Part 2: Our audit of the Government's financial statements

2.1
Our audit report on the Government's financial statements provides independent assurance that the financial statements present fairly the Government's financial performance and position. Confidence in the reliability of this information allows Parliament, the public, and the international community to confidently scrutinise the Government's financial performance and position.

2.2
The audit report included an unmodified opinion and a description of the key audit matters arising during the audit.

2.3
Each year we review whether the previous year's key audit matters remain relevant and consider any new matters that should be included in the audit report.

2.4
The key audit matters highlighted in our audit report for the year ended 30 June 2021 were:

• calculating the value of other persons' and corporate tax revenue;
• valuing property, plant, and equipment:
  • state highways;
  • electricity generation assets;
• valuing financial assets where market data is not available:
  • student loans;
• valuing insurance liabilities, superannuation liabilities and veterans' disability entitlements liabilities:
  • Accident Compensation Corporation's (ACC) outstanding claims liability;
  • Government Superannuation Fund's unfunded liability;
  • Veterans' Disability Entitlements liability; and
• entitlements under the Holidays Act 2003.

2.5
Overall, we were satisfied that the balances and disclosures in the Government's financial statements about these matters were reasonable and appropriate.

Recognising other persons' and corporate tax revenue

2.6
The Government recognised other persons' tax revenue of $8.8 billion and corporate tax revenue of $15.8 billion for the year ended 30 June 2021.

2.7
Other persons' and corporate tax revenue for the year needs to be estimated because the final income tax owed for a year is known only when a tax return is filed. Filing could happen more than a year after the end of the tax year.

2.8
The estimation process relies on macro-economic forecasts about how the economy will perform. It also relies on assumptions about how these macro-economic forecasts relate to taxable profits.

2.9
As a result of Covid-19, there is increased uncertainty about how the New Zealand economy will perform. Therefore, judgements were made about the performance of the economy and they were used to estimate tax revenue for the year ended 30 June 2021.

2.10
We reviewed the systems, processes, and controls for receiving and reviewing provisional and final tax returns, tax assessments, and tax revenue. This included understanding Inland Revenue's information technology system for managing tax. We also:

• assessed the controls for significant reconciliation processes;
• tested the underlying data used in the tax revenue estimation models;
• reviewed the main assumptions and judgements used to estimate tax revenue from other persons and corporates; and
• assessed the reasonableness of the most important variables in the models, given the economic impact of Covid-19.

2.11
We used independent economic experts to assess the main assumptions about the future (such as economic growth) and tested how sensitive the estimates were to changes in the main assumptions. The independent experts also considered alternative macro-economic indicators that could reliably estimate tax revenue from other persons and corporates. We were satisfied that the macro-economic indicator used was reasonable.

2.12
We also:

• performed a retrospective review of the 2020 tax estimation compared to actual information received from taxpayers to assess the robustness of the methodology used for the estimation of tax revenue. (Information is available up to the March 2020 tax year only and that means limited information for the period affected by Covid-19);
• reviewed the accounting adjustments to tax revenue processed by Inland Revenue;
• reviewed the year-end procedures and testing performed by Inland Revenue for significant taxpayers, and any adjustments arising from this review by Inland Revenue; and
• reviewed the relevant disclosures.

2.13
As a result of the audit work, we were satisfied that other persons' and corporate tax revenue for the year ended 30 June 2021 are reasonable and that the disclosures are appropriate.

Valuing property, plant, and equipment

2.14
The Government owned physical assets of $213.2 billion at 30 June 2021. Considerable judgement is needed to determine the value of some of these assets because there are inherent uncertainties in valuing them.

2.15
Valuers have considered the economic effects of Covid-19 on significant estimates and judgements. These include economic indicators for interest rates and inflation, cash flow forecasts, any changes in levels of service, and replacement costs.

2.16
Assets that needed significant judgement to determine their value at 30 June 2021 included state highways and electricity generation assets. We discuss each in more detail below.

State highways

2.17
The state highways (excluding land) were valued at $42.7 billion at 30 June 2021 by an independent valuer. The value of the state highways cannot be measured precisely. Significant estimates and assumptions are made, including assumptions about quantities and rates used to construct the state highways, the remaining useful life of the assets, and the unit costs to apply. Changes to the underlying estimates and assumptions can cause a material movement in the valuation of the state highway network.

2.18
Work done over the last four years has improved the quality of the data used in the valuations, but uncertainties remain.

