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Appendix: Our audit report on the financial statements of the Government

Central government: Results of the 2017/18 audits

INDEPENDENT AUDITOR’S REPORT

TO THE READERS OF THE FINANCIAL STATEMENTS OF THE GOVERNMENT OF
NEW ZEALAND FOR THE YEAR ENDED 30 JUNE 2018

Opinion

I have audited the financial statements of the Government of New Zealand (the financial statements of the Government) for the year ended 30 June 2018 using my staff, resources, and appointed auditors and their staff. The financial statements of the Government on pages 36 to 138 comprise:

  • the annual financial statements that include the statement of financial position as at 30 June 2018, the statement of financial performance,analysis of expenses by functional classification,statement of comprehensive revenue and expense, statement of changes in net worth,and statement of cash flows for the year ended on that date, a statement of segments, and notes to the financial statements that include accounting policies, borrowings as at 30 June 2018, and other explanatory information;
  • a statement of unappropriated expenditure for the year ended 30 June 2018;
  • a statement of expenses or capital expenditure incurred in emergencies for the year ended 30 June 2018; and
  • a statement of trust money administered by departments for the year ended 30 June 2018.

In my opinion, the financial statements of the Government on pages 36 to 138:

  • present fairly, in all material respects the Government’s:
    • financial position as at 30 June 2018;
    • financial performance and cash flows for the year ended on that date;
    • borrowings as at 30 June 2018;
    • unappropriated expenditure for the year ended 30 June 2018;
    • expenses or capital expenditure incurred in emergencies for the year ended 30 June 2018; and
    • trust money administered by departments for the year ended 30 June 2018;
  • comply with generally accepted accounting practice in New Zealand, in accordance with Public Benefit Entity accounting standards.

My audit was completed on 1 October 2018. This is the date on which my opinion is expressed.

The basis for my opinion is explained below and I outline the key audit matters addressed in my audit. In addition, I outline the responsibilities of the Treasury and the Minister of Finance and my responsibilities relating to the financial statements of the Government. I also comment on other information and explain my independence.

Basis for opinion

I carried out my audit in accordance with The Auditor-General’s Auditing Standards, which incorporate the Professional and Ethical Standards and the International Standards on Auditing (New Zealand) issued by the New Zealand Auditing and Assurance Standards Board. My responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the financial statements of the Government section of this report.

I have fulfilled my responsibilities in accordance with The Auditor-General’s Auditing Standards.

I believe that the audit evidence I have obtained is sufficient and appropriate to provide a basis for my opinion.  

Key audit matters

Key audit matters are those matters that, in my professional judgement, were of most significance in my audit of the financial statements of the Government for the current year. In applying my professional judgement to determine key audit matters, I considered those matters that are complex, have a high degree of uncertainty, or are important to the public because of their size or nature. This year, I have included the entitlements under the Holidays Act 2003 as a key audit matter because of the significant uncertainties associated with the obligations to remediate issues under the Act and the public interest in this matter as it affects a significant number of current and former public servants.

The key audit matters addressed in my audit of the financial statements of the Government as a whole, and in forming my opinion thereon, are as follows.

Recognising tax revenueHow we addressed this matter

The largest source of revenue for the Government is income tax. This revenue source totals $51.8 billion for the year ended 30 June 2018.

As outlined in Note 2, income tax is subject to significant assumptions and judgements due to the timing differences between the reporting date and when taxpayers file tax returns.

In order to record tax revenue, judgement is applied to estimating:

  • the amount of tax revenue to be collected from provisional taxpayers who have not yet filed their final tax return;
  • the amount of tax revenue where payments have been received but no provisional or final tax return has been filed; and
  • the amount of tax revenue to be collected from, or refunded to, taxpayers who are not subject to provisional tax.

We obtained an understanding of the systems, processes, and controls in place over the receipt and review of provisional and final tax returns, tax assessments, and tax revenue receipts.

We assessed controls in place over significant reconciliation processes.

We tested the underlying data used in the various tax revenue estimation models to ensure that it was relevant and was used appropriately. This was performed by reviewing evidence to support key assumptions. The sensitivity of key assumptions was also tested.

