Appendix 4: Background information on public sector auditing and the Office's systems and processes

Auditor-General’s mid-term review.

What is covered in a public sector audit?

A public sector audit will consider whether:

  • a public organisation fairly reflects the delivery of its services and the results of its activities in its financial statements and, as required, statement of service performance;
  • a public organisation is complying with aspects of its statutory obligations;
  • a public organisation is carrying out its activities effectively and efficiently;
  • waste is occurring or likely to occur as a result of any act or failure to act by a public organisation;
  • there is any sign or appearance of a lack of probity as a result of any act or omission by a public organisation or by one or more of its members, office holders, or employees; or
  • there is any sign or appearance of a lack of financial prudence as a result of any act or omission by a public organisation or by one or more of its members, office holders, or employees.

The Public Audit Act 2001 (the Act) sets out the last five of these requirements.19 As a result, a public sector audit is broader than a private sector audit, which will usually only consider whether the organisation fairly reflects the results of its activities in its financial statements.

The simple existence of an audit has value because the public sector knows that its work will be independently reviewed and reported on. Knowing that it will be audited can also moderate a public organisation's activities so that it is more consistent with the expectations set out in its legislative and regulatory framework.

Audits come at a cost that management and those charged with governance sometimes see as a compliance cost that should be minimised. This can be because the public organisation is paying for a service that it is a secondary audience for. The primary audience is Parliament and the public.

This is particularly the case in more commercially based public organisations, such as council-controlled trading organisations, port companies, and Crown research institutes. These organisations have a Board that may have expectations about what an audit will or will not cover. Although these Boards may not be the audit's primary audience, they should receive a professional audit service.

Independence

The Act provides a robust and broad mandate to ensure that the Auditor-General is independent of both central and local government. This level of independence is comparatively rare worldwide, but it is essential to the performance of the role.

To be able to discharge their role effectively, the Auditor-General needs to be able to challenge the effectiveness, efficiency, and integrity of public sector processes and those responsible for implementing and governing those processes, including Ministers.

The duty to act independently is part of the affirmation of Office that all Auditors-General must make as part of their appointment process. This is a legislative requirement that the Act sets out.20 Other than the Act's requirements, the Auditor-General cannot be directed to carry out a piece of work.21

The Act is more than 20 years old. Surveys of Australian and New Zealand legislation commissioned by the Australasian Council of Auditors-General have considered the independence of those Auditors-General. New Zealand has consistently been rated with the highest or second-highest score.

The survey considers key factors that contribute to the independence principles of the International Organisation of Supreme Audit Institutions (INTOSAI). The results show that the Act contains the appropriate safeguards for the role of the Auditor-General to remain independent and that the Auditor-General has the appropriate powers to carry out their mandate.

INTOSAI's performance measurement framework recommends that the role of the Auditor-General be written into the state's legal framework at the highest level, ideally within its constitution. Because New Zealand does not have a written constitution, it is theoretically possible that a simple majority vote of Parliament could alter or repeal the Auditor-General's independence and mandate.

As a result, it is essential that politicians and the public understand and respect the independent role that the Auditor-General plays in New Zealand's public accountability system and that the way the Auditor-General and their Office operates is maintained.

To be effective and credible, the Auditor-General and their staff must be independent of the public organisations being audited. To ensure independence, the Act provides that the Auditor-General:

  • is an officer of Parliament and can report directly to Parliament;
  • is appointed by the Governor-General on the recommendation of the House of Representatives for a single term of no more than seven years;
  • is paid under a permanent legislative authority from Parliament, with the amount determined independently by the Remuneration Authority; and
  • makes any requests for funding directly to Parliament through the Officers of Parliament Committee (rather than through the Executive).

Auditors whom the Auditor-General appoints to carry out audits on the Auditor-General's behalf must also be independent. When the Auditor-General appoints an auditor, they are required to sign an engagement form to confirm that they will comply with the requirements of objectivity and independence and carefully manage conflicts of interest. There are also strict limits on the number of years that senior team members can audit the same public organisation.

Auditing firms are sometimes asked to carry out reviews or provide consultancy advice to the public organisations that they audit. The Auditor-General has a standard that covers whether auditors can accept those other engagements. Only engagements of an assurance nature can be carried out as well as the audit.

Audit service providers are required to get approval from the Office of the Auditor-General before they can accept those other engagements. This will be provided only after a rigorous assessment to ensure that independence is preserved.

The work allowed in the Auditor-General's Auditing Standards is more prohibitive than the standards applying to private sector audits. Independence standards applying to private sector audits allow auditors to carry out non-assurance work, including tax planning, that the Auditor-General does not permit. This position has been taken because there have been high profile international failures where conflicts of interest have been at least part of the issue.

In recent years, I have increased my expectation of audit service providers' independence to ensure that commercial interests do not undermine this fundamental tenet of auditing.

All the Office's staff are required to complete an annual employee independence declaration. This outlines their financial interests and relevant personal, employment, and business relationships.

Six months later, every employee must complete a statement of compliance. This confirms that their personal independence disclosures are up to date and that they have complied with specified key independence policies of the Office.

The Office actively uses this information to ensure that staff resourced on audits and inquiries are independent in both fact and appearance.

The Auditor-General does not comment on government or local authority policy decisions, because these are appropriately determined by democratically elected representatives. However, the Auditor-General can report on whether public organisations are carrying out their activities effectively and efficiently in a manner consistent with those policy decisions and, ultimately, whether those activities are achieving their stated aim.

Despite the Office's relatively settled constitutional position, legislation has been proposed in recent years that would extend the power of the Executive in a way that would affect the independent role of the Auditor-General and other Officers of Parliament.