2.19
We examined how the state highways are valued, the significant estimates and assumptions used, and their reasonableness. We confirmed the competence, capabilities, and objectivity of the valuer, considered the valuer's main assumptions, and assessed the valuation procedures.

2.20
We considered whether there were any limitations placed on the valuer and whether centrally calculated assumptions applied to the valuation were appropriate.

2.21
We confirmed that key controls were operating over the systems and processes used to record costs and other asset information about the state highways.

2.22
We also considered how the valuer took the economic effects of Covid-19 into account and the effect of any estimation uncertainties on the final valuation. There was no significant impact at 30 June 2021.

2.23
As a result of the audit work, we were satisfied that the value of the state highways at 30 June 2021 is reasonable and that the disclosures are appropriate.

Electricity generation assets

2.24
The electricity generation assets were valued at $18.0 billion at 30 June 2021. Valuing electricity generation assets is complicated and relies on significant assumptions about the future prices of electricity, generation costs, and how much electricity will be generated. Each of these assumptions affects the others.

2.25
These assumptions are sensitive to small changes that can have a significant effect on the value of the electricity generation assets.

2.26
We examined how electricity generation assets are valued. We confirmed the competence, capabilities, and objectivity of the valuers, tested their procedures for carrying out the valuations (including the information they used), and considered their main assumptions and judgements.

2.27
We tested the sensitivity of the main assumptions to confirm that they were reasonable. We compared the forecast prices of electricity to the expected longer-term wholesale prices and market data, where it was available.

2.28
We considered how the valuers took the economic effects of Covid-19 into account in the valuations and the effect of any estimation uncertainties on the value of electricity generation assets. There was no significant impact in 2020/21.

2.29
We also considered whether the valuers considered the future of the aluminium smelter at Tiwai Point to estimate the value of electricity generation assets.

2.30
As a result of the audit work, we were satisfied that the value of electricity generation assets at 30 June 2021 is reasonable and that the disclosures are appropriate.

Valuing financial assets where market data is not available

2.31
The Government had financial assets that were valued, where market data is not available, at $20.5 billion at 30 June 2021. These financial assets include loans, including student loans (which we discuss separately in paragraphs 2.35-2.40), investments, deposits, private equity investments, and small business cashflow loans.

2.32
When there is no quoted market price for a financial asset, the value of the asset is estimated using an appropriate technique, such as a valuation model. These models are usually complex, using inputs from market data when available. Otherwise, inputs are derived from non-market data, which requires greater judgement.

2.33
Based on a sample, we reviewed the valuation techniques, controls, and inputs used to determine the value of financial assets where market data is not available. We tested the internal controls over data entered into financial systems for these assets and assessed the controls and valuation approaches applied where a fund manager carried out the valuation. We compared the fair value of financial assets to independent information, investigated any significant variances, and assessed the appropriateness of the inputs used in the valuation where market data is not available.

2.34
As a result of the audit work, we were satisfied that the value of financial assets where market data is not available at 30 June 2021 is reasonable and that the disclosures are appropriate.

Student loans

2.35
At 30 June 2021, student loans were valued at $10.8 billion. Student loans are measured using actuarial and predictive models, which reflect current student loan policy and macro-economic assumptions. The value is sensitive to changes in several assumptions, including future income levels, repayment behaviour, inflation, and discount rates.

2.36
There is added uncertainty now about how Covid-19 might affect student loan repayments.

2.37
We tested a sample of student loan applications during the year to ensure that they were correctly paid out. We tested the internal controls over student loans entered into financial systems and actuarial models used by the valuer, checked that the underlying information used in the valuation was correctly extracted from the system, and assessed the controls and valuation approaches applied by the valuer.

2.38
We performed a retrospective review of the actual repayments of student loans in previous years against prior year cash flow forecasts, to consider whether there was any estimation bias.

2.39
We used an independent expert to review the main assumptions in the student loans model. That review included a review of the cash flow forecasts, the use of the risk-free discount rate and the risk premium used to determine the fair value of loans, and adjustments for employment and overseas non-compliance due to Covid-19.

2.40
As a result of the audit work, we were satisfied that the value of student loans at 30 June 2021 is reasonable and that the disclosures are appropriate.

Valuing insurance liabilities, superannuation liabilities, and veterans' disability entitlements liabilities

2.41
The Government has significant insurance liabilities from Accident Compensation Corporation (ACC) claims, public servants' superannuation liabilities, and veterans' disability entitlements liabilities at 30 June 2021.

