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Part 3: Novopay's effect on school audits

Schools: Results of the 2012 audits.

Background

3.1
New Zealand's 2500 or so state schools have about 750,000 students. The major cost of schools is the employment of teachers and other staff. Schools spend about 63% of their total costs on staff. Also, most schools' income is directly related to staff. About 53% of their income is by way of a grant from the Ministry for teachers' salaries. With some limited exceptions, schools use the Ministry's outsourced payroll service for the payment of all their staff.

3.2
The Ministry pays about $170 million to about 90,000 people each fortnight through its outsourced payroll service. In August 2012, the Ministry introduced Novopay. In its report on the schools sector for 2012, the Ministry noted that:

Problems with the Novopay system were evident from the first pay round, with approximately 5,000 staff underpaid, approximately 700 staff overpaid, and 15 people not paid at all.2

3.3
In this Part, we summarise the problems with Novopay, their effect on the 2012 school audits, and what the Ministry is doing to resolve those problems.

The problems with Novopay

3.4
Novopay was introduced in August 2012. Substantial public and media criticism followed, particularly before the Ministry was satisfied that it had stabilised the operation of Novopay in mid-2013. In summary, the criticisms covered:

  • the number of employees that were not paid, underpaid, or overpaid;
  • the financial and other effects on staff;
  • the financial and other effects on schools;
  • the other types of errors that Novopay was generating;
  • the inaccuracy of the reports that Novopay produced;
  • the lack of support for schools despite their enhanced role in data entry and ensuring data quality;
  • the additional work that schools had to carry out to administer their payroll; and
  • the extra costs needed to make Novopay work to an acceptable standard.

3.5
There have been several reviews of the problems that arose when introducing Novopay. The main reviews have been a Technical Review by Deloitte in March 2013 and a Ministerial Inquiry in June 2013, which gave an account of the reasons for the problems. The main findings from these reviews were that:

  • Weaknesses in project governance and leadership allowed Novopay to go live with significant risks.
  • Novopay was not adequately developed or tested in some important respects.
  • The payroll service centre was not fully ready to go live.
  • Schools were not ready and the Ministry did not adequately train and support school staff.
  • Novopay cost much more than had been forecast.

3.6
Considerable publicity about the extent of errors followed Novopay's introduction. These errors include under- and overpayments, and schools being incorrectly charged with other schools' employees.

3.7
We asked the Ministry for information about the extent of the errors, so that we could consider them in relation to the overall payroll and put them into perspective. The Ministry does not have this information available at a school level. However, the Ministry has given us some analysis of overpayments.

3.8
The amount of established debt relative to total payroll indicates the extent of overpayments. For the last few months of 2012, after the transition to Novopay, debt was 0.56% of payroll, compared to an average of 0.07% under the previous system, Datacom. The percentage has since dropped to 0.15% for 2013.

3.9
The average value of debt outstanding to schools under Datacom fluctuated between $230 and $714 a school. In December 2013, this debt was $4,308. This did not directly affect schools' operational funding because most overpayments relate to teachers' salaries, which the Ministry pays. Most (2029) schools had total overpayments from operations grants of less than 1% of their operations grant funding.

Schools' financial reporting

3.10
The Education Act specifies that schools should prepare audited financial statements. These are to show the school's financial performance and financial position – income and expenditure during the year and assets and liabilities at the end of the year. Schools should submit draft statements to the auditor by 31 March in the following year. The Ministry should receive the audited statements by 31 May.

3.11
The Auditor-General is responsible for carrying out the annual audits of schools' financial statements. The Auditor-General discharges this responsibility by appointing auditors from about 35 audit firms to carry out the about 2500 audits on her behalf. Normally, more than 90% of school audits are completed by the statutory deadline of 31 May at a total cost of about $10.5 million and with no modified audit opinions because of payroll-related matters.

3.12
Our audits are designed to provide assurance that a school's financial statements fairly reflect the school's financial performance and financial position. We carry out our audits to provide reasonable assurance about whether the statements are free from material misstatements. We do not look at every transaction, and we do not guarantee that the statements are completely accurate.

3.13
Material misstatements are differences or omissions of amounts and disclosures that, in our judgement, are likely to influence a reader's overall understanding of the statements. If we find material misstatements that are not corrected, we refer to them in our audit opinion.

