In forming our Strategy 2009-12, we considered:

• our legislative audit mandate; and
• our operating environment.

Our legislative audit mandate

In New Zealand’s system of government, Parliament authorises all government spending and gives statutory powers to public entities to enable them to carry out their role. Public entities are accountable to Parliament for their use of the public resources and powers that Parliament gives them. As part of this accountability, Parliament seeks independent assurance from the Controller and Auditor-General (the Auditor-General) that public entities are operating and accounting for their performance in the way that Parliament intended.

The Auditor-General is an Officer of Parliament. This means that the Auditor-General is answerable directly and only to Parliament, and is independent of the Executive Government. The Auditor-General is responsible for auditing all public entities in New Zealand – a total of about 4000 public entities – and for reporting to Parliament about the performance of the public sector.

The work of the Auditor-General is carried out by staff in two business units (the Office of the Auditor-General and Audit New Zealand) and by auditors contracted from the private sector. We refer to these collective resources as the “Office”.

Under the Public Audit Act 2001 (the Act), the Auditor-General carries out:

• annual audits;
• performance audits and other studies; and
• inquiries into any matter relating to a public entity’s use of its resources.

In addition, the Auditor-General must audit every local authority’s Long-Term Council Community Plan (LTCCP). The Auditor-General may also perform other auditing or assurance services at the request of a public entity, such as auditing financial information in a prospectus or giving assurance to a public entity about its purchasing or contracting procedures.

Public entities use the public funds allocated to them by Parliament to pay audit fees (for annual audits and LTCCP audits, and other auditing or assurance services that they request). Parliament gives the Auditor-General separate funding to carry out performance audits, studies, and inquiries at the Auditor-General’s discretion (discretionary funding).

Under the Act, the Auditor-General fulfils the statutory functions of the Office by “reporting”. At the broadest level, the Auditor-General may report to a Minister, a committee of the House of Representatives, a public entity, or any person on any matter arising out of the performance and exercise of the Auditor-General’s functions, duties, and powers that the Auditor-General considers it desirable to report on. The Auditor-General’s reporting should support Parliament in holding the Executive Government to account, resulting in improvement in the performance of public entities and the public sector, and contributing to the public’s trust in the public sector.

The Auditor-General’s legislative audit mandate, set out in the Act, considers five areas:

• Authority: Are activities being carried out, and accountability requirements observed, within the authority granted by Parliament?
• Waste: Are taxpayers’ dollars and public resources being wasted? Do governance and management arrangements ensure that public entities obtain and apply resources in an efficient and economical way?
• Probity: Are public entities meeting Parliament’s and the public’s expectations of an appropriate standard of behaviour?
• Performance: Are services and activities being carried out effectively, and achieving their intentions and their desired effect on outcomes or objectives?
• Accountability: Have public entities given full and accurate public accounts?

Our operating environment

We have been mindful of the changing economic conditions and other factors in our operating environment when developing our Strategy 2009-12. Major influences on our work in this environment include:

• potential for fraud or corruption;
• ongoing spending constraints;
• accountability requirements for public entities;
• taking a longer-term view of operating environments;
• effect of adopting New Zealand equivalents to International Financial Reporting Standards (NZ IFRS);
• increasing audit fees;
• feedback that we receive from public entities, select committees, and other stakeholders, to understand what Parliament and public entities expect of us; and
• changes we have been making to the focus of our annual audits of public entities.

Potential for fraud or corruption

In the current economic conditions, it is widely anticipated that there will be increasing attempts by individuals to fraudulently or corruptly use public resources for personal gain. New Zealand continues to have a high ranking as a “clean” country in the most recent Transparency International survey, and the more extreme forms of fraud or corruption do not appear to be prevalent here. However, we should not be complacent, given the increasing pressure on the wise use of public money and the wider economic conditions.