2.42
Estimating the values of these liabilities is complicated and there are inherent uncertainties in the valuations. Actuaries estimate the amounts based on assumptions about the future (including the economic effects of Covid-19).

2.43
The calculations use risk-free discount rates information and CPI assumptions, which the Treasury publishes.

2.44
We had an independent expert consider the appropriateness of the risk-free discount rates and CPI assumptions that are published by the Treasury. This review included assessing the appropriateness of the methodology, including the reasonableness of the Treasury's conclusions about the ongoing reviews of selected aspects of the methodology.

2.45
We tested the application of the methodology in determining the risk-free discount rates and CPI assumptions.

2.46
As a result of the audit work, we were satisfied that the risk-free discount rates and CPI assumptions are appropriate for use in valuing these liabilities at 30 June 2021.

ACC's outstanding claims liability

2.47
ACC's outstanding claims liability has been valued at $55.4 billion at 30 June 2021.

2.48
The assumptions used to determine the value of ACC's outstanding claims liability include assumptions about discount rates, risk margin, the effects of inflation and innovation on future medical costs, and how long it will take people to recover from injuries.

2.49
We examined how ACC's outstanding claims liability is valued by assessing the reasonableness of the approach. We also reviewed ACC's main assumptions about each significant type of claim to see whether these were appropriate. The impact of Covid-19 on these assumptions and estimation uncertainties was considered minimal.

2.50
We tested the systems and controls and, in particular, tested the process for recording claims in detail. We tested the main assumptions by considering past claims. We assessed the reasonableness of forecasts that differed from past experience by looking at the evidence supporting the forecasts.

2.51
We used an independent actuary to review the scope, approach, and reasonableness of the estimated liability.

2.52
We tested the reconciliations of the underlying claims data with ACC's systems, examined the sensitivity analysis for movements in the main assumptions, and reviewed the related financial statement disclosures.

2.53
As a result of the audit work, we were satisfied that ACC's outstanding claims liability at 30 June 2021 is reasonable and that the disclosures are appropriate.

Government Superannuation Fund's unfunded liability

2.54
The Government's unfunded liability for public servants' superannuation entitlements for members of the Government Superannuation Fund (the Fund) was valued at $11.0 billion at 30 June 2021 by an independent actuary.

2.55
The value of the unfunded liability is sensitive to the value of the Fund's assets, expected rates of salary increases for members of the Fund, and estimated inflation and discount rates. The Fund's assets, which are mainly shares and bonds, are traded in markets. Changes in the prices of these shares and bonds affect the amount of the unfunded liability.

2.56
We examined how the unfunded liability for public servants' superannuation entitlements is valued.

2.57
We engaged our own actuary to review the main assumptions, judgements, and procedures used to value the unfunded liability.

2.58
We tested the main controls that ensure that membership data used in the actuary's valuation is reliable. We assessed the appropriateness of the main assumptions used to estimate the value of the unfunded liability, including the expected rates of salary increases, against external benchmarks.

2.59
We tested the design and implementation of key controls over investments. We obtained an understanding of the valuation techniques and inputs used by the respective fund managers to value the investments. The value of the funds was reconciled to the latest valuation reports. Any movements between the last valuation date and the year-end data were checked against supporting documentation. We also considered the estimated return on assets owned by the Fund.

2.60
As a result of the audit work, we were satisfied that the unfunded liability for public servants' superannuation entitlements at 30 June 2021 is reasonable and that the disclosures are appropriate.

Veterans' disability entitlements liability

2.61
The Government recognised a veterans' disability entitlements liability of $3.0 billion at 30 June 2021.

2.62
Working out the value of the veterans' disability entitlements liability is subject to uncertainty, because of possible deficiencies in the underlying data used to make the estimate, the extent to which veterans will take up their full entitlement, the discount rate, the inflation rate, and changes in mortality rates.

2.63
We examined how the veterans' disability entitlements liability is valued. We reviewed the method used to calculate the liability and confirmed the competence, capabilities, and objectivity of the actuary. We also tested the valuation procedures.

2.64
We used an independent actuary to review the main assumptions, judgements, and procedures used to value the liability.

2.65
We tested key controls over the reliability of veterans' data used in the actuary's valuation.

2.66
As a result of the audit work, we were satisfied that the veterans' disability entitlements liability at 30 June 2021 is reasonable and that the disclosures are appropriate.