3.14
The results of each school audit are contained in an audit report, which is a public document attached to the financial statements of each school, and a management letter, which is addressed to each board. Auditors who are not satisfied with the figures in the financial statements are expected to issue a modified audit opinion.

3.15
To ensure that our school audits are as efficient as possible, we have a centralised audit approach to schools' payrolls. It would be substantially more expensive for our audit teams to carry out their 2500 school audits solely using the information available at each school. Every year, the Auditor-General's appointed auditor of the Ministry audits the central payroll system and provides assurance that the annual payroll reports that the system produces may be relied on for the purposes of preparing schools' financial statements.

3.16
In previous years, the Ministry has provided schools with their annual payroll reports by mid-January. This has allowed most schools to submit their draft financial statements to the school auditor by the 31 March deadline. The assurance report from our appointed auditor of the Ministry on the work carried out on the central payroll system is normally available by the end of February. This has allowed school auditors to complete most of their audits by the 31 May deadline.

The 2012 financial reporting process of schools

3.17
Because payroll has such a significant effect on the expenditure of schools and related grant income, the Novopay problems have had a significant effect on our 2012 audits of schools.

3.18
At the time of our audits, the Ministry was focused on stabilising the Novopay system to pay school employees accurately and consistently. Understandably, preparing historical payroll information for financial reporting purposes had a lower priority. This affected our audit work.

3.19
We started our 2012 central assurance work late and found that:

  • We could not rely on the controls operated centrally to the same extent that we could in previous years. For example, data input in the Novopay service centre was not reviewed independently.
  • New errors were being generated each pay period, adding to the significant number of transactions to be processed, including corrections of previous errors.
  • Compared with the previous system, Novopay relies far more on schools checking for and detecting errors. However, schools have limited opportunity to check their payroll.
  • We could not confirm the Novopay data on banking staffing, which measures the extent to which schools have used their annual staffing entitlements for teachers, or on staff leave balances.
  • The Ministry had problems accessing some of the data. This affected the ability of the Ministry to answer questions about the data in a timely way.
  • The security of data needed to be improved.

3.20
The annual payroll reports were not made available to schools until mid-March 2013 they would usually be expected in early-to-mid February. The data was difficult for schools to reconcile and contained errors. Therefore, many schools submitted their draft financial statements to their auditor with incorrect or no payroll figures.

3.21
We had to carefully consider the balance between having audits completed on time, minimising additional audit fees, and not issuing modified audit opinions unnecessarily. Because of the late availability of the end-of-year payroll reports, we concluded that it would not be possible to achieve the normal 90% completion rate by the statutory deadline. We concluded that it was in the public interest to delay completing our audits to avoid issuing modified audit opinions unnecessarily – it would be better for us do more work to be able to provide positive assurance on the financial statements.

3.22
We considered the option of not extending the audit work carried out centrally and at each school, but this would have resulted in many modified audit opinions. Public confidence in Novopay was already low. We did not wish to reinforce that low public confidence unnecessarily.

3.23
Schools had little confidence in the accuracy of the payroll information, and many schools spent considerable time on payroll matters. This made it more likely that there would be less focus on financial reporting processes.

3.24
Because we had concluded that the controls within Novopay could not be relied on, we had to carry out more extensive and detailed checks of payroll transactions than in previous years. This work could not begin until the middle of March 2013, when the annual payroll reports became available. To confirm the accuracy of the annual payroll reports, we compared a sample of these reports with the base payroll data. We extended our usual anomaly identification process.

3.25
The central assurance work was carried out in phases, with school audits being released for completion in batches between late April and late June 2013. We worked closely with the Ministry and received satisfactory explanations for many of the apparent anomalies that we identified. However, the final batch of schools to be released contained anomalies that were not possible to resolve centrally. For these, the Ministry had to tell the schools and we had to tell auditors that schools had to satisfactorily resolve these anomalies.

3.26
Despite the additional work we carried out centrally, many school audit teams had to do more audit work to assess the significance of errors that had not been corrected and to consider whether our central assurance work had missed any errors.

3.27
The total cost of this additional audit work was about $1.56 million: $0.66 million on the more extensive central assurance work and about $0.90 million on additional audit fees for school auditors. The Ministry met these additional audit fees. The annual audit fees that all schools pay totalled about $10.5 million.