We tested the reasonableness of the estimation models by checking actual revenue received related to previous financial years against estimates made in those years.

I am satisfied that the assumptions and judgements applied in estimating tax revenue are reasonable.

Valuing property, plant, and equipment

How we addressed this matter

The Government owns significant physical assets totalling $159.0 billion.

The valuation of some of these assets requires significant judgement due to the uncertainties inherent in the valuation of these assets, the quality of data available, and the benefits these assets provide. I have identified some specific assets where such judgements are evident.

 

 

State highway network

As outlined in Note 16, the state highway network has been valued at $31.7 billion at 30 June 2018 by an independent external valuer. Due to the unique nature of the state highway network, the value of the assets cannot be measured with precision. Significant estimates and assumptions have been applied to the valuation, which include assumptions on: quantities and rates used in the construction of state highway network components, the remaining life of the assets, and the unit costs to apply. Changes to the underlying estimates and assumptions can cause a material movement in the state highway valuation.

There are some uncertainties about the values assigned to different components (formation, bridges, etc.) of the state highway network due to limited information on quantities and useful lives within some databases and incomplete information relating to certain cost components.

Some of the costs associated with road construction (for example, traffic management) in urban areas are assessed as being a significant part of the network that may potentially be undervalued. An allowance to recognise these costs has been included since 2014 where a reliable estimate can be made.

We obtained an understanding of how the state highway network is valued, the significant estimates and assumptions used, and the reasonableness thereof. This involved confirming the competence, capabilities, and objectivity of the valuer, challenging the valuers’ key assumptions, and assessing the valuation procedures, including the information extracted from databases. We also considered whether there were any limitations placed on the valuer and the appropriateness of centrally calculated rates that were applied to the valuation.

We also carried out audit procedures to confirm that key controls were operating over the systems and processes used to record cost and other asset information related to the state highway network.

I am satisfied that the value of the state highway network at 30 June 2018 is reasonable and consistent with valuation practices, and that the disclosures outlining the inherent uncertainties in the valuation are appropriate.

Rail network

As outlined in Note 16, the rail network has been valued at $1.2 billion at 30 June 2018. In arriving at this value, the freight and the metro transport parts of the network have been valued on different bases, reflecting the commercial nature of the freight part of the network and the public benefit nature of the metro transport part of the network.

The extent to which the freight part of the network is commercial is open to debate. The Government is currently conducting a review of rail, which is working towards defining the purpose of rail and determining the appropriate structure and capital requirements and funding mechanisms for KiwiRail in future years. This review is ongoing and might result in changes that could affect the valuation of the freight part of the network.

As outlined in Note 16, the valuation of the rail network could increase by up to $5.0 billion if the entire rail network was not considered commercial and it was valued on an optimised depreciated replacement cost basis.

We considered the evidence around the commercial nature versus the public benefit nature of the freight part of the rail network. The evidence included reviewing:

  • the State-owned Enterprises Act 1986;
  • strategy documents;
  • forecast results;
  • correspondence setting out the Ministers’ expectations; and
  • minutes from KiwiRail Board meetings.

As in past years, the evidence showed mixed results for the commercial nature versus the public benefit nature of the freight part of the rail network.

We also considered the updated terms of reference for the review of rail in New Zealand. The outcome of the current review will be key in deciding whether valuing the freight network on a commercial basis remains appropriate.

Due largely to the current review of rail, I am satisfied that the judgement to value the freight part of the network on a commercial basis for the current year, although marginal, remains reasonable, and that the disclosures appropriately outline the significant judgements.

Electricity generation assets

As outlined in Note 16, the electricity generation assets, which are at least 51% owned by the Government, are valued at $15.9 billion at 30 June 2018.The valuation of these assets is carried out by specialist valuers because of the complexity and significance of the assumptions about the future prices of electricity, the generation costs, and the generation volumes that these assets will create.

As a result, small changes to these assumptions, in particular, the forecast prices of electricity and the discount rates used to determine the present value of these prices – could significantly change the value of these assets.

