit service providers have withdrawn themselves from consideration in respect of some or all of the schools they currently audit, due to retirement or business reasons. Different auditors will need to be appointed for those schools.

The process for the vast majority appears to be going well, and in respect of these, re-appointments or new appointments will be completed in accordance with the Allocation Model.

It is likely that a tender process will be used for the others.

While no appointments have yet been made I was satisfied that the process currently underway appeared reasonable and appropriate.

Audit Allocation Model

As can be seen from the appointments above, the vast majority have been made using the Allocation Model. 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 consider the Allocation Model 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 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. This is a view shared by all of the private sector audit service providers that I consulted. I understand that the contestable process will continue to be used in individual cases when appropriate, but I doubt this will happen very often and I consider the current mix about right.

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.

While the Allocation Model has operated well since last reviewed in 2010, I consider that it would be good practice for it to be revisited within the next few years although I have no particular expectation that material change will be necessary.

Audit fees

Section 42 of the Audit Act 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. Considerable detail including a clear breakdown of appropriate team mix and rates is expected. In respect of the school round of appointments, the OAG has provided to all audit service providers involved a detailed brief of its expectations around fee levels and any movements from previous years. Once the OAG has approved each auditor's compliance with that guidance, it is then for the auditor and entity to agree the fees. 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 reach agreement without further intervention from the OAG, and that is almost always the case.

In the year under review there are currently no outstanding disputes over audit fees.

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 by OAG senior management of overall movement in audit fees is conducted.

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 consistency, care and patience in helping to resolve these issues.

While the process for the appointment and fixing of fees for schools has just commenced, I have observed some tension over school audit fees for a small number and in a few regions. Some audit service providers consider the cumulative effect of several years of audit fee increase constraint, particularly where the base rate has been historically low, could result in some withdrawal from the market if fees do not increase. I recommend that extra care is taken in this round where historically low rates remain, to ensure the fees are reasonable for all parties and that there is not a loss of provider depth or quality.

Overall, 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

Except as mentioned, 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 very limited numbers of subsequent dissatisfaction, but in this year less than previously. This is most commonly raised by the entity. 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. It is not uncommon for these to arise where extra work had been incurred because of poor quality financial information provided by the entity or a lack of full understanding of the information required by the auditor.

The number involved remains very small. I have reviewed several of the disputed cases. In all cases the Auditor-General has taken a consistent, constructive and objective position and has sought to assist the parties resolve the issue. As mentioned earlier, I am unaware of any currently outstanding disputes.

Other issues

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


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 regarding both appointments and fee setting and monitoring. 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 interest 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 reasonably.

Yours sincerely

John R Strahl.