3.28
Only 772 (31%) of audits were completed by the statutory deadline of 31 May 2013. Our appointed auditors have other work from June onwards, much of it outside the public sector, and, therefore, had to fit in the remaining 1708 school audits with their other work. At the time of finalising this report, about 30 (1%) of the 2012 audits had yet to be completed.

3.29
By the time this report was being finalised, only five audit opinions had been modified because of Novopay.

Banking staffing and accrued leave

3.30
Schools are allocated an annual staffing entitlement, expressed in full-time teacher equivalent units, which is reduced as teaching days are used. The banking staffing facility allows teaching resources to be used flexibly. Any unused full-time teacher equivalent units are effectively "banked" and may be used later in the year for staffing above a school's entitlement.

3.31
Under- or overuse of a school's entitlement normally results in either an asset (a net underuse is reimbursed in cash) or liability (a net overuse will be deducted from the school's operations grant for the following year) being recorded in the school's financial statements.

3.32
The "balancing period" for banking staffing normally extends to 31 March of the following year, when the school may reduce their under- or overuse and the resulting asset or liability. However, because of problems with Novopay, the Ministry decided to modify the banking staffing facility and extended the balancing period from one year to two years, with the option that schools could settle their banking staffing balances if they wished.

3.33
This meant that for most schools, no asset or liability for banking staffing was recorded in their financial statements at 31 December 2012 because the balancing period had not ended. The position has since returned to normal for the 31 December 2013 financial statements of schools. However, for many schools the recorded asset or liability at 31 December 2013 will reflect a two-year "wash-up" rather than the normal one year.

3.34
The use of the banking staffing facility has evolved to enhance the way banking staffing works for schools, but the underlying system has not changed. Schools receive a staffing entitlement to employ regular teachers. The Ministry funds schools separately through operations grants for short-term relief teachers. However, since 2002, schools have been allowed to use any banking staffing under-use for short-term relief teachers.

3.35
When introducing Novopay, the Ministry discovered that the rate it used to calculate banking staffing usage for short-term relief teachers encouraged schools to use short-term relief teachers instead of regular teachers. This indirectly created additional entitlement and led to the Ministry providing considerable additional funding to schools for teachers between 2004 and 2011. The Ministry estimated this additional funding to be about $420 million over this period.

3.36
The Ministry has now adjusted the rate at which short-term relief teachers are charged to banking staffing to remove the incentive and equalise the cost to the Ministry of funding short-term relief teachers through banking staffing or operational funding. However, incentives remain (to a lesser extent) within the banking staffing facility in relation to the use of long-term relief teachers. We understand that the Ministry is closely monitoring how schools use these teachers.

3.37
The Ministry has focused more on ensuring that Novopay's banking staffing report is reliable, particularly in relation to the effect of overpayments on banking staffing balances.

3.38
The Ministry has told us that it intends to carry out a comprehensive review of the banking staffing facility in 2014. Because of the complexity of banking staffing, we fully support the Ministry's proposal to carry out such a comprehensive review.

3.39
Historically, the Ministry had not had reliable enough records of annual leave for non-teaching staff in schools to be in a position to require schools to record a liability for annual leave in their financial statements. However, some schools have maintained their leave records, which have been considered reliable enough to support the recording of a liability in the school's financial statements. Such liabilities can be recorded only if it is possible to make a reliable estimate of the amount owing.

3.40
We have taken a pragmatic view of this matter on the understanding that the introduction of a new payroll system would result in reliable leave records, which would support including annual leave liabilities in the financial statements of schools.

3.41
Unfortunately, despite the introduction of Novopay, there remain challenges in the Ministry being able to provide all schools with reliable information about outstanding leave balances to support recording an annual leave liability.

3.42
We will continue to liaise with the Ministry about this matter and advise our auditors when this information becomes reliable enough for the routine inclusion of an annual leave liability in schools' financial statements. We hope that most schools will be able to recognise this annual leave liability in their 2013 financial statements.

How the Ministry of Education addressed problems with Novopay

3.43
As the Ministerial Inquiry report noted, when the problems with Novopay became apparent in September 2012, their nature and scale overwhelmed the Ministry and its outsourced provider of payroll services. It took until early 2013 for the Ministry to begin to take major steps to stabilise Novopay and its supporting processes, including setting up a specialised Novopay business unit in March 2013.

3.44
During the last year, the Ministry has devoted substantial time and effort to resolving the problems. Although the Ministry considers that it has stabilised the routine payroll operation, much work remains to ensure that Novopay can provide a reliable payroll service in the long term. As part of the fortnightly pay cycle, the Ministry relies on many manual procedures that use a lot of resources and are inconsistent with the objective of moving to the Novopay system.

