Appendix 2: Report of the independent reviewer

Pauline Courtney
Barrister and Commercial Mediator (AAMINZ)
P O Box 10 318
Wellington 6140

18 July 2024

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

Dear Mr Ryan

ANNUAL REPORT OF THE INDEPENDENT REVIEWER OF AUDIT ALLOCATION PROCESSES 2024

Background and instructions

Under s 14 of the Public Audit Act 2001 (the Audit Act), you are appointed as the auditor of all public entities. Section 42 of the Audit Act authorises you 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 3,340 public entities in New Zealand, of which approximately 3275 must be separately audited, it is impractical for Audit New Zealand itself to carry out all these audits. Therefore, you contract auditors from the private sector to carry out many of these audits on your behalf. In the year under review Audit New Zealand carried out approximately 50% of all public sector audits (measured by audit fees) not including schools.

The Office of the Auditor-General (OAG) sets strategy, policy and standards, and appoints and oversees auditors, both from Audit New Zealand and the 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 second year that I have carried out this review, which covers the year ending 30 June 2024. I am a Barrister and Commercial Mediator with Kate Sheppard Chambers working in the civil/commercial and public law areas. I hold an LLB(Hons) and BCA from Victoria University of Wellington. I am independent of the Office of the Auditor-General, Audit New Zealand and all private sector audit service providers (ASP).

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;
  • fix and monitor the reasonableness of audit fees; and
  • anything else that impacts on those activities.

No limitation has been placed on the manner in which I may carry out my work. I have been free to inspect any documents or files that I consider appropriate to the review; and to discuss any 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 I 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 two client organisations, one a major government department, the other a major council that as well as its annual financial report audit underwent an audit of its Long-Term Plan. While a small sample, some similar responses led me to consider as part of this review the third of the bulletpoints above. As a result, I had some useful discussions with senior representatives of your office about what is being done, and areas where further benefit might be achieved.

The review undertaken for this report was not an audit of every decision made of which there are many. My review is based on a consideration of various material issues that arose during the year based on information provided by your Office; and related inquiries I considered it appropriate to pursue.

Types of Audit Appointments

In accordance with the policies and practices adopted by your Office, there are four main types of audit appointments:

  • an appointment made of an auditor to an entity, usually for a term of 3 years under the Audit Allocation Model (Allocation Model);
  • an appointment of an auditor for an entity, following a contestable process, if you consider that is appropriate in the given circumstances;
  • a re-appointment of an auditor for a further term, usually 3 years, to audit that same entity;
  • where an audit involves 150 or more budgeted hours, the individual auditor and senior personnel may not usually undertake the audit work for more than 6 years, thus a new auditor must be appointed, although that may be another person in the same firm.1

Appointments for new entities

In the financial year 2023-2024, the Auditor-General appointed auditors for eight new public entities including four schools and four non schools. I had received confirmation that the appointments were made using the principles set out in the "Allocation Model"; the reasons given for the appointments 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

Existing auditors were re-appointed during the past financial year to audit 60 public entities for a further term. For most of the appointments covered by this paragraph I observed no dissatisfaction from the entities. In the very small number of cases where the appointment of different auditors was sought, including where concern about audit fees was expressed, I reviewed the considerations taken into account having regard to the published principles used to appoint auditors and to set audit fees, and the process adopted. The reasons given for the decisions appeared reasonable.

New appointments for existing entities in the non-school sector

In the year under review 15 new appointments were made for existing entities in the non-school sector. (However, I note that 13 of those were related; and 12 of the appointments involved an entity and its subsidiaries.) The documentation I reviewed related to the new appointments indicated that the principles of the Allocation Model had been applied, and prudent and relevant considerations of both a technical and relationship nature had been considered, before you made the new appointments.

During the year under review no tender process was undertaken.

Moderating of fees for local authority audits

Because of reporting and auditing challenges in the local authority sector for the period 2023-2025, the decision was taken to moderate fees in three tranches: 1) city councils; 2) regional councils; and 3) district councils. In the year under review moderation of the third tranche occurred. The documentation I reviewed indicated that a robust process had been undertaken. The approach sought to align proposed fees among similar types of local authorities. Careful analysis of past and current considerations was evident; including to ensure that the approach adopted should not undermine the reasonableness of other audit fees.

Audit Allocation Model

In the past 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 always to 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 understand there continues to be consideration given to the practical application of those principles. I would encourage that work be completed soon; and that the public document currently available, be updated.

I continue to support the use of the Allocation Model as an appropriate basis for allocation decisions for most appointments. Before 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. I understand that the contestable process will continue to be used in individual cases where appropriate. I consider that when the work on the principles and practical application is completed, it is important that an accurate summary is published, to ensure transparency and consistency of decision-making.

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 that past year, a careful and consistent process has been followed.

Audit fees

Section 42 of the Audit Act authorises the Auditor-General to set the fees 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. If the Auditor-General and the public entity fail to agree as to the reasonableness of a fee, the matter must be submitted to arbitration. As has been the case in previous years, 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 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 and include why any change 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 continuing 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 the 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 database 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 involvement of the OAG.

In the year under review there are currently no active outstanding disputes over audit fees but there remain some limited cases where additional fees have been sought, which are still under discussion. In no case over the past 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 that arise over fees are during or after the end of an audit. Some arise from the constrained financial position of particular small entities. Some arise from misunderstandings about what is required, some about 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 the year under review a number of requests were received from auditors for an additional fee for additional work requirements. You have given permission for auditors to discuss increases directly with the entities within certain limits without the need to obtain your consent first. I consider this additional flexibility to be reasonable.

Overall, I am satisfied that the approach of the Auditor-General has been consistent and reasonable in the process of setting and resolving issues over audit fees, including additional recoveries.

Other Issues

In my view, no other material issues arose in the previous year that warrant comment in this report.

Conclusion

I have been provided with 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; including related to the relevant internal processes of the OAG regarding both appointments, fee setting and monitoring. On the basis of that review and the explanations provided, nothing has come to my attention that would impact on my conclusion that:

  • the process and methods used to allocate audits have been conducted fairly, reasonably, and with suitable probity and objectivity;
  • the approach and process used to fix and monitor the reasonableness of audit fees has been reasonable having regard to the interests of all parties; and has been conducted with suitable probity and objectivity;
  • the subsequent issues that have arisen for both appointments and fees have been dealt with objectively, fairly and reasonably.

Yours sincerely

Pauline Courtney
Barrister

1: In exceptional circumstances the Auditor-General can agree to more than 6 years.