5. Financial Statements and Assurance Auditing
(Section 15 of the Public Audit Act 2001)
In relation to the Office’s assurance activities, the Independent Peer Review Team’s Terms of Reference specifically tasked the Peer Review Team to consider:
- the conduct of financial audit engagements, including the audit of Long-Term Council Community Plans and the Controller Function; and
- the allocation of audits and the setting and monitoring of audit fees.
And more generally:
- the operation of the Office’s quality control systems; and
- relationships with primary stakeholders, in particular Parliament.
Our report addresses these activities in three segments, the financial audit, including the operation of Audit New Zealand, the audit of the Long-Term Council Community Plans and, finally, the Controller Function.
The Controller and Auditor-General’s mandate and responsibilities are set out in the Public Audit Act 2001. Among a range of matters relating to the abovementioned issues, the Act specifically provides for:
- the Auditor-General to be the auditor of every public entity (section 14);
- the Auditor-General must from time to time audit the financial statements, accounts and other information that a public entity is required to have audited (section 15);
- the Auditor-General may at any time examine a public entity with respect to its activities with a view to establishing if it is:
- operating effectively and efficiently;
- operating in compliance with its statutory obligation;
- operating in a wasteful manner; and
- operating with a lack of probity or financial prudence (section 16); and
- the Auditor-General may, with agreement of an entity, provide other auditing services that are reasonable for an auditor to perform. (Section 17).
In addition, and of relevance, section 23 requires the Auditor-General to publish the auditing standards that the Auditor-General applies, or intends to apply, to the conduct of audits and inquiries, and the provision of other auditing services.
The Auditor-General may appoint:
- an employee of the Auditor-General, a person qualified to be an auditor of a company, or a partnership to carry out the functions under sections 15 or 17; or
- any person who in the opinion of the Auditor-General is suitably qualified to carry out functions under sections 16 or 18 (Inquiries).
The Auditor-General may charge fees for the provision of services under sections 14, 15, 16, and 17.
The Auditor-General’s outcomes framework has three output classes, the first of which is the ‘Provision of audit and other assurance services’ which relates to the Auditor-General’s statutory duty to carry out annual audits of the financial reports of, and in some cases performance information about, 4000 public entities. The class involves the following activities:
- annual and other statutory audits;
- auditor appointments and fee monitoring of annual audits; and
- quality assurance of annual audits.
The annual audit accounts for about 87 per cent of the Office’s total expenditure and produces two main products:
- the audit report provided to the users of an entity’s financial statements and performance information; and
- the management report addressed to the entity’s governing body and management setting out any significant issues identified by the Appointed Auditor during the audit.
The Auditor-General contracts with individuals (Appointed Auditors) from Audit New Zealand and private sector firms (Audit Service Providers). The Appointed Auditors are personally accountable for the quality of audit work performed. This is largely done on an allocation basis, rather than through some competitive approach (e.g. public tenders). Significant attention is given to ensuring the associated audit fee is fair to both the public entity and the appointed auditor.
As the Auditor-General ultimately retains responsibility for the audit of all public entities, a comprehensive quality assurance program of all Appointed Auditors is in place to ensure audits are performed effectively and efficiently and in accordance with relevant professional standards.
The outputs from this class contribute to another class, ‘Parliamentary Services’, which involves using the collective knowledge and wisdom of the Office to provide advice and assistance to Select Committees and other stakeholders. Much of this contemporary knowledge of all public sector entities is gained during the annual audit. Besides annual audits, the knowledge is also gained from general entity/sector intelligence gathering done through sector manager relationship responsibilities, as well as from performance audits and inquiry work.
The main measures of performance for the output class ‘Provision of audit and assurance services’ relate to timely completion of an entity’s financial report, reductions in the number of qualified opinions, increased acceptance of Audit New Zealand’s recommendations, and improvements in the measures of performance in central government.
As already noted, the Auditor-General’s staff are organised into two business units, the OAG and Audit New Zealand. For financial audits, the OAG carries out audit planning; sets policy and standards; appoints Auditors and oversees their performance; and provides reports and advice to Parliament. Audit New Zealand, which is the Auditor-General’s largest Audit Service Provider, carries out annual audits allocated by the Auditor-General and provides other assurance services to public entities within the Auditor-General’s mandate.
Office of the Auditor-General
Within the OAG, responsibility for the achievement of the annual audit outcomes rests with the Accounting and Auditing Policy team, who have developed their own Management Plan to supplement and support the Auditor-General’s Strategic Plan. The team’s key functional responsibilities include accounting policy, auditing policy, quality assurance, school audit and auditor appointments. That team sees itself as the “professional conscience” of the organisation in terms of compliance with accounting, auditing and other professional standards (Quality Assurance) across the range of products produced by the Office. It also plays a significant and influential role, with Sector Managers, in determining the scope and breadth of the annual audit.
It would seem that, in recent years, the team has had difficulty in obtaining, developing and/or retaining the capability it needs to fully and effectively support the roles expected and required of it. While this is somewhat understandable in the current international and local labour market for appropriately qualified and experienced professional personnel, the Peer Review Team was pleased to note that resourcing is now close to full complement and, more importantly, was particularly impressed with the overall quality and capability of the team. Undoubtedly, the ability to retain or replace such key staff involves a significant risk for the OAG.
The annual audit, as defined by the Office, differs in a number of not insignificant ways from the audit of a private sector organisation’s annual financial audit and also from that undertaken by comparable public sector audit institutions.
In part, this enhanced audit is a direct consequence of Parliament’s intent as expressed through legislation, such as the requirement to form a view on the Statement of Service Performance while other influences appear to be largely determined by the OAG. Broadly speaking, the latter fall into three categories:
- defining public interest in the accountability of the public sector in a unique and wider manner (enhancing transparency);
- inclusion of aspects of the performance audit mandate into an annual program of audit (enhancing frequency of coverage and performance); and
- pursuing specific interests of the Auditor-General, particularly directed at lifting the bar on public sector performance (enhancing performance).
This is achieved through requiring Appointed Auditors to comply with the Auditor-General’s Auditing Standards and to carry out audits in accordance with some very specific instructions issued annually by the Auditor-General. The latter are called Audit Briefs.
The Auditor-General’s Auditing Standards are based on Institute of Chartered Accountants of New Zealand ethical and professional standards which apply to auditing in the private sector. The Auditor-General has expanded those standards to provide some additional standards and additional specific instructions in the application of components of other standards. As a consequence, the requirements placed on the Appointed Auditors are greater and more detailed than in the private sector. Additional standards exist in relation to:
- AG-1 Reporting to the Auditor-General (supporting the overall statutory functions of the Auditor-General and the Office’s advice and reporting to Parliament);
- AG-2 Appropriations Audit and Controller Function (setting out the requirements for these unique statutory public sector tasks);
- AG-3 Performance, Waste and Probity (prescribing how some aspects of the performance audit mandate is to be incorporated into an annual audit); and
- AG-4 Audit of Service Performance Reports (setting out how auditors should discharge the statutory requirements on the audit of this information).