We obtained an understanding of how electricity generation assets are valued. This involved confirming the competence, capabilities, and objectivity of the valuers, testing the valuers’ procedures for carrying out the valuations, including the information they used to carry them out, and challenging the valuers’ critical assumptions and judgements. We also used our own valuation specialists to assess the valuers’ procedures.

We tested the sensitivity of the key underlying assumptions used by the valuers to ensure that they were reasonable, and we compared the forecast prices of electricity to the expected longer-term wholesale prices and market data where it was available.

I am satisfied that the valuation of electricity generation assets at 30 June 2018 is reasonable, and that the disclosures appropriately outline the sensitivity and the complexity of the valuation of electricity generation assets.

Valuing insurance and superannuation liabilities

How we addressed this matter

The Government has insurance liabilities of $45.3 billion and public servants’ superannuation liabilities of $11.0 billion as at 30 June 2018. The valuation of these liabilities is complex and requires actuaries to estimate the value, based on assumptions about the future. I have identified some specific liabilities because of the significance of the value of those liabilities and the uncertainties inherent in the valuations.

 

Accident Compensation Corporation’s outstanding claims liability

As outlined in note 11, the outstanding claims liability of the Accident Compensation Fund (ACC) has been valued at $40.6 billion at 30 June 2018 by an independent actuary.

Key assumptions used to value the outstanding claims liability include:

  • selecting an appropriate risk-free discount rate to present value future cash flows;
  • selecting an appropriate risk margin for the inherent uncertainty in the estimate of the present value of future cash flows;
  • estimating the impact of inflation and innovation on future medical costs; and
  • estimating the length of rehabilitation from injuries.

The sensitivity of each assumption is analysed in Note 11. This sensitivity analysis indicates that assumptions are closely linked, cannot be viewed in isolation, and changes in assumptions can have a large impact on the value of the liability as well as the actuarial gain or loss recognised.

We obtained an understanding of how ACC’s outstanding claims liability is valued by assessing the reasonableness of the approach taken to value the liability. We also reviewed the key assumptions adopted by ACC for each significant claim type to ensure that these were appropriate.

We tested the systems and controls and carried out detailed testing of the process for recording claims.

We tested key assumptions by evaluating them against past claims experience. We assessed the reasonableness of forecasts that diverged from past experience by looking at the evidence supporting the forecasts.

We engaged our own actuaries to review the scope, approach, and reasonableness of the estimate of the liability.

We tested the reconciliations of the underlying claims data to ACC’s systems, examined the sensitivity analysis for movements in key assumptions, and evaluated the related financial statement disclosures.

I am satisfied that the assumptions and judgements applied in estimating ACC’s outstanding claims liability at 30 June 2018 are reasonable, and that the disclosures outline the sensitivity of the valuation to changes in assumptions.

Government Superannuation Fund’s unfunded liability

As outlined in Note 20, the Government’s liability for public servants’ superannuation entitlements for past and current members of the Government Superannuation Fund has been valued at $11.0 billion at 30 June 2018 by an independent actuary.

The present value of the unfunded liability is also sensitive to the estimated return on the Fund’s assets, expected rates of salary increases for public servants who are members of the Fund, and estimated inflation and discount rates. The Fund's assets are exposed to share price risks arising from its holding of equity instruments. Equity instruments are reported at fair value. Movements in share prices therefore directly translate into movements in the value of the share investment portfolio.

The sensitivity of critical assumptions and judgements is analysed in Note 20. This sensitivity analysis indicates that assumptions are closely linked, cannot be viewed in isolation, and changes in assumptions can have a large impact on the value of the liability.

We obtained an understanding of how the Government’s liability for public servants’ superannuation entitlements is valued. This involved confirming the competence, capabilities, and objectivity of the actuary, as well as testing the actuary’s valuation procedures. We engaged our own actuaries to review the assumptions, judgements, and procedures used to value the liability.

We tested key controls that ensure the completeness and accuracy of membership data that was used in the actuary’s valuation.