Although we do not consider that these proposals were deliberately planned to have this effect, we need to be constantly vigilant about this.

Quality

New Zealanders benefit from a mature public accountability regime and a strong public financial management system.

New Zealand legislation sets out most reporting requirements for public sector organisations, particularly the content of, and time frames for, reports. Financial reporting standards developed by an independent standard setter, the External Reporting Board (XRB), support this legislation.

Most public organisations in New Zealand understand the importance of transparency and accountability, and of completing annual financial and non-financial reporting to a high standard in a timely way.

They are also largely receptive to the recommendations that auditors make to further improve their reporting and operational effectiveness and efficiency. For example, in 2021/22, large public organisations implemented 676 recommendations to improve systems and processes that auditors had made during the annual audits.

Audits carried out on the Auditor-General's behalf must reflect the unique nature of the organisations in the New Zealand public sector and the standards that should be expected from those who manage public resources.

For this reason, the Auditor-General can determine how audits are done by setting their own auditing standards. These are known as the Auditor-General's Auditing Standards. So that these standards are transparent to Parliament and the public, the Auditor-General is required to publish the auditing standards they apply or intend to apply in a report to the House of Representatives at least once every three years.22

The Auditor-General's Auditing Standards consist of the Professional and Ethical Standards (including standards for quality) and the Auditing Standards of the New Zealand Auditing and Assurance Standards Board. These are supplemented by Auditor-General's Statements. The Auditor-General's specific standards cover situations where there is generally no equivalent standard issued by the XRB.

Each year, staff from the Office of the Auditor-General's quality assurance team review the quality of mandatory audits against the Auditor-General's standards. The quality assurance programme covers all appointed auditors during a three-year cycle and assesses the quality of audits. Figure 1 shows the quality grades for appointed auditors for the last four years.

Figure 1
Audit quality grades for all appointed auditors, 2018/19 to 2021/22

Figure 1 Audit quality grades for all appointed auditors, 2018/19 to 2021/22

All audit service providers, including Audit New Zealand, also have their own quality assurance programmes and are subject to external reviews by professional accounting bodies and regulators. The external reviews of Audit New Zealand are on the invitation of the Auditor-General.

External reviews provide additional scrutiny of the Office's quality control systems and processes, and help benchmark their effectiveness. While we were completing this mid-term review:

  • the Financial Markets Authority was carrying out a review of Audit New Zealand's system of quality control and a sample of issuer audits; and
  • the New Zealand Institute of Chartered Accountants was carrying out a practice review of Audit New Zealand.

Quality assurance reviews are also carried out on other Office products. A quality assurance review of selected inquiries was recently completed. It found that the inquiries were within the Auditor-General's mandate and that there was clear evidence to support the judgements and findings in the reports.

In 2019, a quality assurance review of three performance audits concluded that they were supported by enough appropriate audit evidence. The most recent quality review of a sample of performance audits was carried out in September 2022.

Every two years, the Australian National Audit Office reviews two performance audits and provides feedback and suggestions for improvement. This is a part of a mutual peer review relationship, and staff from the Office also review the Australian National Audit Office's performance audits.

A new standard for quality needs to be adopted by the end of 2022. This is Professional and Ethical Standard 3 – Quality Management for Firms that Perform Audits or Reviews of Financial Statements, or Other Assurance or Related Services Engagements (PES 3).

PES 3 requires the Auditor-General to sign off an annual monitoring report by 15 December 2023 that formally concludes that the objectives of the standard have been met. This will need a step-change in reporting and monitoring of quality by those that have ownership of, and responsibility for, Office products.

The adoption of PES 3 provides an opportunity for the Office to consider and integrate the multiple reviews that help to provide assurance over the quality of the Office's work.

In adopting PES 3, the quality assurance team will also have additional responsibilities for managing the system of quality and monitoring. The audit quality team has not been at full capacity for some time. There are staff vacancies and audit quality staff have been deployed to support other parts of the organisation.

As a result, there have been delays in completing the Office's programme of quality assurance reviews. A governance group from the Office has been monitoring this regularly.

Given the importance of the Office producing high-quality work, monitoring and governance over the quality assurance programme must continue. It is particularly important to gain assurance that delays to quality assurance reviews are not compromising the Office's strong quality assurance systems and the move to new quality assurance standards.

Being held to account

The Crown funds the Auditor-General through Vote Audit for performance audits and inquiries and supporting accountability to Parliament. Annual audits and other assurance work carried out by Audit New Zealand are funded from audit fees paid by public organisations.

As an Officer of Parliament, the Auditor-General does not have a responsible Minister. The Officers of Parliament Committee, which is chaired by the Speaker, is responsible for considering funding requests by the Auditor-General. The Finance and Expenditure Committee reviews Vote Audit.

The Officers of Parliament Committee appoints a private sector auditing firm to carry out an annual audit of the Auditor-General's financial and non-financial performance. Policies ensure that the auditor appointed by the Officers of Parliament Committee is independent of the Office and performs only minimal or no audit work for the Auditor-General as a contracted audit service provider.

The Auditor-General also has an Audit and Risk Committee. Three of its four members are independent of the Office (including the chairperson). This committee reports publicly on its activities in the Office's annual report.

The Office's audit allocation model and fee-setting processes are independently reviewed annually. The findings of this review are also set out in the Office's annual report.

19: See section 16(1) of the Act.

20: See section 9 of the Act.

21: For example, the Auditor-General cannot be directed to complete a performance audit or inquiry by whichever political party holds power.

22: See section 23 of the Act.