Ongoing spending constraints

The Pre-Election Fiscal Economic Update in 2008 and other forecasts since anticipate deficits in the Crown Financial Statements for most of the next 10 years. Therefore, there is increased pressure on the public sector to be cost-effective and to explore alternative methods of service delivery. We expect continued evolution in, and questioning of, ways of providing services, including more collaboration among public entities and more delivery of public services through non-government and private sector partners.

Spending constraints will also increase the importance of public entities having good quality internal performance management information and external performance reporting, as they will be expected to demonstrate the effect and benefits of their outputs and chosen methods of service delivery.

Accountability requirements for public entities

The 4000 or so public entities that we audit range from large departments, Crown entities, and State-owned enterprises to very small local bodies. The public sector audit portfolio is dominated by smaller public entities and subsidiaries of larger public entities, which do not often present significant public risk. They include public entities such as schools, cemetery trusts, and reserve boards.

All public entities, regardless of size and function, are required to prepare annual financial statements, usually in accordance with generally accepted accounting practice. They are also often required to report other information about their performance.

We are acutely aware that accountability requirements – including those for the annual audit and the associated fees – are often a burden for smaller public entities.

In Figure 1, we show that 87% of annual audits in the public sector take less than 100 hours each to complete. Of the remainder, 9% take from 100 to 500 hours, 3% take more than 500 hours, and 1% take more than 1000 hours each to complete.

Figure 1
Public sector portfolio by annual audit hours

While all public entities should have some level of accountability to Parliament or the public, we consider that many smaller public entities incur disproportionate costs to meet their statutory reporting obligations and associated assurance requirements. For example, no matter how large or small a public entity is, the Auditor-General is generally required to:

• audit the public entity in keeping with NZ IFRS and the International Standards on Auditing; and
• address the accountability requirements relevant to each public entity and the specific requirements of legislation for our own audit work.

There has generally been stability in statutory public accountability arrangements since 2002-04. However, considerable flow-on audit implications have arisen from statutory changes made in 2002-04.¹ Overall, these changes have been extremely beneficial for the Office. They have provided a platform for collaborative work between our audit service providers, and a basis for development work in response to the dominating effect of financial reporting standards.

In particular, our audit responsibilities for LTCCPs and associated amendments are having a significant effect on us and our resources. At present, based on the results of the 2006 and 2009 LTCCP audits and the issues that we identified, our audit work appears to be warranted. However, a large amount of effort and resource is involved in preparing to carry out a demanding audit that occurs only once every three years.

New Zealand’s system of public sector accountability has long been regarded internationally as a model approach, and should be preserved. However, accountability requirements – including those for audit and other disclosure requirements, and the associated costs – are often a burden for smaller public entities. We are aware that not all countries share New Zealand’s requirement for universal annual audits of public entities, and that there are different accountability models for smaller public entities in other jurisdictions. This leads us to question whether the size and complexity of a public entity could be better used to differentiate accountability requirements.

Taking a longer-term view of operating environments

There is a greater focus on, and awareness of, the long-term implications of issues arising in the broader operating environment for public entities, and the need to address these issues in decision-making, financial management, and service delivery.

Taking a longer-term view in the current fast-moving economic and employment conditions raises risks for the public sector and for public entity performance, including the integrity of decision-making, financial management, and governance. It requires monitoring service delivery against long-term needs and plans.

For some time, there has been general public concern about asset development and management – particularly network utility assets, because of their critical importance to communities throughout New Zealand. It is vital for the public to have confidence that these assets and other important services, such as health and welfare services, will continue to be available and will meet changing community needs.

Arrangements for asset management and service delivery, and for associated information and reporting, are becoming more complex. Arrangements need to take account of a range of factors such as inter-generational equity, short-term and long-term well-being, and value for money in terms of community outcomes.

Taking a longer-term view and providing greater certainty about the availability and service capability of key assets is likely to result in a growing range of funding and delivery arrangements between public entities, the private sector, and the non-government sector. Issues about procurement, governance, conflicts of interest, and misuse of resources need to be developed and understood in the context of the wider purposes of these arrangements. Deciding whether funds have been spent wisely and with due probity is more challenging in this environment.