Entitlements under the Holidays Act 2003

2.67
The provision for employee entitlements in the Government's financial statements includes a provision relating to historical non-compliance with the Holidays Act 2003. Some public organisations need to do more work to finalise the amounts owed to each individual, resulting in uncertainty in the value of the provision. A number of organisations have started or completed a review of current and historical payroll calculations to ensure that they have complied with the legislation. Where possible, provision has been made in the Government's financial statements for obligations arising from these reviews, where settlement has not been made.

2.68
For certain organisations, particularly district health boards and schools, complexities mean it is taking longer to calculate the amounts owed to each individual. District health boards and schools employ many people and the amounts needed to settle these obligations remain uncertain. For the organisations most significantly affected, we considered the progress made in resolving the historical payroll calculation issues.

2.69
For those organisations that had a provision, we assessed the approach used to calculate the provision. We also reviewed the processes followed for calculating a provision and tested a sample of transactions. We considered the completeness of the data used for calculating a provision. We assessed the competence, capabilities, and objectivity of independent experts who were involved in the calculations and considered the reasonableness of the main assumptions and judgements made in calculating the provision, including consideration of the impact of Covid-19 on the valuation.

2.70
For those organisations that did not have a provision, we made sure that they could not reasonably quantify an amount. We also reviewed the disclosures made.

2.71
As a result of the audit work, we were satisfied that the provision for entitlements under the Holidays Act 2003 at 30 June 2021 is reasonable, and that where a liability cannot be reliably measured, the contingent liability disclosures are appropriate.

Other audit matters

Electricity network assets

2.72
The electricity network assets comprising the national grid are currently recorded at cost, which differs from the valuation approach for all other classes of assets. As with the rail network assets, we have accepted a different valuation approach at an entity and Government financial statements level. Rail infrastructure assets are valued on a for-profit basis for the purposes of KiwiRail's statutory financial statements and on an optimised depreciated replacement cost basis for inclusion in the Government's financial statements. In our view, a similar approach should be taken for this class of assets. It is the only major class of assets in the Government's financial statements not valued at fair value.

2.73
During the audit we looked for, and did not identify, any significant changes to the valuation approach.

2.74
We will continue to talk with the Treasury about this matter.

Emissions Trading Scheme liability

2.75
The valuation of the Emissions Trading Scheme liability presents a risk due to its level of public interest, its accounting impact, the degree of judgement involved, and the inherent uncertainty due to the many governance and co-operation agreements between agencies.

2.76
We have reviewed the governance and co-operation arrangements between the agencies with administrative responsibilities for parts of the Emissions Trading Scheme.

2.77
We obtained an understanding of the Emissions Trading Scheme systems and processes, and tested controls over the Emissions Trading Scheme systems at both the Ministry for Primary Industries and Environmental Protection Authority.

2.78
We performed substantive audit procedures to gain assurance over Emissions Trading Scheme transactions and balances.

2.79
We reviewed the appropriateness of the methodology, data, and assumptions used by the Ministry for Primary Industries to make material estimates for inclusion in the Government's financial statements.

2.80
As a result of the audit work, we were satisfied that the Emissions Trading Scheme liability is fairly stated in the Government's financial statements.

Outcomes from reviews currently under way

2.81
The findings of the Health and Disability System Review were released in March 2020. The recommendations of the review included creating two new agencies and reducing the number of district health boards from 20 to between eight and 12.

2.82
During 2020/21, the Government announced the disestablishment of all district health boards with effect from 30 June 2022 and the establishment of the two new agencies, Health New Zealand and the Māori Health Authority.

2.83
We have considered the impact of these changes on the Government's financial statements. Although the use of the going concern assumption in the preparation of the district health boards' financial statements will be affected, there is no effect at the level of the Government's financial statements.

Management of appropriations

2.84
The Statement of Unappropriated Expenditure, included in the Government's financial statements, is an important summary of all unappropriated expenditure incurred in the financial year.

2.85
There was a significant improvement noted in the management of appropriations in 2020/21. There were decreases in both the number of instances of unappropriated expenditure and the amount of unappropriated expenditure. This year is the least number of unappropriated expenditure items we have had so far this century.

2.86
Instances of unappropriated expenditure identified by public organisations, rather than by the Treasury or auditors, have increased as well. This points to a greater understanding amongst public organisations about the Controller function.

