Part 3: Our audit of the Government's financial statements

3.1
In this Part, we summarise our audit report on the Government's financial statements.

3.2
Our audit report on the Government's financial statements each year provides independent assurance that the financial statements present fairly the Government's financial performance and position. Our work allows Parliament, the public, and the international community to be confident in the appropriateness and reliability of the financial information presented.

3.3
For 2022/23, our audit report included an unmodified opinion and a description of the key audit matters arising during the audit. 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.

3.4
The key audit matters included in our audit report on the Government's financial statements for the year ended 30 June 2023 were:

• calculating the value of other persons and companies tax revenue;
• valuing property, plant, and equipment:
  • land;
  • state highways; and
  • electricity generation assets;
• valuing financial assets where market data is not available:
  • student loans;
• valuing the Accident Compensation Corporation's outstanding claims liability; and
• entitlements under the Holidays Act 2003.

3.5
We discuss each of these matters below.

Calculating the value of tax revenue from other persons and companies

3.6
The Government recognised tax revenue of $9.9 billion from other persons and tax revenue of $18.3 billion from companies.

3.7
Tax revenue for the year from other persons and companies was 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 tax year.

3.8
The estimate is based on forecasting other persons and companies' taxable profits, which relies on assumptions and projecting how the economy will perform in the future.

3.9
Estimating tax revenue is inherently uncertain and judgement is used to estimate:

• the performance of the New Zealand and global economy and how it relates to tax revenue;
• the amount of tax to be collected from provisional taxpayers who have not yet filed their final tax return; and
• the amount of tax revenue where payments have been received but no provisional or final tax return has been filed.

3.10
We considered tax revenue from other persons and companies to be a key audit matter because the calculation is complex and subject to a high degree of judgement and estimation.

3.11
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 used to manage tax.

3.12
We tested the underlying data used in the forecast tax revenue estimation models to confirm that it was relevant and used appropriately. We reviewed the main judgements and assumptions applied in the models and considered the sensitivity of the models to changes in assumptions.

3.13
We used independent economic experts to assess the main assumptions about the future, such as economic growth, which could cause a material adjustment to tax revenue from other persons and companies.

3.14
We were satisfied with the continuing appropriateness of net operating surplus as a macro-economic indicator used to estimate tax revenue from other persons and companies.

3.15
We reviewed any changes in tax policy in terms of the likely impact on tax revenue recognition.

3.16
We also:

• carried out a review of Inland Revenue's retrospective review of the 2022 tax estimation to tax return information received from taxpayers to assess the robustness of the methodology used to estimate tax revenue;
• reviewed the accounting adjustments to tax revenue processed by Inland Revenue;
• reviewed the year-end procedures and testing carried out by Inland Revenue for significant taxpayers, and any adjustments arising from this review by Inland Revenue; and
• reviewed the relevant disclosures.

3.17
As a result of the audit work, we were satisfied that tax revenue from other persons and companies for the year ended 30 June 2023 was reasonable and that the disclosures were appropriate.

Valuing property, plant, and equipment

3.18
The Government owns property, plant, and equipment with a carrying value of $267.4 billion at 30 June 2023.

3.19
Revaluations are carried out regularly or when there is a material difference between fair value and carrying value. Considerable judgement is needed in determining the valuation approaches and assumptions for some of these assets.

3.20
Valuers have considered the impact of prevailing economic conditions on the significant estimates and judgements applied in the valuation process, such as the effect of interest rates and inflation.

3.21
For assets valued using the optimised depreciated replacement cost approach, supply chain disruptions and labour supply constraints have caused increases in construction costs, which affected valuations. Valuers have needed to assess the extent to which these cost changes are short-term or ongoing and need to be taken into account for cost-based valuations.

3.22
We considered the valuation of the classes of property, plant, and equipment outlined below a key audit matter because of the significance of the amounts involved, the level of complexity, and the judgements applied.

Land

3.23
Land was valued at $79.7 billion at 30 June 2023.

3.24
The value of land is based on different valuation approaches. The approach selected will be informed by how that land is used.

3.25
The most significant approaches used include market-based sales evidence, rateable values per square metre of adjacent land, and sales indices.

3.26
There are significant judgements involved in these valuations.

For land that was not subject to a revaluation this financial year

3.27
We assessed the reasonableness of the method used to confirm the valuation was not materially different from the land's fair value and reperformed the calculations.