Audit Briefs are prepared and updated annually by the OAG and provide detailed guidance and impose specific requirements on Appointed Auditors to supplement the financial audit at each public sector entity. Separate briefs are prepared for a wide range of ‘industry’ sectors that comprise the Auditor-General’s client base. Currently, some 20 briefs are prepared covering ‘sectors’ such as the following:
- Energy Companies
- Government Departments
- State Owned Enterprises
- District Health Boards
- Port Companies
- Cemetery Trusts
The audit briefs also help ensure that a consistent approach on particular issues is taken by all Appointed Auditors.
Topics to be incorporated within each brief are determined by the OAG consistent with its assessment of the requirements and priorities applicable to each ‘industry’ sector. Some topics may be included in every brief prepared, while others may appear only in some briefs, or in just one. Individual topics appear to have their genesis in the following requirements:
- to further reinforce and highlight important aspects of the Auditor-General’s Auditing Standards;
- to seek specific information on aspects of an entity’s operations of interest to the OAG;
- to direct specific audit work/investigation on aspects of an entity’s operations of interest to the OAG;
- to require additional work to facilitate the clearance procedures for the consolidation of the Government’s Financial Statements; and
- to prescribe reporting requirements, both in terms of topics of specific interest and generally on the overall annual audit outcomes.
In excess of 50 topics have been identified for inclusion in the current round of briefs, but it would seem that the maximum number that might appear in an individual brief is in the order of 25-28 topics.
As discussed elsewhere in this report, the OAG issues, from time to time, good practice guides covering a range of topics in which it has a specific interest and expertise. Interestingly, some of the instructions included in audit briefs specifically require Appointed Auditors to review and audit aspects of an entity’s operations that are covered by such a guide, using the guide as a normative model against which to assess performance. This mode of operations creates the risk that the OAG effectively becomes, or is seen to become, the policy setter in such matters and raises questions about audit independence. The OAG advises that care is therefore taken to ensure that, so far as possible, the guides set out generally accepted and agreed standards for the sector (e.g. through detailed consultations with relevant agencies) and are written at a level of principle rather than as ‘detailed’ rules to enable entities to adapt them to their own circumstances. The Peer Review Team does not consider this apparent conflict of interest to be a major issue in the New Zealand context.
While no hard data was available to the Peer Review Team, anecdotal evidence provided in discussions with a range of stakeholders suggested that the impact of the requirements for the enhanced audit is a significant percentage addition to the cost of an annual financial statement audit. Based on figures suggested by a range of various Audit Providers and Audit Clients, this could amount to several million dollars in any one year. However, the OAG disputed this conclusion, indicating that any addition would be likely to be less than 5 per cent. Moreover, it would take considerable effort on their part to assess such a figure.
It was also suggested to the Peer Review Team that there was a tendency for the audit briefs to expand over time; described as brief creep. The OAG’s staff advised that this issue had been recently recognised and addressed by a review and revamp of the internal brief preparation process. The Peer Review Team did sight evidence of a new and seemingly more robust process but it remained unclear, with the mix of responsibility between Sector Managers and the Accounting and Auditing Policy Team, if anyone directly responsible to the Auditor-General had, or was able to have, an overall and holistic view of the entire process and outcomes. The OAG has advised that as the 'owner' of the annual audit product, the AA-G - Accounting and Auditing Policy is responsible for ensuring 'brief creep' does not occur beyond the bounds of the Auditor-General's expectations of a public sector audit and processes to reinforce that will be strengthened.
Although the Peer Review Team would generally be supportive of the direction, scope and breadth of the enhanced audit in the public sector, it was not evident that this had been subject to recent scrutiny and evaluation by the OAG and/or external stakeholders, particularly the Parliament. The direction, scope and breadth of enhanced financial statements audit in the public sector should be addressed as a matter of priority by the OAG in relation to its own performance and for the information of its stakeholders, particularly the Parliament.
Suggestions for improvement
- The retention and recruitment of a small number of key staff is a risk that needs to be specifically covered in the Risk Management Plan for the Office.
- The direction, scope and breadth of the enhanced financial statements audit in the public sector should be evaluated as a matter of priority by the Office of the Auditor-General in relation to its own performance and for the information of its stakeholders, particularly Parliament.
The Australasian Council of Auditors-General Peer Review of the New Zealand Audit Office reported in August 2001 that “the Office of the Auditor-General should undertake a formal analysis of the cost/benefit of the contestable regime.” In describing the contestable regime that report noted “In 1992, as New Zealand was undergoing extensive public sector reform, the then Auditor-General introduced a system of contestability for public sector auditing. Audit New Zealand was separated and ‘ring fenced’ from the Office of the Auditor-General and was required to compete for audit assurance work with private sector audit service providers. However, at that time the Auditor-General signalled his intention to retain some in-house capacity to undertake audit assurance work and reserved the right to withhold the audit of some public entities from the contestable model.”
Subsequently, after review, including extensive consultation, the OAG changed the principal method of awarding contracts for audits of public entities. This changed the process from one that was based mainly on an option of contestable (tendered) contracting to one where most audits of public entities are allocated to Audit Service Providers on the basis of a set of principles/criteria. This process has now been in place for a number of years. The set of principles, listed in the “Report on the Review of the Allocation Model’, comprise the following:
- The Auditor-General’s independence will be maintained
- The Auditor-General will allocate audits to Audit Service Providers which satisfy the Auditor-General’s auditing standards and have the capacity and experience to hold a viable portfolio of audits in the sector
- Allocations will involve critical masses of audits in sectors to enable Audit Service Providers to justify their investment in regular sector specific training and development
- The total work allocated to private sector Audit Service Providers will not be less than the current level under contestability (subject to audit quality being maintained), but the allocation process may involve the loss of a specific audit or audits in a particular sector, and a growth in other audits or sectors
- Allocations will take geographic concentration into account, to enable the development of “centres of excellence” by Audit Service Providers at specific locations
- The need for the ongoing viability of Audit New Zealand will be taken into account, while recognising that the initial allocation will entail some reallocation of audit engagements from Audit New Zealand to private sector Audit Service Providers 31
- Allocations will be grouped to ensure, as far as possible, that they are practical, cost effective and maintain audit quality
- Opportunities will be created for collaboration between Audit Service Providers
- Initial engagements will be for terms of two to four years
- Appointments will continue to be subject to the Auditor-General’s regular quality assurance reviews.