We evaluated the appropriateness of key assumptions used in estimating the return on assets owned by the Fund and compared the expected rates of salary increases against external benchmarks.

I am satisfied that the Government’s reported liability for public servants’ superannuation entitlements at 30 June 2018 is reasonable, and that the disclosures outline the sensitivities of the valuation to changes in assumptions.

Valuing financial assets and liabilities

How we addressed this matter

As outlined in Note 26, as at 30 June 2018, the Government has financial assets of $142.5 billion (of which $80.3 billion are valued at fair value and $62.2 billion are valued at amortised cost) and financial liabilities of $131.2 billion (of which $10.2 billion are valued at fair value and $121.0 billion are valued at amortised cost).

Financial assets and liabilities measured at fair value include derivatives (which have a principal value of $232.5 billion), marketable securities, and share investments.

Where quoted market prices are not available to determine the value of financial assets and liabilities, fair value must be estimated. This is done by applying a valuation approach that is most appropriate for the asset or liability, such as using valuation models. Inputs into the models will use market data when available; otherwise inputs are derived from non-market data, which requires judgement.

The fair value of financial assets and financial liabilities that are valued using non-observable inputs are valued at $4.3 billion and $0.06 billion respectively.

We obtained an understanding of the valuation techniques, controls, and inputs used to determine the fair value of financial assets and liabilities. 

We also carried out a range of audit procedures that reflected the nature of the financial assets and liabilities being valued, the valuation techniques adopted, and the uncertainties that existed in determining their fair values. These audit procedures included:

  • testing the internal controls in place over data relating to financial assets and liabilities that has been entered into financial and treasury systems;
  • obtaining an understanding of the controls and valuation approaches applied where a fund manager carries out the valuation;
  • comparing the fair value of financial assets and liabilities to independent information and investigating any significant variances; and
  • assessing the appropriateness of the inputs used for valuing financial assets and liabilities where the fair value was dependent on non-observable inputs.

I am satisfied that the fair values of financial assets and liabilities at 30 June 2018 are reasonable and that the disclosures outline the significant judgements.

Entitlements under the Holidays Act 2003

How we addressed this matter

As outlined in Note 25, a number of entities have commenced a review of payroll calculations in order to ensure compliance with the Holidays Act 2003 and other relevant legislation.

Where possible, provision has been made in the financial statements of the Government for obligations arising from those reviews or settlement has been made in the current or previous financial year.

To the extent that an obligation cannot reasonably be quantified at 30 June 2018, an unquantified contingent liability has been disclosed. Work continues to be undertaken by entities to calculate the potential liability required to remediate the issues associated with the calculation of these entitlements. In the case of certain sectors, complexities exist and the calculation of the liability is taking longer than expected to resolve. Entities within these sectors employ a significant number of public servants and the liabilities to settle these obligations remain uncertain.

For those entities most significantly affected, we obtained an understanding of the progress made in resolving the payroll calculation issues and we assessed the reasonableness of the approach to the financial reporting of these issues.

We carried out a range of procedures to audit the liabilities recognised, including:

  • reviewing processes followed for valuing the liabilities and testing a sample of transactions,
  • assessing the competence, capabilities, and objectivity of independent experts who were involved in the valuation,
  • challenging critical assumptions and judgements made in estimating the liabilities.

Where no liability could be reliably measured, we engaged with and challenged entities and their experts to understand the complexities associated with the calculation of a liability, what uncertainties existed, and the progress being made to resolve these uncertainties.

I am satisfied that the liabilities recognised for entitlements represent the best estimate using available information and that, in those cases where a liability cannot be reliably measured, the disclosures are appropriate.

Responsibilities of the Treasury and the Minister of Finance for the financial statements of the Government

The Treasury is responsible for preparing financial statements of the Government that:

  • comply with generally accepted accounting practice in New Zealand, in accordance with Public Benefit Entity accounting standards; and
  • present fairly the Government’s financial position, financial performance, and cash flows; and
  • present fairly the Government’s:
    • borrowings;
    • unappropriated expenditure;
    • expenses or capital expenditure incurred in emergencies; and
    • trust money administered by departments.