3.45
The Ministry considers that it achieved a steady state with Novopay in mid-2013. However, the Ministry acknowledges that, more than 18 months after Novopay went live, much remains to be done to ensure that a robust and sustainable outsourced payroll service is in place with minimal manual procedures. Recent problems with the 2014 "start of year" payroll processes underscore this.

3.46
Since mid-2013, the Ministry has begun remedial work, such as in:

  • data quality;
  • controls at the Novopay pay centre; and
  • security and privacy.

3.47 Also, the Ministry continues work to resolve problems with:

  • overpayments;
  • leave; and
  • tax.

3.48
The Ministry has told us about further remediation plans for Novopay. The Ministry considers that putting these plans into effect should progressively improve the performance of the Ministry's outsourced payroll service and the confidence that users have in the service.

3.49
However, in the short term, we expect considerable resources to continue to be applied to Novopay problems, so regular pay runs can be successful, with few manual procedures, system errors, and data quality problems.

3.50
Schools now play a larger role in the payroll process. It is important that all schools fully appreciate this enhanced role and are able to respond appropriately. The Ministry needs to consider providing further guidance to schools about the main controls that each school should have to increase assurance that Novopay is working effectively and consistently.

Avoiding delays in schools' 2013 financial reporting

3.51
To improve the financial reporting process, the Ministry has:

  • made annual payroll reports available to schools earlier than last year, and each school has been sent a supporting schedule of adjustments that have to be made to the figures in the annual payroll reports to prepare their financial statements; and
  • better supported schools in the financial reporting process with guidance on financial reporting and standard payroll processes.

3.52
However, the need to ensure that resources have been available to help resolve operational problems associated with fortnightly pay runs has limited the Ministry's actions. Because of ongoing operational problems and problems with collating payroll information for each school, the Ministry has not been able to provide the necessary payroll information to schools in the time frame set. The Ministry has provided information about six weeks later than planned, which is likely to delay the completion of the 2013 school audits.

3.53
Although the Ministry has provided schools with further guidance about the 2013 financial reporting process, the process is complex because of payroll errors, which schools need to account for when preparing their financial statements.

3.54
Because of delays in the Ministry providing payroll information to schools, we have only recently completed our central assurance work on 2013 payroll information. We have been able to provide assurance to our auditors about:

  • the annual payroll reports used in the financial statements of schools;
  • withdrawals from the Ministry's and schools' bank accounts as reflected in the payroll reports;
  • the allocation of costs between salaries grants and operations grants;
  • banking staffing information; and
  • accrued leave.

Novopay's effect on our audit of the Ministry of Education

3.55
Novopay also affected our 2012/13 audit of the Ministry, because the cost of the Education Services payroll is included in the Ministry's non-departmental schedules in the Ministry's financial statements.

3.56
In its statement of service performance, the Ministry reported on the accuracy of payments made throughout the year to 30 June 2013, the first 11 months of Novopay's operation. The lowest fortnightly reported performance was 86%, with an average of 96.7% against a target of 100%.

3.57
In our 2012/13 audit report, we drew attention to the disclosures in the Ministry's financial statements about matters that arose during 2012/13 relating to the Ministry's provision of education services payroll.

3.58
Also, delays in the completion of school audits because of problems with Novopay affected the Ministry's sub-consolidation of school results for preparing the Government's financial statements. The major effect was that the Ministry had to make more use of 2011 audited financial information from schools instead of 2012 information.

3.59
We have reported to the Ministry about our assessment of the management control environment for Novopay. As noted in paragraph 3.5, the Ministry has also received the Ministerial Inquiry report, a technical review of the problems arising from the use of Novopay, and some other specifically targeted reports from other sources.

3.60
We have recommended some improvements and the Ministry is continuing to work on putting changes into effect to make Novopay more reliable.


2: Ministry of Education (2012), New Zealand Schools Ngā Kura o Aotearoa: A report on the compulsory schools sector in New Zealand – 2012, Wellington, page 20, available at the Ministry of Education's Education Counts website, www.educationcounts.govt.nz.

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CoverSchools: Results of the 2012 audits

ISBN 978-0-478-41069-3 (print)
ISBN 978-0-478-41070-9 (online)