As a consequence, most audit appointments are now made by direct allocation after consultation with a representative of the relevant governing body and/or Chief Executive. In some cases an audit tender process may still be used. Generally, this is likely to be confined to large public entities with a commercial focus where the OAG considers it appropriate and also in the schools sector if the Board of Trustees considers it appropriate. Appointments are normally made for three years and are generally rolled over with the same firm at the expiration of each period where performance has been satisfactory and fee negotiations are satisfactorily resolved. Notwithstanding that the individually approved Appointed Auditor will move off particular tasks in accordance with current industry practice, it has become the norm for firms to retain an audit for an extended period of time. With some entities approaching 12 or more years with the one audit firm, the Peer Review Team questioned the absence of a specific policy to address whether this is good practice. We note, for example, that a number of studies have shown a link between the length of tenure of an audit firm and the diminished efficiency of an audit.
The Peer Review Team was advised it was common practice in the New Zealand private sector not to change auditing firms. In other jurisdictions it would not be uncommon to test the market for alternative audit service providers from time to time. In addition, the Peer Review Team considered that there would, on occasions, be genuine circumstances where an entity might wish to seek the services of an alternative auditing firm for a better overall outcome. While the OAG’s current policies would permit that to happen, this option did not appear to be widely known to those who might wish to pursue it.
In conjunction with the operation of the allocation model, the Auditor-General has commissioned Mr David Gascoigne, on an annual basis, as an independent evaluator of the basis upon which audits are allocated to Audit Service Providers. His reports are published in the Office of the Auditor-General’s Annual Reports. In 2007, he concluded that the processes in place “have been appropriate for their purpose, and have been applied in a way which has been consistently fair and appropriate, having regard to the rights, interests and obligations of the parties concerned.” He also noted “that the processes by which audits in the public sector have been allocated and fees have been set in the financial year to 30 June 2007 have been carried out with due probity and objectivity.” In addition, an internal review of the Audit Allocation model completed in August 2007 identified a number of general, as well as some specific, issues for ongoing attention by the OAG but concluded, overall, that the move to the model “has a beneficial outcome.”
The following charts show the current allocation of work among Audit New Zealand, the four major accounting firms and other private sector Audit Service Providers. At the time of the last Peer Review, mentioned above, Audit New Zealand held some 61 per cent of the work load by hours, and the private sector 39 per cent. In 2007, Audit New Zealand’s share of the work (in hours) had reduced by some 14 percentage points to 47 per cent.
It was apparent that the set of principles established to underpin the operation of the Audit Allocation model has now evolved into a list of criteria that is used in the selection of an Audit Service provider for the audit of each entity. In discussion with relevant OAG staff, the Peer Review Team was advised that a process is in place to work through the established criteria prior to putting a formal submission to the Auditor-General recommending the appointment of a nominated Appointed Auditor. The Peer Review Team was unable to sight evidence of this process.
In discussing the Allocation Model with a wide range of stakeholders, the Peer Review Team was advised that the process had support among Audit Service Providers and public sector entities and was generally a preferred model over the prior contestable model. There was some concern noted at the Central Government level that the current model limits the attainment of the benefits that might be might be expected to be achieved with a more market orientated approach. In addition, it is important to note the responses to the Peer Review Team’s interviews were provided by those who were participants within the system. Those who are outside the arrangements may have a differing view and it is incumbent on the OAG to ensure, and be seen to ensure, that new participants can reasonably enter the system and that barriers to entry are legitimately limited to issues of qualification and performance.
Overall, the Peer Review Team endorses the current approach but does note that there are some areas of risk to the OAG that need effective ongoing management. In particular, these include the need:
- to document criteria for determining allocations and then document the reasons for individual decisions;
- to ensure that there is a strong and effective fee management and monitoring arrangement in place (discussed below);
- to develop and articulate how the plan handles allocations into the longer term future; and
- to ensure (in appropriate circumstances) that scope exists, and is known to exist, for entities to test the market from time to time for alternative Audit Service Providers.
The Peer Review Team understands that the Audit Allocation Model would not sit comfortably with the Government’s procurement policy which includes a focus on an open and competitive process. This is an aspect which the OAG addresses in its annual audit of a number of public sector entities. The Review Team was advised by the OAG on this matter as follows:
- The allocation model is broadly consistent with the government’s general procurement policy, which dovetails with good practice advice produced by the OAG. Those general policy statements acknowledge that, at times, it will be more practical and cost effective to procure without a tender process.
- The model is not consistent with the mandatory rules on procurement for government departments, which were developed as a result of free trade commitments. These rules do not apply to the Auditor-General and are not designed with this office in mind.
- The OAG has been careful to document fully the rationale for departing from a competitive process, to incorporate steps to benchmark prices, so far as possible, and to review the operation of the model regularly.
- The OAG view is that the current model enables it to appropriately safeguard quality and control in the way in which private sector auditors carry out statutory functions in the name of the Auditor-General, while maintaining a price discipline through other means. Parliament and other stakeholders are regularly briefed on the allocation model to ensure that they understand why a tender process is not used and to provide an opportunity to discuss how it is working.
- Therefore, while there will always be a risk of criticism for not using an open competitive process for this work, the OAG actively works to manage that risk.
Suggestions for improvement
- It is suggested that the Office of the Auditor-General address the issue of public sector entities having the same Audit Service Provider for periods approaching, and exceeding, twelve years in the interests of preserving audit independence and maintaining the efficiency and effectiveness of the entities concerned.
- It is suggested that, in the selection of Appointed Auditors, the assessments against each selection criterion should be documented and summarised in the relevant submission to the Auditor-General.
- It would be prudent for the Office of the Auditor-General to minimize the risks associated with being seen not to comply with the main requirements of the government’s procurement policy.
Under an Audit Allocation model and in the absence of ‘normal’ market pressures, audit fee setting and monitoring are likely to assume greater importance than might otherwise be the case. At the start of new audit appointments, or at the point of renewal of an existing contract, Appointed Auditors and entities are given the opportunity to negotiate audit fees for the period of the contract (normally 3 years). However, in some circumstances the period may be limited to 12 months. The Public Audit Act 2001, at section 42, requires the fee to be reasonable, having regard to:
- the nature and extent of the services provided;
- the requirements of the Auditor-General’s auditing standards;
- the qualifications and experience of the persons necessarily engaged in providing the services; and
- any other matter the Auditor-General thinks fit.
Prior to discussing proposed fees with an entity, Appointed Auditors are requested to present a draft proposal to the OAG for, among other matters, a preliminary assessment as to the reasonableness of the proposal. Appointed Auditors are encouraged to provide entities with detailed background on factors driving any proposed fee increase. In the absence of an agreement on fees after reasonable negotiations, either party may request the OAG to provide a formal analysis of the data drawing on its overall knowledge of fees. It was indicated that only 2-3 per cent of cases reach the stage where a formal analysis is requested. The analysis is provided to both parties. If agreement still proves elusive, the Auditor-General can use his powers under the legislation to set a fee which will become binding unless changed by arbitration. This power is rarely used, with only one instance being identified in the recent past.