3.28
Where indices or market data was used, we compared the information to external sources of information.

For land that was subject to a revaluation this financial year

3.29
We assessed the appropriateness of the valuation approach applied by independent valuers or entities.

3.30
We confirmed the competence, capabilities, and objectivity of the independent valuers, considered the valuers' main assumptions, and tested that information provided to the independent valuers was consistent with the information held by entities.

3.31
We discussed with valuers, and considered the appropriateness of, how economic factors and market conditions have affected the valuations.

3.32
Where entities used an index as a basis for recording a valuation movement, we assessed the appropriateness of the index used to other external data sources and compared the retrospective accuracy of indices applied in previous periods.

3.33
As a result of the audit work, we were satisfied that the value of land at 30 June 2023 was reasonable and that the disclosures were appropriate.

State highways

3.34
The state highways (excluding land) were valued at $59.5 billion at 30 June 2023 by an independent valuer.

3.35
The value of the state highways cannot be measured precisely due to the unique nature of the state highway network. Significant estimates and assumptions are made, including assumptions about quantities and unit rates used to construct the state highways and the remaining useful life of the assets. Severe weather events in early 2023 further complicated the valuation of parts of the state highway due to the need to determine the impairment or write-off of assets.

3.36
Changes to the underlying estimates and assumptions can cause a material movement in the valuation of the state highways.

3.37
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. We considered whether there were any limitations placed on the valuer and whether centrally calculated rates applied to the valuation were appropriate.

3.38
We confirmed that key controls were operating over the systems and processes used to record costs and other asset information about the state highways.

3.39
We considered how the valuer took the current economic environment into account, including the judgements applied in assessing whether recent cost increases are temporary or reflect sustainable market conditions that need to be taken into account in assessing replacement cost rates.

3.40
We also assessed the reasonableness of the impairments and write-off of assets.

3.41
As a result of the audit work, we were satisfied that the value of the state highways at 30 June 2023 was reasonable and that the disclosures were appropriate.

Electricity generation assets

3.42
The electricity generation assets were valued at $20.1 billion at 30 June 2023.

3.43
Valuing electricity generation assets is complicated and relies on significant assumptions about the future prices of electricity, generation costs, generation capacity, and demand. Each of these assumptions affects the others.

3.44
These assumptions are sensitive to small changes that can have a significant effect on the value of the electricity generation assets.

3.45
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.

3.46
We considered the reasonableness of valuation approaches and assumptions. We tested the sensitivity of the main assumptions to confirm that they were reasonable.

3.47
We compared the forecast prices of electricity to the expected longer-term wholesale prices and market data, where it was available.

3.48
We considered how the valuers took the current economic environment into account in the valuations and the effect of any estimation uncertainties on the final valuations of electricity generation assets.

3.49
We also considered whether the valuers took into account the future of the New Zealand Aluminium Smelter at Tiwai Point in determining their valuation assumptions.

3.50
As a result of the audit work, we were satisfied that the value of electricity generation assets at 30 June 2023 was reasonable and that the disclosures were appropriate.

Valuing financial assets where market data is not available

3.51
The Government's financial statements included financial assets that were valued using significant non-observable inputs (that is, where market data is not available) of $24.4 billion at 30 June 2023.

3.52
These financial assets include loans (including student loans, discussed below), investments, and deposits.

3.53
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.

3.54
We considered the valuation of financial assets where market data is not available, including student loans, a key audit matter as their calculation is complex and subject to a high degree of judgement and estimation.

3.55
Based on a sample of investments, we reviewed the valuation techniques and tested the controls and inputs used to determine the value of financial assets where market data is not available.

3.56
Taking into account the nature of the selected financial assets, the valuation techniques adopted, and the uncertainties in determining values, we:

• tested the relevant internal controls over data entered into financial systems for these assets;
• assessed valuation approaches applied where a fund manager carries out the valuation;
• compared the fair value of financial assets to independent information and investigated any significant differences; and
• assessed the appropriateness of the inputs used in the valuation where market data is not available.

3.57
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 2023 was reasonable and that the disclosures were appropriate.

