Report of the independent reviewer

John R Strahl 
P O Box 33141
Wellington Mail Centre 
Lower Hutt

1st July 2022.

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 2022

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 3,830 public entities in New Zealand, of which approximately 3,320 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 sector 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 seventh year that I have carried out this review.

This is my report on that review for the year ending 30 June 2022. I am a former partner and chairman of law firm DLA Piper New Zealand, and currently am a director of various entities, none of which are public entities. I consider that 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'

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 two major private sector audit service providers used by your Office.

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 all the material issues which arose during the year based on a list made available by your Office. In addition to that I reviewed a random selection of other files and met with and received comments from two private sector audit service providers.

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.

COVID 19 impacts.

The year under review was dominated by the continuing impact of Covid 19 on the ability of all auditors, both in the public and private sector, to complete all audits on time. This was due to a combination of factors including the increased audit issues which arose as a result of Covid 19, the strain on entities themselves with additional work pressures, the absence of staff and the unavailability of off shore resources to assist in audit work. This led to a greater than usual workload over the sector in general coupled with a smaller work force to complete all audits in a timely way. This impacted on the audit resources of Audit New Zealand in a material way. The filling of positions for auditors to the school sector was also strained with many firms not having spare capacity to take on more work. It also led to the requirement to allocate a large number of audits from Audit New Zealand but in circumstances where the audit resources of the private sector ASPs was also limited. Overall I consider that your office has performed with credit to ensure that a credible audit performance was delivered over the public sector with no material objection to your new and changed appointments which were largely accepted by all entities.

Appointments for new entities.

In the last financial year, the Auditor-General appointed auditors for 29 new public entities including 8 schools and 21 non schools.

All of these appointments were made following the principles set out in the 'Allocation Model'. I reviewed a sample of 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.

Existing auditors were re-appointed during the last financial year to audit 2,370 public entities and their subsidiaries, (2,134 schools and 236 non schools), for a further term. 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 in the non school sector.

In the year under review there were 59 new appointments made for existing entities in the non-school sector. This was a very significant increase from previous years and included those new appointments made as a consequence of the re-allocation of audits from Audit New Zealand. This was largely driven by the need to free up resources in Audit New Zealand by the re-allocation of some of its current audits to private sector providers to ensure that all public sector audits could be completed in a timely manner.

Following the identification of those audits of Audit New Zealand that could be best re-allocated, all major private sector providers were invited to express interest in taking on additional audits and were asked to confirm both availability of resource and independence.

Applying the principles of the Allocation Model, and considering the available resources of the private sector ASP's, recommendations were then made for new appointments by you. This was a dynamic and evolving process and took place in several tranches. Limited consultation was possible with the entities concerned.

There was no tender process undertaken.

I have reviewed the processes undertaken and the explanation given for each appointment. Nothing has come to my attention which would suggest that either the process undertaken or the decisions made were other than reasonable and appropriate in the circumstances. When the affected entities having a change of auditor were advised, the vast majority expressed no objection. In respect of the very small number who questioned the proposed change, I am satisfied that reasonable consideration was taken in confirming those appointments.

Appointment of school auditors.

The appointment of auditors to the school sector for the three year cycle for audits for the period ending December 2021 was completed in the current year. This is a very major project with approximately 2,450 schools and school related entities having to have an audit undertaken.

Completion of the appointments in the school sector was impacted by the overall pressures of Covid-19 referred to earlier, and was also made harder by the withdrawal from the sector of some existing ASPs and the request of some others for a reduced number of audits. Audit New Zealand does not currently undertake any school audits and it did not have the capacity to take any on.

There was no tender process undertaken.

Both existing and possible new ASPs were asked to record interest in taking audits and also to express a view as to appropriate audit fees. In general, material increases in audit fees were requested with several ASPs advising that if fees could not be increased, they would not be available to audit.

This led your Office to carry out a comprehensive review of what was a reasonable fee for a school audit. This was conducted on a general basis, a geographic basis and an individual basis for all schools. The end result of the review lead to your approval of significant fee increases. This amounted to about 12% for schools in the North Island and a 31% increase for schools in the South Island. I consider that these increases were both necessary and reasonable.

The appointment of auditors to all schools has now been completed. I have concluded from my review that the processes undertaken were appropriate and reasonable and were determined having due regard to the Allocation Model. I did not encounter any significant objection from schools either to the appointments made or to the new fees.

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-O-478-38310-2) and is provided to any entity and auditor when appropriate. It is consistently followed and referred to when issues arise.

During the year under review, 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. 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 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 shared by all of the audit service providers that I have consulted. I understand that the contestable process will continue to be used in individual cases where appropriate. I consider that with the work on the principles and practical application being completed, that it is important that an accurate summary of these are 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 the last 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 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 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 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 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 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 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 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 the year under review there were a number of requests from auditors for an additional fee due to additional work requirements often as a result of Covid 19 but also other factors. You have given permission for auditors to directly discuss increases with the entities within certain limits without the need to first obtain your consent. I consider that this additional flexibility to be reasonable.

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, including additional recoveries.

Other issues.

There are no other material issues which arose in the previous year which in my view warrant comment in this report.

Conclusions.

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