At much the same time as the introduction of the Audit Allocation model, there was a general national and international upward movement in audit fees. Primarily, this occurred through increased scope of audits as a result of legislative and international standard changes, partly attributable to international market failures, the rising cost of professional indemnity insurance, and sharply increased salary costs for audit personnel.
In 2006, the OAG commissioned Rutherford Sloan Ltd to undertake “an independent review of the processes used by the Office of the Auditor-General to monitor and moderate the audit fees applicable for approximately 4000 public entities.” They were required to:
- review the work developed to date relating to the Office of the Auditor-General’s audit fees monitoring mechanisms;
- gather the expectations of external stakeholders including Treasury and SOLGM (Society of Local Government Managers); and
- advise where the Office of the Auditor-General can make further improvements.
Overall, Rutherford Sloan concluded “We are of the view that the fee monitoring mechanisms, whilst capable of some modest enhancement and refinement, are performing their function in an appropriate manner and delivering against the objective of fair and reasonable audit fees.”
The Peer Review Team was of the view that the quality of information the OAG provides to parties having difficulty in reaching agreement on fees was relevant, seemingly of an acceptable quality and well presented. The Peer Review Team noted the data used to support this function was drawn from a variety of sources, including various desktop spreadsheets, not necessarily routinely maintained and with some considerable reliance on ‘corporate’ memory. The Peer Review Team is very supportive of the OAG’s current plans to build a database and model to facilitate the modelling of audit fees on a more rigorous and sound basis than currently exists. The Auditor-General’s Annual Report for 2006-7 noted that specific actions currently being progressed included:
- ‘improving the documentation of the current fee monitoring processes of the office;
- enhancing the tracking of the main drivers of audit costs (for example, auditor salaries); and
- continuing and expanding many of the processes already in place (for example comparing audit fees by sector using size proxies to identify fee outliers).’
Fee setting and monitoring was regularly raised in the Peer Review Team’s discussion with stakeholders interviewed, particularly those representing public sector entities. They conveyed the general view that they had little or no effective role in the fee setting process and often saw themselves as price takers. While this had not resulted in any significant expressed concern with the level of fees being charged and as such was not deleterious to the entity’s relationship between the auditor and/or the OAG, it creates the risk of such concerns arising in the future. The Peer Review Team accepts the fee setting process, as described above, as a reasonable approach, but notes that effort needs to be directed to ensuring entities are fully conversant with the process and their ability to have an appropriate involvement in the process is well understood and encouraged.
5.6.1 The OAG is involved in a number of formal interventions with Appointed Auditors in the latter’s execution of individual audits. The more significant of these are:
- setting auditing standards and tasking Appointed Auditors through the audit brief (as previously discussed);
- advising on significant and/or emerging accounting and auditing issues;
- considering proposed qualifications to audit opinions; and
- maintaining a comprehensive quality assurance program.
From time to time, the OAG will be approached for advice on complex accounting and audit issues arising out of individual audits. Normally, this would not be expected to occur until the Appointed Auditor has fully considered the issue, including consulting their own technical advisors. In addition, it would be expected that their approach to the OAG would include a considered view and a recommended course of action. The OAG would then be using its own sources and advisors to develop its approach to the issue, and the proposed course of action. This sequential process would be followed irrespective of which Audit Service Provider is involved. Consideration might be given to whether this is the best business model for issues arising within Audit New Zealand where it seems it may create some duplication of effort and a sub-optimal allocation of resources under the control of the Auditor-General.
The OAG has a strong and comprehensive Quality Assurance policy encompassing all the Office’s products, including the annual audit. The extension of the policy to encompass all the Auditor-General’s products is a recent initiative. The focus of the annual audit QA program is on each Appointed Auditor and targets coverage of all such Auditors once every three years with a priority given to new appointees, those with previously identified concerns, and those where issues may be identified through another mechanism. The program is well planned and executed with onsite visits and follow-up action as necessary. In addition, common issues emerging from the QA program are advised to all Appointed Auditors that they may, as applicable, learn from the process.
Suggestions for improvement
- The desirability of merging at least some of the technical resources of Audit New Zealand and those of the Office of the Auditor-General should be further investigated for better operational effectiveness and efficiency, particularly where the skills involved are difficult to recruit and retain.
Issues associated with the quality of schools audits have received particular attention within the OAG in the last two years. Of the approximately 4000 annual audits undertaken, 2457 are classified as school audits which, apart from the number involved, tend to be very small and widely dispersed around the country. The following two charts compare the size of the average schools audit with the average size of all other audits. Only four schools audits have an input of 100 hours or more and over 1000 of the audits have an input of fewer than 4 person days. In addition, the average cost of staffing school audits is approximately $81 per hour, while for all other audits it is in the order of $145 per hour. At present, there are some 60 Audit Service Providers operating in the school sector ranging from large national firms to small regional practices. It is also a sector where the quality assurance process indicates the quality of the audits reviewed is not consistently as good as in other sectors.
There appear to be some tensions between the completion of the enhanced audit referred to previously and the resources actually available to schools and the quality of the audit process. The Peer Review Team notes the current audit brief for the schools sector is in excess of 90 pages of additional instructions and/or guidance to Appointed Auditors and considers this is likely to exacerbate the tensions noted above. Consideration should be given to encouraging greater participation in the audit approach being taken and simplifying the processes involved.
Audit New Zealand is a separate business unit operating under the Controller and Auditor-General of New Zealand. It is responsible for carrying out annual audits of public entities (also referred to as “enhanced audits”) and for providing specialised assurance services with respect to governance, risk, contracting and project management.
Audit New Zealand has approximately 217 staff, structured along functional and sectoral lines, working from seven different locations. All staff are provided with wireless laptop computers, mobile phones, secure wireless access and encryption software for the key working paper files (TeamMate and the document management system).
In addition, staff are provided with a national training program based on identified competencies. These competencies are described for each position; job descriptions are up-to-date; and there is a mentoring program for new employees. New staff also receive appropriate training and professional development to allow them to understand the Audit New Zealand structure, methodology, policies and procedures.
There has been good attendance at national training program events. Audit New Zealand also monitors compliance of staff with professional development requirements of the Institute of Chartered Accountants of New Zealand by way of self-reporting. Audit New Zealand also has an adequate process in place to ensure that all staff maintain professional independence as required by professional bodies. Staff are required to complete an employee independence declaration form every year.