Student loans

3.58
The Government held student loans with a value of $9.4 billion at 30 June 2023.

3.59
Student loans are measured using actuarial and predictive models, which reflect current student loan policy and macro-economic assumptions.

3.60
The value is sensitive to changes in several assumptions, including future income levels, repayment behaviour, inflation, and discount rates.

3.61
For student loans, we:

• tested a sample of student loan applications during the year to ensure that loans were correctly paid out;
• 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;
• used an independent expert to review the main assumptions in the student loans model, including a review of the cash flow forecasts, the risk-free discount rate and risk premium used to determine the fair value of loans, and adjustments for employment and overseas non-compliance;
• assessed the controls and valuation approaches applied by the valuer and tested the operational effectiveness of controls over the valuation model; and
• carried out 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.

3.62
As a result of the audit work, we were satisfied that the value of student loans at 30 June 2023 was reasonable and that the disclosures were appropriate.

Valuing the Accident Compensation Corporation's outstanding claims liability

3.63
The outstanding claims liability of the Accident Compensation Corporation (ACC) has been valued at $51.5 billion at 30 June 2023 by an independent actuary.

3.64
Estimating the value of the outstanding claims liability is complicated because it consists of many sub-components that are aggregated to arrive at the overall estimate.

3.65
Assumptions used to determine the value of the outstanding claims liability include:

• the risk-free discount rates and consumer price index assumptions published by the Treasury and used in calculating a present value of expected claims payments;
• the risk margin for the inherent uncertainty in the estimate of the present value of expected claims payments;
• the effects of inflation and innovation on future medical costs; and
• how long it will take people to recover from injuries.

3.66
Assumptions are closely linked and cannot be viewed in isolation. Changes in assumptions can have a large effect on the value of the outstanding claims liability (and the gain or loss that is recognised).

3.67
We considered the valuation of the outstanding claims liability a key audit matter because the calculation is complex and subject to a high degree of judgement and estimation.

3.68
We examined how ACC's outstanding claims liability is valued. We confirmed the competence, capabilities, and objectivity of the actuary who carried out the valuation, and tested their procedures.

3.69
We assessed the reasonableness of the methodology applied. We also reviewed ACC's main assumptions about each significant type of claim to see whether these were appropriate.

3.70
We engaged an independent expert to consider the appropriateness of the risk-free discount rates and consumer price index assumptions published by the Treasury.

3.71
We tested the systems and controls and, in particular, tested the process for recording claims. We tested the reconciliations of the underlying claims data with ACC's systems.

3.72
We tested the main assumptions by considering past claims.

3.73
We assessed the reasonableness of forecasts that differed from past experience by looking at the evidence supporting the forecasts.

3.74
We engaged an actuary to review the scope, approach, and reasonableness of the estimated liability.

3.75
We examined the sensitivity analysis for movements in the main assumptions, and reviewed the related financial statement disclosures.

3.76
As a result of the audit work, we were satisfied that ACC's outstanding claims liability at 30 June 2023 was reasonable and that the disclosures were appropriate.

Entitlements under the Holidays Act 2003

3.77
The provision for employee entitlements includes $2.5 billion for amounts owing to employees who have been paid less than their legal entitlements under the Holidays Act 2003.

3.78
Of the total, $2.1 billion of the provision relates to employees of Te Whatu Ora Health New Zealand and $0.4 billion to some school employees paid through the Ministry of Education.

3.79
These public organisations have not yet finished determining the final amounts they owe to their staff. They have made a sufficiently reliable estimate based on a sample of former and current employees, applying assumptions, and projecting the result over the affected employees.

3.80
Applying the Holidays Act 2003 to complex employment arrangements requires a good understanding of both the legislation and employees' contractual terms. To determine the entitlements also often requires judgement and negotiation and agreement with employee representatives.

3.81
Where an obligation is uncertain or cannot be reasonably measured at 30 June 2023, there is an unquantified contingent liability. This is the case for known cases of non-compliance for some school employees paid through the Ministry of Education because analysis has not yet progressed to the point where a calculated estimate of payments is possible.

3.82
We have reported this as a key audit matter since 2018 because of its nature and effect on many public employees.

3.83
For Te Whatu Ora and the Ministry of Education (on behalf of school employees), we considered the progress made during the year in resolving the holiday pay calculation issues.

3.84
We reviewed the changes in the provision since the previous year and considered the support for any significant movements.