2.87
During our audit, we assessed the accuracy and completeness of the disclosure of unappropriated expenditure. This included confirming that the final listing of unappropriated expenditure and any expenditure incurred under section 25 of the Public Finance Act 1989 is correctly reported in the Government's financial statements. It also included confirming the completeness and accuracy of all disclosed unappropriated expenditure with the relevant public organisations and confirming with those with no unappropriated expenditure disclosed that no unappropriated expenditure has been identified during the year.

2.88
We identified no areas of concern to report. We acknowledge the progress made in managing appropriations and the collaborative manner in which the Treasury has worked with us on this.

2.89
As a result of the audit work, we were satisfied that the Statement of Unappropriated Expenditure is accurate, complete, and consistent with what will be reported in the individual organisations' annual reports.

Ongoing improvement in note disclosures

2.90
One of the benefits of work completed last year (to better understand the effects of Covid-19 on the Government's financial statements) was improvements made to the note disclosures about key assumptions and judgements. In 2019, disclosures about the state highway valuation were also enhanced. These enhanced disclosures should greatly assist the readers of the Government's financial statements to understand the basis and risks inherent in this valuation process.

2.91
We reviewed the note disclosures in the Government's financial statements to ensure that they conveyed appropriate information to readers in a way that is accessible and adds to the overall understanding of the financial statements.

2.92
We also reviewed the Covid-19 commentary and disclosures to ensure that they were relevant and understandable to the readers of the Government's financial statements and focused on key assumptions and judgements.

2.93
We have previously indicated that we would consider in turn the note disclosures in the Government's financial statements in more depth for all areas of the financial statements to ensure they continue to convey the appropriate information to readers in a way that is accessible and adds to the overall understanding of the financial statements. This year, our focus was on the insurance note disclosures, particularly the ACC claims insurance liability. We were pleased to see a more refined disclosure in this note.

2.94
As a result of the audit work, we were satisfied that the effects of Covid-19 are adequately disclosed in the Government's financial statements. We are also satisfied with the progress that has been made with other disclosures.

Large-scale asset purchase programme

2.95
In response to the economic impact of Covid-19, the Reserve Bank of New Zealand (the Reserve Bank) implemented a large-scale asset purchase (LSAP) programme. This programme involves the repurchase of New Zealand Government Bonds and Local Government Financing Agency Bonds. The Reserve Bank halted additional asset purchases under the LSAP programme on 23 July 2021.

2.96
The Reserve Bank had purchased $52.9 billion (at fair value) of New Zealand Government Bonds (NZGBs) and $1.6 billion of Local Government Funding Agency (LGFA) bonds on the secondary market up to 30 June 2021. The LSAP programme's impact on the Government's financial statements can broadly be summarised as follows:

• A loss of $4.0 billion is reported in the financial statements. The loss represents the difference between the price paid by the Reserve Bank to acquire the NZGBs and the carrying value of the bonds at the date of repurchase.
• The benefit of lower borrowing costs (interest expenses) in the current year and possibly for the future as the fixed interest rate payable on the NZGBs is replaced by the lower floating Official Cash Rate (0.25% at 30 June 2021) payable on bank settlement deposit account borrowings.

2.97
A model was prepared when the LSAP programme was introduced to calculate the difference between the price paid to re-purchase the bonds and the value of the bonds at the date of each transaction. A "first in first out" method was applied, which assumes that the bonds purchased first were the bonds issued earliest.

2.98
On a sample basis, we agreed the bond information in the model to the Treasury and Reserve Bank systems, tested the accuracy of key calculations in the model, and assessed whether the first-in-first-out method was correctly applied.

2.99
As a result of the audit work, we were satisfied that the loss recognised for the year ended 30 June 2021 was reasonably calculated and that the disclosures are appropriate.

Overriding of internal controls

2.100
There is an inherent risk in every organisation of fraud resulting from management override of internal controls. People in management positions are in a unique position to perpetrate fraud because of their ability to manipulate accounting records and prepare fraudulent financial statements by overriding controls that otherwise appear to be operating effectively.

2.101
We examined the controls for collecting financial information from public organisations included in the Government Reporting Entity and the adjustments to that information for consolidation purposes. We also tested the appropriateness of journal entries and other adjustments made in the preparation of the Government's financial statements through review of journals and disclosures.

2.102
We reviewed significant accounting estimates for bias, and engaged specialists to assist with those reviews, where appropriate.

2.103
As a result of the audit work, we were satisfied that the risk of management override of internal controls for the Government's financial statements has been adequately mitigated.