Audit New Zealand, however, has been experiencing a high percentage of staff turnover per year; therefore, recruitment and retention has been identified as a key challenge, particularly at the senior auditor and manager level. Nevertheless, during the interviews conducted by the Peer Review Team, the audit staff felt that a key part of the success of Audit New Zealand was the culture and good camaraderie created in the office. Audit staff felt that Audit New Zealand was competitive from a benefits and salary perspective while offering a broader exposure to accounting and auditing issues. Staff suggested additional opportunities for exchange with other national audit offices as an enhanced marketing tool that could assist in competition with the private sector firms - exchanges which would be part of a more formalised arrangement than exists at present. The OAG acknowledged the need to have formal two-way exchange programmes rather than the ad hoc manner in which the past exchanges have been working.
Peak workloads at Audit New Zealand are during the period of April-November and they are well managed. To accommodate peak demands, Audit New Zealand encourages use of time off in lieu; more planning and interim audit work in advance; filling gaps with other assignments; attempting to rely on internal controls if possible; and arranging for the use of staff from private sector firms. They also have outsourcing arrangements with audit offices overseas which provide a few individuals annually during their busy periods. Retention has improved over the last 18 months.
Audit New Zealand has approximately 750 audit clients. The following chart shows the allocation of fee revenue among the various client sectors. The main client sectors are the same as the sectoral groups previously mentioned.
Annual audits are allocated by the Auditor-General to Appointed Auditors from private sector accounting firms and from Audit New Zealand. From the OAG’s perspective, they treat Audit New Zealand as they would any other Audit Service Provider and therefore expect it to comply with any Audit Briefs issued and to meet the Auditor- General’s audit standards. A discussion regarding the allocation model and its impact on the OAG is provided under the sub-section 5.4 Audit Appointment/Allocation.
Before 2004, as indicated earlier, audits were allocated under a contestability model in order to enforce a level of efficiency within the audit process and to “right size” the operations of Audit New Zealand. Around the same time, a number of significant international changes occurred in the accounting and auditing profession due to major failures of private companies, for example, in the US, Italy and Australia. As a consequence, the auditing world saw an increased expectation from auditors with respect to the nature of their services. The difficulty for Audit New Zealand was that it had responded to the contestability regime by reducing its level of investment in training, audit tools, audit methodology and quality control so that it could ensure a cost structure that was lower than that of the private sector. The outcome was that Audit New Zealand achieved the desired efficiencies of the contestability model by becoming a low cost audit service provider but the robustness of its audit methodology and audit practices was considerably impaired.
However, the change to an allocation model where tendering of audits is the exception has provided an opportunity for the Auditor-General and Audit New Zealand to reinvest in training, methodology and quality control. This move to the allocation model has also allowed Audit New Zealand to recover fees for reasonable increases in the nature of its audit work and to improve its professional practices; create the aforementioned national training program for staff; update its audit methodology; and develop a new quality control system.
With respect to audit methodology, Audit New Zealand’s updated audit methodology puts more emphasis on fraud, documentation, risk assessment and controls. There are many standard forms and templates available to auditors to assist with the implementation of the new methodology. These forms and templates are reasonable and consistent with the approach of many other National Audit Offices and private sector firms. Audit New Zealand has benchmarked the updated audit methodology against the Institute of Chartered Accountants in New Zealand auditing standards, the Auditor-General’s auditing standards including the interpretative statements of the Institute’s auditing standards as well as comparing it with that of some other national audit offices. Further updates to the audit methodology and templates are planned with respect to the integration of information technology specialists within the audit team and full compliance with International Standards on Auditing as they are adopted by the New Zealand Institute of Chartered Accountants and come into force (currently envisaged within the next three years).
The electronic working paper package of Audit New Zealand is TeamMate, which is also used by a significant number of other national audit offices. TeamMate, within Audit New Zealand, is governed by a TeamMate manual that prescribes strict naming conventions and specific guidelines for the creation of individual audit files. A review of the TeamMate practice manual and discussions with the manager responsible for TeamMate outline that Audit New Zealand is a leader in the use of TeamMate and indicate that good internal support is provided in respect of its use.
With respect to operational planning and reporting, Audit New Zealand demonstrates a clear relationship between strategic objectives in place, critical success factors, key performance measures, and outcomes. The accountability for each organisational outcome is clearly defined and the performance of Audit New Zealand against those measures is regularly monitored. An independent review of the efficiency and cost effectiveness at Audit New Zealand was also completed in July 2007. The review indicated that Audit New Zealand’s core systems and practices are improving and noted, for example, that direct costs are reasonable when compared to those of comparable private audit service providers; that the dollar amount and the time spent on training is now reaching the same level as that of comparable private audit service providers; and, that the remuneration of staff falls within appropriate remuneration ranges, given the job characteristics and the market. The report, however, also identified several areas for improvement including:
- management information systems (including the timesheet and billing system) are not integrated and could be improved to provide better performance information;
- some staff grades, particularly for audit manager and audit director, where the productivity could be more comparable with that of private audit service providers;
- indirect costs at Audit New Zealand which represent 45 per cent of its overall costs could be closer to industry standards set at 30 per cent;
- knowledge management could be applied to a fuller extent; and
- opportunities for improvement exist to better manage workflow.
The OAG responded that Audit New Zealand has a range of business plan objectives in order to achieve these desired improvements.
In reaching its conclusions with respect to the operations of Audit New Zealand, the Peer Review Team noted that Audit New Zealand has reinstituted a quality assurance system which, along with its audit methodology, permits it to comply with the standards of the Auditor-General, that is consistent with the Institute of Chartered Accountants of New Zealand’s auditing standards and that is reflective of best practice. But this recent investment in training, methodology and information technology must remain strong and robust in order for Audit New Zealand to remain committed to maintaining a strong and robust audit methodology; to maintain high professional standards; to maintain the level of skills and competencies required to pursue its audit operations; and to ensure consistent application of methodology, standards and procedures.
The Peer Review Team also acknowledges that Audit New Zealand has taken steps to improve its operational performance (eg. smoothing the workload, increasing the number of chargeable hours, and reassigning portfolios) but encourages further action to respond to the opportunities for improvement noted in the efficiency and cost effectiveness review of earlier this year.
The Peer Review Team itself examined the audit methodology, quality assurance process and operations of Audit New Zealand in more depth and identified a number of additional areas of possible improvement, as discussed below.
Organizational Structure of Audit New Zealand and Co-ordination with the Office of the Controller and Auditor-General
The organizational structure of Audit New Zealand would be best characterized as being flat and without any significant degree of internal specialization. Generally, each Director within the organization manages a portfolio of audit clients that can cover the total span of client types identified previously and reports directly to the Executive Director and/or the General Manager of the Operations group.
To assist audit staff, two functional specializations have been created in the areas of professional practices and specialist audit services. As well, there are five sectoral chairs who are responsible for providing advice and direction in respect of the five larger client groups of Audit New Zealand – local government, tertiary education, central government and crown entities, health, and licensing trusts/energy.