3.85
For the calculations for Te Whatu Ora, we:

• obtained an understanding of the changes made to methodology, assumptions, and sample sizes compared to the previous estimate and the updated employee information; and
• considered the expertise of those engaged to do the calculations.

3.86
For the Ministry of Education (on behalf of school employees), we obtained an update on the Holidays Act compliance programme and reviewed management's assessment of their best estimate in line with PBE IPSAS 19: Provisions, Contingent Liabilities and Contingent Assets and requirements of the Holidays Act 2003.

3.87
We reviewed the disclosures for compliance with relevant financial reporting standards.

3.88
As a result of the audit work, we were satisfied that the provision for entitlements under the Holidays Act 2003 at 30 June 2023 was reasonable and that, where a liability is uncertain or cannot be reliably measured, the contingent liability disclosures were appropriate.

Other audit matters

3.89
The following matters, while not key audit matters, were also considered particularly significant during the audit.

State of emergency – extreme weather events

3.90
During the financial year, the North Island experienced severe weather events that affected public organisations, including some that form part of the Government's financial statements.

3.91
Significant events such as these have the potential to materially affect financial reporting.

3.92
The Government's financial statements includes disclosure of these impacts in note 3, North Island Weather Events (NIWE).

3.93
We planned our work with the appointed auditors of affected public organisations to consider and assess the impact of the NIWE, such as the effect on:

• appropriations, including potential scope issues;
• revenue recognition, such as insurance proceeds;
• liability recognition where there are obligations created; and
• impairment of property, plant, and equipment, including state highways.

3.94
Through the appointed auditors of the affected public organisations, we:

• gained an understanding of the various financial impacts and considered the accuracy and the appropriateness of the accounting treatment;
• considered the Treasury's assessment of the potential effect on the Government's financial statements; and
• considered the appropriateness of disclosure of these matters in the Government's financial statements.

3.95
On 1 June 2023, the Government announced that it would enter into a funding arrangement with councils in cyclone-affected and flood-affected regions to support them. We considered the potential accounting treatment implications of this announcement and the appropriateness of the disclosure included in the Government's financial statements.

3.96
We concluded that the accounting treatment and the disclosure of the NIWE in the Government's financial statements were appropriate.

Health sector reforms

3.97
During 2020/21, the Government announced the disestablishment of all district health boards (DHBs) with effect from 30 June 2022 and the establishment of Health New Zealand (Te Whatu Ora) and the Māori Health Authority (Te Aka Whai Ora). The Te Whatu Ora annual report for the year ended 30 June 2023 was the first time the financial information for most of the health sector was prepared, and audited, within a single public organisation.

3.98
There were inherent additional risks associated with a change of this significance. Te Whatu Ora faced challenges in collating financial and non-financial information from numerous sources and in assessing the accounting treatment of certain items (such as the valuation of all the hospitals or the provision for holiday pay), as well as transactions between other health agencies (such as the transfer of inventory from the Ministry of Health).

3.99
We have:

• considered any potential additional risks associated with this reform change, and any potential effect on the Government's financial statements throughout the audit cycle;
• considered the potential effect on specific account balances, including the valuation of property, plant, and equipment, the holiday pay provision, disclosures, and overall financial reporting; and
• reviewed any disclosures relating to the financial effect on the Government's financial statements.

3.100
Creating the first annual report for Te Whatu Ora was a significant achievement. The Board and management of Te Whatu Ora were able to do this despite concurrent restructure and consolidation of financial and other systems.

3.101
Although there were some understandable delays in receiving the required information, the Treasury, Te Whatu Ora, and auditors were able to complete the work required and there was no effect on the signing of the Government's financial statements.

Education sector amalgamation

3.102
In February 2019, the Government announced that the country's 16 Institutes of Technology and Polytechnics (ITPs) would merge to form Te Pūkenga.

3.103
The head office for Te Pūkenga did not provide sufficient instructions to business units for the collation of financial information at 30 June 2023 and there was a lack of review of information provided to ensure that accounting policies were consistently applied. There was also limited consideration given to inter-business unit or inter-group eliminations for consolidation into the Government's financial statements.

3.104
This resulted in unsubstantiated financial information which, although not material for the Government's financial statements, is significant for the integrity of the broader public financial management system.