Appendix 2: Report of the independent reviewer

Annual report 2019/20.

21 July 2020.

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

John R Strahl
PO Box 33141
Wellington Mail Centre
Lower Hutt

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 of the Audit Act 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 3,900 public entities in New Zealand, of which 3,400 must be separately audited, it is impractical for Audit New Zealand itself to carry out all these audits. You thus contract auditors from the private sector to carry out many of these on your behalf. Audit New Zealand still remains by far the largest single provider, carrying out close to half of all public sectors audits (measured by audit hours).

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 person 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 the fifth year that I have carried out this review.

This is my report on that review for the year ending 30 June 2020.

I am a former partner and chairman of law firm DLA Piper New Zealand, and currently am a director of various entities, one of which is a public entity audited by Audit New Zealand, and one of which is private and is audited by one of your private sector audit providers. I excused myself from the consideration of the appointment and fee setting for the entity audited by Audit New Zealand. I consider that I am independent of the Office of the Auditor-General, Audit New Zealand and all private sector audit firms.

My instructions are;

' 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 considered  appropriate  to  the review and to discuss matters arising with staff of your office. 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 the allocation of audits and the processes of fixing fees and your Office's involvement in resolving disputes, with one major private sector audit provider used by your Off ice and with Audit New Zealand.

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 15 new public entities.

All of these appointments were made following the principles set out in the 'Allocation Model' on which I will comment later. I reviewed the reasons given for each appointment which appeared reasonable and I did not observe any dissatisfaction by any of those entities to the appointment made, the terms of appointment, or the proposed audit fee.

Re-appointments (other than for schools).

Existing auditors were re-appointed during the last financial year to audit 386 public entities and their subsidiaries for a further term. In addition to this number, 22 existing auditors were re-appointed for Polytechnics and their subsidiaries but only for a term of one year as Polytechnics are to be disestablished. There were also auditors appointed for a special audit of the disestablishment of the 16 Polytechnics. In each case the auditor of the Polytechnic was appointed. 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 no new appointments made for existing entities other than schools and school related entities.

Appointment of school auditors.

The major exercise for the appointment of auditors to the school sector was completed last year. Two residual outstanding issues were finalised with the re-appointment of existing auditors. Out of normal cycle Audit Service Provider changes were made for 61 schools, most due to the resignation of an existing auditor, and 4 to resolve other issues. All these appointments were made in accordance with the Allocation Model and no dissatisfaction to any of these appointments has been observed.

Audit Allocation Model.

In the last year all appointments of auditors to both new and current entities, and including all re­ appointments, have been made using the Allocation Model rather than the use of a contestable tender process. The Allocation Model has been the principal method used for auditor appointments since it was first adopted in 2003 and later revised in 2010. It is a well established set of principles and they are summarised in a public document entitled; "Appointing public sector auditors and setting audit fees." The principles summarised in that document are;

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 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 strongly shared by all of the private sector audit service providers that I have consulted. Audit New Zealand also supports the use of the Allocation Model. They all consider that the use of the Allocation Model also strengthens the ability to ensure independence of appointments and independence of approach during the completion of the audit. I understand that the contestable process will continue to be used in individual cases when appropriate.

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

I consider that the Allocation Model has operated well since last reviewed in 2010. I have been informed that the Office is now commencing a review of the Model and of the principles contained in it. I welcome that review as good practice and because of the importance of the reliance on the Model. This does not however indicate that I expect that there will be major change, as change should only occur for improvement and not be change just for the sake of change.

I would suggest as part of that review, consideration be given to making more transparent, the principles adopted and reasons for them.

Audit fees.

Section 42 of the Public Audit Act 2001 authorises the Auditor-General to set the fee for all audits of public entities, which must be reasonable. The factors to be taken into account when determining whether the fee is reasonable are set out in that section. In the event of a dispute, either party may refer any fee set to arbitration.

This year your Office provided updated advance guidance to all auditors for upcoming appointments of your approach to and factors that would be acceptable and unacceptable reasons for any movement in the then current level of fees. This clearly set out those reasons where a change may be suggested and those reasons which would be considered unacceptable. In every case the guidance stresses that regardless of the reasons for any proposed fee movement, the Audit Proposal to the entity must properly explain them including why the case is suggested.

I consider it good practice to provide in advance this guidance to auditors before the fee proposal is submitted. I would encourage this approach continue at the commencement of each year.

At an individual entity level, at the commencement of every audit appointment, the fee proposed by the auditor, which is expected to be based on the guidelines previously provided, including a clear explanation of any material change 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. Once the OAG has approved the draft, it is then provided to the entity by the auditor, who then has authority to seek to agree the fee with the entity. 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 and that is almost always the case.

In the year under review there are currently no active outstanding disputes over audit fees although, and as normal, there are isolated instances of some general discontent by some entities over the level of audit fees, and fresh issues may well arise following the completion of current audits. This is to be expected particularly where over the last 3 years I have observed a general increase of audit fees across the public sector in the order of about 9%.

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.

Most issues which arise over fees are during or after 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, some in respect of additional work not covered in the original scope of works being necessary, and sometimes the quality of and speed in which information is provided by the entity and rework by the auditor as a result leads to tension. In all cases reviewed, the OAG has shown consistency and care in helping to resolve these issues.

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 regarding re-appointments.

When it is time to consider the re-appointments of auditors, it is the practice of your office to inform each entity and to seek their views. In the last year a limited number of entities, and for various reasons, expressed a desire for a change. 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 a bit of each. It is not uncommon for these to arise where extra work had been incurred because of poor quality financial information provided by the entity, delays in providing the necessary information, or a lack of full understanding of the information requirements of 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 but for some entities the renewal has been limited to a period of one year rather than the usual 3 year term to enable a further reconsideration in a year's time. I consider this a reasonable approach.

Other issues.

While not an issue over appointment, a question of the possible independence of an auditor and an entity which it was auditing arose during the year. Independence is an essential requirement for the appointment of an auditor and it is obviously an ongoing requirement. I therefore reviewed the question that arose, the process undertaken to consider the issue and the steps taken to mitigate any possible breach of the independence requirement.

I am satisfied that this issue was thoroughly and appropriately considered, that the mitigation steps taken to ensure continued independence were appropriate and that the overall conclusions reached on the issue were sound.

The advent of Covid-19 is highly likely to have an impact on the time required to complete the current round of audits. Delays due to lack of access over the lock down period and fresh issues arising for some entities over asset valuations and going concerns matters will require more audit time for many entities than has currently been provided for. The increased time in some cases is likely to be material and in excess of the additional time that could be considered reasonable to be absorbed by the auditor. As a consequence it is likely that requests will be made for increases in audit fees for the current year. I have observed your internal considerations of how these are to be considered which largely follows your established protocols for considering requests for fees increases when proposals have already been agreed. Individual consideration and approval for any increase will be required. While early in the process, I have concluded that your proposed approach is reasonable.

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 meet 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 signature

John R Strahl.