3.4 Auditing the Balanced Budget Requirement

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Section 100(1) of the Local Government Act 2002 (the 2002 Act) requires local authorities to set each year’s operating revenue at a level sufficient to meet operating expenses, i.e. “balance the budget”. However, section 100(2) of the 2002 Act allows a local authority to set projected operating revenues at a different level from that which would be necessary to meet operating expenses, provided that the local authority resolves that it is financially prudent to do so, having regard to –

(a) the estimated expenses of achieving and maintaining the predicted levels of service provision set out in the long-term council community plan, including the estimated expenses associated with maintaining the service capacity and integrity of assets throughout their useful life; and

(b) the projected revenue available to fund the estimated expenses associated with maintaining the service capacity and integrity of assets throughout their useful life; and

(c) the equitable allocation of responsibility for funding the provision and maintenance of assets and facilities throughout their useful life; and

(d) the funding and financial policies adopted under section 102.

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The intent of this provision is to ensure that local authorities make adequate and effective provision for the ongoing maintenance of service levels.

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A variation of this provision was first introduced in 1996 with an amendment to the Local Government Act 1974 by the Local Government Amendment Act (No. 3) 1996. The wording of the earlier section was a more prescriptive balanced budget requirement. This earlier section had the effect of requiring local authorities to cash fund their depreciation expense (subject to a few limited exceptions) and became known as the funding of depreciation requirement.

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While the 2002 Act provides greater flexibility to allow local authorities not to balance the budget, it increases the complexity of the judgements that auditors need to make in assessing compliance.

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We are therefore currently developing our expectations as to what work we will expect our auditors to undertake to assess compliance with section 100(1) for the financial year ending 30 June 2006 (the first year in which a local authority must have its long-term council community plan (LTCCP) audited).

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For the financial year ending 30 June 2004 (and also the financial year ending 30 June 2005) we have advised our auditors that they need to ask local authorities how they have demonstrated compliance with section 100(1).

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For those local authorities which indicate that they have not complied with section 100(1), we expect that they will have:

• made reasonable efforts to assess the impact of their decision not to set each year’s projected operating revenues at a level sufficient to meet that year’s projected operating expenses in terms of the considerations set out in section 100(2)(a), (b), (c) and (d);
• resolved not to set projected operating revenues at a level sufficient to meet that year’s projected operating expenses;
• included a statement in the LTCCP that the budget does not balance, and the reasons for this decision; and
• identified any information deficiencies – in terms of being able to demonstrate compliance with the considerations set out in section 100(2)(a), (b), (c) and (d) – and put in place an action programme for remedying these deficiencies before 2006.

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If these steps are taken, and the decision to not comply with section 100(1) appears prudent, then we have advised our auditors that it will not be necessary to make any reference to the non-compliance in the audit opinions that are issued on a local authority’s financial statements.

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We have advised local authorities of these expectations in our newsletter titled Auditing The Future: Project Update #2, December 2003. The newsletter is available on our web site at www.oag.govt.nz.