In the opinion of the Peer Review Team, however, the structure of audit operations in Audit New Zealand could be more efficient if audit responsibilities were assigned in a manner that would permit greater specialization amongst the Directors and staff. The result would most likely be greater economies of scale, greater efficiencies in the performance of the audit work and improved identification of audit issues. The OAG responded that Audit New Zealand has already moved to better specialisation in its recent re-allocation of Director Portfolios
The Peer Review Team also noted different levels of duplication between Audit New Zealand and the OAG. Firstly, as already discussed under sub-section 5.6 Annual Audit Performance of this report, the Accounting Technical group at Audit New Zealand performs work related to the application of accounting and auditing standards, while the Accounting and Auditing Policy group at the OAG covers the same ground. Secondly, Sector chairs at Audit New Zealand and Sector Managers at the OAG appear to have similar responsibilities as they are both responsible for providing direction to auditors in their area of specialization. Thirdly, reviews of controversial opinions can require an opinion of a review committee at Audit New Zealand and of yet another committee at the OAG. The results of one committee cannot impact on the need for, or answers of, the other. As a result, although it may be desirable to continue to treat Audit New Zealand as a quasi independent service provider, consideration should be given to reducing the level of duplication between Audit New Zealand and the OAG in order to improve the efficiency of audit operations.
Finally, the Peer Review Team noted that a number of the individuals working in the Professional Practices group of Audit New Zealand (including the General Manager) continue to have responsibilities for an audit portfolio. The rationale for this approach is that it provides these individuals with a greater appreciation of the responsibilities of the audit practitioners that they are attempting to assist and therefore more practical guidance and direction will be provided. With the increasing rate of change in international auditing standards and practices, however, it is now increasingly difficult for audit offices to ensure that their audit methodology and quality assurance services remain robust if their professional practices staff are not completely assigned to that task.
Consequently, Audit New Zealand should review the assignment of audit responsibilities to its professional practices staff to ensure that they can continue to devote sufficient time to keeping the audit methodology and practices of Audit New Zealand current and relevant. However, the OAG indicated that Audit New Zealand does not have the critical mass to fully assign its staff totally to the Professional Practices Group. Of the professional staff complement of eight, five staff members (including the General Manager) have an audit portfolio for audits for the year ended 30 June 2007. Moving forward, the audit portfolio for the General Manager has been considerably reduced: the Technical Director and Professional Development Manager no longer have an audit portfolio and the PPG is recruiting for a 0.5 FTE Audit Manager to assist the Director Audit Methodology and Director Audit Standards/ QA to ensure sufficient time is devoted to keeping the audit methodology and practices current and relevant. Audit New Zealand will continue to review the arrangement.
Quality Assurance Methodology and Practices of Audit New Zealand
A new quality assurance system was recently reinstituted and recorded in a Quality Control Manual. The material within the Quality Control Manual provides comprehensive direction with respect to, among other things, the following:
- ethics and independence;
- professional development;
- engagement performance;
- assignment of the engagement team;
- differences of opinion within the engagement team; and
- professional and technical consultation.
The Peer Review Team noted that, although the Quality Control Manual includes a wide range of policies and follows the recently implemented international standard on quality control, it does not provide sufficient information with respect to policies surrounding recruitment, performance evaluation, career development and promotion. During interviews, the Peer Review Team was made aware that such information exists but it is not part of the Quality Control Manual. The OAG agrees with the suggestion to ensure sufficient information surrounding recruitment, performance evaluation, career development and promotion is included in the Quality Control Manual. The policies relating to these subject matters are to be in the Human Resources Policies and Procedures. Audit New Zealand intends to update this into the next review of the Manual before 30 June 2008.
Another specific policy of the Quality Control Manual relates to when the Accounting Technical Group has developed a position on the matter in question or when there have been interpretations issued in respect of accounting or auditing standards, they will then provide training and updates to staff describing the result. These updates may be in the form of a newsletter to audit teams, updates to the technical guidance library that is available to all staff, or updates to audit manuals or electronic working paper tools. However, as discussed in paragraphs 4.4.19 through 4.4.22 of this report, during our interviews with staff of the Auditor-General and Audit New Zealand, we noted that knowledge management was highlighted as an issue within both organisations. In that regard, Audit New Zealand does have a number of tools and processes to disseminate key decisions and information but we did not find a comprehensive strategy addressing the organisation’s approach to knowledge management including its approach to capturing and sharing the many decisions and positions that are established at an audit engagement level but that are not subject to changes in accounting standards or decisions by organisations such as the Auditor-General.
Moreover, when differences of opinion within the engagement team arise and are solved, the Quality Control Manual states that “If the team member is satisfied with the explanation, the original documented concerns should be deleted from the engagement file.” In the opinion of the Peer Review Team, any notes signifying a difference of opinion within the team should be retained in order to evidence that the discussion arose and was resolved properly. The OAG responded that they did not agree and that their position was taken for professional risk management purposes.
Finally, the Quality Control Manual also indicates that Audit New Zealand will not include in its inspection work, matters that were undertaken for the OAG because that body does its own practice inspection. The checklists for inspectors confirm that no such work is undertaken (e.g. for performance audits and inquiries). Section 17 work, however, is subject to quality control and practice inspection. As a result, quality assurance inspections at Audit New Zealand should be extended to include all work done on the enhanced audit. The OAG responded that, it is their intention that because the OAG owns the product and Audit New Zealand only assists the OAG, the product should continue to be subject to the OAG quality assurance programme.
Annual Audit Methodology and Practices of Audit New Zealand
Following the reinstitution of the Audit New Zealand quality assurance system in 2006, inspection results have highlighted several issues. Such issues are not of the significance that would have questioned previously issued opinions but do show lapses in application of audit methodology and practices. With the update of Audit New Zealand’s audit methodology and policies with that of best practice and international standards, Audit New Zealand has identified a number of methodology application issues being addressed through the current and ongoing methodology work programmes and through National Professional Development training. This includes enhancing the quality of analytical reviews, the implementation of reliance and testing of information controls (a limited number of staff have electronic audit tools that permit testing of controls electronically or the extract and analysis of data directly from an information system) and improving the quality of planning and reporting of an audit.
The Peer Review Team itself also reviewed a number of audit files and saw evidence of the updated methodology and new quality control system as well as the areas for improvement noted in the quality assurance inspections. As a result, while it is noted that Audit New Zealand has the appropriate tools and methodology to conduct quality audits and that staff are more focussed on their role, more effort is required to ensure that Audit New Zealand executes its new methodology and policies in a manner that will continue to deliver high quality professional services and adapt to the international changes in the accounting and auditing profession, In the opinion of the Peer Review Team, the response to these challenges should be for Audit New Zealand to continue its efforts to train all of its staff in the elements of the new audit methodology and practices but to also hold separate in-depth training on key elements of that methodology and separate training sessions customised and targeted for senior staff.