An increased emphasis in statute and public expectations of consultation and regard for specific matters in decision-making, combined with complex and long-term asset management and development needs, is requiring careful judgement within our inquiries.

Effect of adopting International Financial Reporting Standards

The Accounting Standards Review Board’s decision to adopt NZ IFRS has had a significant effect on the public sector and our work during the past four years.

Public entities were required to prepare financial statements under NZ IFRS for periods starting on or after 1 January 2007.

While the transition to NZ IFRS is now mostly complete, we expect an ongoing level of adjustment and review of standards as NZ IFRS “settles”. However, more importantly, the standards (which were written to be applied by large profit-oriented entities) do not adequately acknowledge the needs of the public sector. Standards that are not appropriate for the public sector environment may generate concern and confusion for public entities and those interested in their reports.

The change to NZ IFRS has increased the complexity for those preparing financial reports and those auditing them. It has put pressure on the financial management capability of the public sector, and has contributed to a high demand for financial and audit expertise throughout the private and public sectors. The combination of complexity and shortage of expertise is affecting the overall performance of the public sector in meeting public accountability statutory requirements. For example, the number of audit opinions in arrears on audit reports at 30 June increased from 312 in 2006 to 362 in 2007 to 453 in 2008. This reflects the increasing pressure on those preparing financial reports and on auditors.

Increasing audit fees

Public sector audit fees have been increasing to keep pace with the wider international demand for accounting and assurance expertise. There are two main factors:

• increased audit costs because audits under NZ IFRS take longer; and
• increased demand for accounting and assurance expertise as a result of developments in both accounting and auditing standards.

Fees overall, including an allowance for the ongoing work associated with NZ IFRS, increased by about 9% for 2007/08. We also experienced greater overruns of audit hours against those anticipated. This fee pressure is likely to continue for the foreseeable future, although it may be blunted somewhat by the current economic downturn.

What Parliament and public entities expect of us

We collect feedback from public entities, select committees, and other stakeholders to give us insight into opportunities for us to contribute to public sector accountability and performance, and the public’s trust in the public sector.

Our 2007/08 client satisfaction survey of public entities showed improved results on the previous year. However, overall results suggested a need for:

• changing our focus to give more attention to a public entity’s business – for example, carrying out a “business audit” rather than just an “accounting audit”, by identifying issues and helping to provide solutions, by sharing beneficial information from others with similar issues, and by sharing best practice information;
• improving our legislative, sector, and public entity knowledge so that we base audit recommendations on a better understanding of each public entity’s context;
• more timely communication to increase consistency among auditors, keep public entities abreast of audit expectations and progress with audit work, and inform public entities about changes in legislative and accounting requirements; and
• ensuring consistency of staff on audits by addressing high auditing staff turnover and increasing the skills of junior auditing staff.

The results of the 2007/08 survey of select committee members and other stakeholders were positive overall, suggesting that the Office is well respected. The main suggestions for development were that we should:

• provide advice on issues beyond financial reporting • ting (while confining advice to areas in which we have established competence); and
• assist select committees to follow up on Estimates and financial review examinations.

Changing the focus of our annual audits of public entities

In the past couple of years, our annual audit work has had to focus more heavily on public entities’ financial statements, and particularly on compliance with the new NZ IFRS requirements. The increased focus of our annual audits on financial statements has been at the expense of our attesting on service performance information and the wider public-interest purposes of our audit work.

We have been telling government departments, Crown entities, and local authorities of our intention to phase in, during 2009-11, the Auditor-General’s revised auditing standard on service performance information (AG-4).

Under this revised standard, auditors will report through annual audits on whether a public entity’s service performance report:

• provides an adequate basis for the assessment of service performance; and
• fairly reflects the public entity’s service performance.

The current financial pressure has heightened the need for us to do further development work to support the implementation of our revised standard.

1: Examples of these changes include the Local Government Act 2002, the Crown Entities Act 2004, and the 2004 amendments to the Public Finance Act 1989.