With respect to the structure of its electronic working paper package (TeamMate), the Peer Review Team noted that Audit New Zealand makes good use of TeamMate and would be considered a leader in its application but the Peer Review Team also noted that the structure of TeamMate does not make maximum use of software in the areas of planning and reporting. External paper files are kept of many of the planning and reporting documents rather than creating and keeping them within the TeamMate file – e.g. the planning memorandum. Seeking opportunities to increase the use of TeamMate in the planning and reporting phases of the audit may help with ensuring improved quality control over some matters identified in past quality assurance inspections. Audit New Zealand responded that, in their opinion, the way that they have structured their TeamMate file is fairly effective and efficient and their standard structure provides them with certain efficiencies including the tailoring of separate sector TeamMate libraries for planning purposes.
Finally, through a review of audit files, other unnecessary practices were observed by the Peer Review Team. For example, the Auditor-General requires a series of reports such as a copy of the Ministerial Letter and a report on the Audit Results even though such items are readily available within the TeamMate file. This material can easily be sent by way of a replica to the Auditor-General. In addition, the OAG does not seem to regard TeamMate as having use beyond the financial audit work of Audit New Zealand. Greater leverage is available in this area to enhance overall performance.
Human Resources Management and Other Related Issues
Audit New Zealand maintains a record of staff attendance at internal courses (delivered by external and internal providers) but attendance at external courses is not monitored until the end of the year. A copy of the annual professional development declaration is maintained by the Professional Development group (which is a sub-group of the Professional Practices group) as an indication of Audit New Zealand’s monitoring of professional practice requirements and external courses.
The Quality Control Manual also includes a policy related to auditor independence. However, more explanation is needed of the policy on auditor rotation, as opposed to the rotation of the quality control person, since it merely refers to a policy of the OAG and therefore makes it difficult for the reader of the Manual to fully understand the implications of this policy. The OAG responded that, in their opinion, the OAG's audit service provider manual policy contents on auditor rotation is sufficient for Audit New Zealand to refer to in its own policies.
Suggestions for improvement
- The structure of audit operations in Audit New Zealand could be more efficient if audit responsibilities were assigned in a manner that would permit greater specialisation amongst the Directors and staff and reduce any duplication between Audit New Zealand and the Office of the Auditor-General. The result would most likely be greater economies of scale, greater efficiencies in the performance of the audit work and improved identification of audit issues.
- Although the Audit New Zealand Quality Control Manual includes a wide range of policies and follows the recently implemented international standard on quality control, it does not provide sufficient information with respect to policies surrounding recruitment, performance evaluation, career development, promotion, and auditor rotation. During interviews, it was evident that such information exists but it is not part of the Quality Control Manual that can be easily accessed. This is a matter that requires attention.
- While it is noted that Audit New Zealand has appropriate audit tools and audit methodology to conduct quality audits and that staff are more focussed on their role, more effort is required to ensure that Audit New Zealand executes its new methodology and policies in a manner that will continue to deliver high quality professional services and adapt to the international changes in the accounting and auditing profession, In the opinion of the Peer Review Team, the response to these challenges should be for Audit New Zealand to continue its efforts to train all of its staff in the elements of the new audit methodology and practices but to also hold separate in-depth training on key elements of that methodology and separate training sessions customised and targeted for senior staff.
In New Zealand, the Auditor-General’s mandate extends across the local government sector. The legal basis of New Zealand’s core local government (entities known as regional, city or district councils) is provided by the following three statutes:
- Local Government Act 2002;
- The Local Electoral Act 2001; and
- The Local Government Rating Act 2002.
While the entities are created by Parliament, the elected members of local government are primarily accountable to the community which they represent and rate for the provision of services. Councils can undertake any function which promotes the wellbeing of their communities. Since 1996, Councils have been required to prepare long-term financial strategies. Under the Local Government Act, they are now required to prepare Long-Term Council Community Plans (LTCCPs).
The LTCCP is a 10 year plan and its purpose is to:
- describe the activities of the local authority;
- describe the community outcomes of the local authority’s district or region;
- provide integrated decision-making and co-ordination of the use of the local authority’s resources;
- provide a long-term focus for the decisions and activities of the local authority;
- provide a basis for the local authority to be accountable to the community; and
- provide an opportunity for the public to participate in decision-making processes on activities to be carried out by the local authority.3
5.9.4 Local authorities must follow a number of steps in preparing their LTCCP. These include:
- consultation with the community;
- development of key policies and plans; and
- putting in place financial strategies and performance measures.4
Two key documents in the LTCCP process are the LTCCP Statement of Proposal (including a draft LTCCP) and the final LTCCP. A summary Statement of Proposal is to be prepared to facilitate public consultation. The Act requires both the draft and final LTCCP to include a report from the Auditor-General. The Auditor-General is required to report on:
- the extent to which statutory requirements have been complied with;
- the quality of information and assumptions underlying the forecast information provided; and
- the extent to which the forecast information and proposed performance measures will provide an appropriate framework for the actual levels of service provision to be meaningfully addressed.
While the LTCCP has a 10 year planning horizon, all local authorities are required to prepare a plan every 3 years. The full provision of the foregoing requirements came into effect for the first time for LTCCP adopted for the period starting 1 July 2006. The next planning period will commence in July 2009, although plans requiring amendments during the intervening period also require a report from the Auditor-General. Discussions with stakeholders highlight that the OAG and local authorities are still working through issues and understandings in relation to the amendment process.
The introduction of these requirements produced some unique and challenging requirements for the Office, both technically and logistically. These included understanding and analysing planning systems; working with uncertain and possibly incomplete information and forward estimates; validating assumptions; and completing this for all authorities in the time prescribed. In addition, there was a desire to maximise the consistency in approach by the three Audit Service Providers to local authorities. Thus the OAG adopted the allocation model to allow Audit Service Providers to develop expertise in their field of LTCCP audits. Legal advice was obtained from time to time to assist in managing the risks that might arise from this activity and to consider the content of the proposed audit report.
The perception from a range of stakeholders was that this task was completed in a generally satisfactory manner but at some considerable cost to the major players, including the Office. It is understood that a significant proportion of the actual costs over initial estimates incurred by the Office have been absorbed by that office. It might be debatable whether a lower audit cost is sustainable into the future, even if, as expected, that it reflects the significant learning process undertaken in the first round of these audits. It was also evident to the Peer Review Team that the Office was heavily involved in the initiation and implementation of these developments in local government and remains so in planning for the next round of these audits.
As with all products of the Auditor-General, the LTCCP audits have been subject to a recent quality assurance review which, perhaps not surprisingly for a new product, has identified a number of procedures and practices requiring attention and review not only for the next round of audits but also for audits of LTCCP amendments as they come to hand. The review also identified a number of procedural strengths from the current round on which to build going forward.
OAG responded to the above observations as follows:
Throughout 2007, the Office has been working with the sector on the implementation issues (and ongoing issues) by bringing the matters to relevant stakeholders (and primarily through SOLGM). Our clear strategy/message is that these are generally matters for the sector to consider and deal with. The sector (and again particularly SOLGM supported by LGNZ and NAMS) had commenced, by the time of the review, a substantial programme to better define good practice. This work has been undertaken by the sector for the sector. We have clearly been on the sidelines and provided comment where appropriate, but the initiatives remain that of the sector. We have been mitigating the risk that we implement and then audit. As an office we have been undertaking a complete overhaul of the LTCCP methodology. This has been very much based around the quality assurance review undertaking as well as with direct feedback from the audit teams. The revised methodology –with the A&AP support – will go live in 2008.
Suggestions for Improvement
- It is incumbent on the Office of the Auditor-General to ensure it remains sufficiently independent of implementation issues related to local government to retain its objectivity and cautious scepticism as part of its audit responsibilities and also be seen to be doing so.
- The Office of the Auditor-General is strongly encouraged to address comprehensively the full range of issues emerging from the recent quality assurance review covering the LTCCP.
The Controller Function has its origins centuries ago in the United Kingdom and has existed in New Zealand since 1865. The function was designed to provide for the safe keeping of public money and to ensure it was only spent in accordance with the appropriation decisions of Parliament. Money could be spent only after it had been issued under the authority of Parliament. Until recently, the Controller’s primary function has been to certify, before the event, that all payments of public moneys from the Crown bank account into a departmental bank account are in accordance with a warrant issued by the Governor-General and that there is an appropriation or other statutory authority against which payment can be charged. As the select committee noted during the 2004 reforms, this system had become effectively symbolic with a warrant being issued daily. The substantive work was in fact taking place through the check on appropriations during departmental audits.
The Controller Function was modernised and changed, effective July 2005, to meet the requirements of a full accrual accounting environment, including accrual-based appropriations. In such an environment, the key point of control should be at the time expenditure is incurred, not when it is actually disbursed. Key features of the new environment include the following:
- Treasury is required to supply monthly reports to the Controller to enable the Controller to examine whether expenses and capital expenditure have been incurred in accordance with an appropriation or other authority;
- the Controller can direct a Minister to report to Parliament if the Controller has reason to believe that any expenditure has been incurred that is unlawful or not within scope, amount or period of any appropriation or other authority; and
- the Controller can stop payments from a Crown or departmental bank account.
Departments provide information to Treasury to enable it to compile and provide the monthly report to the Controller and Auditor-General.
Closely related to the Controller Function is the appropriation audit. Consequently, the two roles have been described as inextricably intertwined. In accordance with the Auditor-General’s Auditing Standard number AG-2, the appropriation audit has been carried out, by Appointed Auditors, as an integral element of the departmental annual financial audit. As part of the modernisation process mentioned above, the Public Audit Act 2001 was amended to ensure that the appropriation audit is carried out as a matter of statutory duty rather than at the discretion of the Auditor-General. As a consequence, Appointed Auditors are required to audit all appropriations to:
- determine whether expenses or capital expenditure have been incurred within the amount, scope and period of an appropriation or other statutory authority;
- ensure that expenses incurred have been for lawful purposes; and
- ensure that any unappropriated expenditure is reported in the financial statements of the relevant department.
While the appropriation audit is separately provided for under legislation, it is the practical basis for the exercise of the powers associated with the Controller function.
To give effect to this modernisation process, the Auditor-General and Treasury have established a Memorandum of Understanding (MOU) to outline their joint understandings and expectations of the role and procedures associated with the Controller function.5 The Auditor-General has reviewed and reissued the relevant Appropriation Auditing Standard. Each month the OAG operates the Controller function under certain standard procedures in accordance with the auditing standard and the MOU
Following the completion of the first financial year of operation of the new procedures, the OAG initiated a quality assurance review of the process underlying the appropriation audit and Controller Function which identified a number of issues for consideration going forward. The review highlighted that the monthly monitoring undertaken as part of the Controller Function is reliant on the satisfactory operation of the following controls and safeguards and, as such, is only as effective as the following:
- the information provided by departments (and subsequently Treasury) is subject to the departments’ own internal control processes;
- departments are subject to an annual department internal control evaluation; and
- departments are subject to annual audits and their financial statements must reconcile to the financial information provided to Treasury to facilitate the preparation of Whole of Government Consolidated Financial Statements.
The quality assurance review also notes the monthly monitoring is unlikely to identify breaches that have not already been identified by departments (or Treasury). The OAG has advised that there is greater discipline in the system now because there is regular reporting and monitoring of expenditure against appropriation. The fact that there is an independent Controller with powers to act (if and when required) and who also carries out an independent appropriation audit alongside the monthly reporting process provides a strong incentive for departments to ‘self declare’. This is evidenced by the number of breaches identified in the first year of operation of the monthly reporting process (84 instances in 2005/06, compared with 45 in the two previous financial years). The number of breaches in 2006/07 was 46, which would indicate that system improvements have been made to address issues that came to light in the first year. As previously noted, the successful completion of the appropriation audit is essential for effective operation of the Controller function. This work is generally not completed until late in the financial year and thus the nature of, and timing for, the effective execution of the Controller function has moved under the modernisation process, from a preventative model to a detective model.
The quality assurance review identified a number of key findings with the execution of the appropriation audit which imposes risks to the successful execution of the Controller function and would also impact the integrity of the annual financial audit. The review found that there was inadequate documentation within many of the files reviewed to demonstrate compliance with key aspects of the relevant auditing standard. In addition, the level of compliance with key aspects of the standard varied between the various Audit Service Providers. The Controller function monthly work was found to be consistent with the MOU. The OAG has advised action has been initiated to address the recommendations of the quality assurance review.
The Peer Review Team notes that, in a number of other jurisdictions, responsibility for the “Controller” function has been effectively subsumed within the executive arm of government, with the relevant Auditors-General considering departmental compliance with appropriation legislation in the context of their annual financial statement audits. Parliament carefully examined this function in 2004 and took steps to strengthen it, as described previously, rather than remove it. The Peer Review Team also notes the Controller and Auditor-General’s strong view that he continues to have an effective role to play in this process, given the particular New Zealand governance arrangements.
3: Controller and Auditor-General 2007. Matters arising from the LTCCP. Page 11 (para 1.3)
5: The MOU can be accessed on the Treasury website http:www.treasury.govt.nz/controller/default.asppage top