The Minister of Finance is responsible for forming an opinion that the financial statements of the Government present fairly the financial position and financial performance of the Government. 

The responsibilities of the Treasury and the Minister of Finance arise from the Public Finance Act 1989.

The Treasury is also responsible for such internal control as it determines is necessary to enable the preparation of financial statements of the Government that are free from material misstatement, whether due to fraud or error. The Treasury is also responsible for the publication of the financial statements of the Government, whether in printed or electronic form.

In carrying out their respective responsibilities for the financial statements of the Government, the Treasury and the Minister of Finance are responsible for assessing the Government’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting.

Auditor’s responsibilities for the audit of the financial statements of the Government

My objectives are to obtain reasonable assurance about whether the financial statements of the Government as a whole are free from material misstatement, whether due to fraud or error, and to issue an audit report that includes my opinion.

Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with The Auditor-General’s Auditing Standards will always detect a material misstatement when it exists. Misstatements are differences or omissions of amounts or disclosures, and can arise from fraud or error. Misstatements are considered material if, individually or in the aggregate, they could reasonably be expected to influence the decisions readers take on the basis of the financial statements of the Government.

For the budget information reported in the financial statements of the Government, my procedures were limited to checking that the amounts agree to the Government’s relevant published budgets.

I did not evaluate the security and controls over the publication, whether in printed or electronic form, of the financial statements of the Government.

As part of an audit in accordance with The Auditor-General’s Auditing Standards, I exercise professional judgement and maintain professional scepticism throughout the audit. Also:

  • I identify and assess the risks of material misstatement of the financial statements of the Government, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for my opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
  • I obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the internal control used by the Treasury to prepare the financial statements of the Government.
  • I evaluate the appropriateness of accounting policies used, and the reasonableness of accounting estimates and related disclosures made by the Treasury.
  • I conclude on the appropriateness of using the going concern basis of accounting that has been used by the Treasury to prepare the financial statements of the Government, up to the date of my auditor’s report, based on the audit evidence I have obtained.
  • I evaluate the overall presentation, structure, and content of the financial statements of the Government, including the disclosures, and whether the financial statements of the Government represent the underlying transactions and events in a manner that achieves fair presentation.

As part of my audit, I obtain information from my staff and appointed auditors of the organisations that are consolidated into the financial statements of the Government, including information about:

  • elimination of transactions between the organisations that are consolidated into the financial statements of the Government;
  • application by those organisations of appropriate accounting policies and Treasury instructions to prepare the financial statements of the Government; and
  • the risks of material misstatement of the financial statements of those organisations that may affect the financial statements of the Government.

I communicate with the Treasury, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that I identify during my audit.

From the matters communicated with the Treasury, I determine those matters that were of most significance in my audit of the financial statements of the Government for the current year and are therefore the key audit matters described in this report.

I am responsible for expressing an independent opinion on the financial statements of the Government and reporting that opinion to you based on my audit. My responsibility arises from the Public Audit Act 2001.

Other information

The Treasury is responsible for the other information. The other information comprises the information included on pages 1 to 35 and 139 to 148, but does not include the financial statements of the Government and my auditor’s report thereon.

My opinion on the financial statements of the Government does not cover the other information and I do not express any form of audit opinion or assurance conclusion on that information.

In connection with my audit of the financial statements of the Government, my responsibility is to read the other information. In doing so, I consider whether the other information is materially inconsistent with the financial statements of the Government or my knowledge obtained in the audit or otherwise appears to be materially misstated. If, based on my work, I conclude that there is a material misstatement of this other information, I am required to report that fact. I have nothing to report in this regard.

Independence

While carrying out this audit, my staff and appointed auditors and their staff complied with the Auditor-General’s independence requirements, which incorporate the independence requirements of Professional and Ethical Standard 1 (Revised) Code of Ethics for Assurance Practitioners issued by the New Zealand Auditing and Assurance Standards Board and the International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants (IESBA Code).

As an Officer of Parliament, I am constitutionally and operationally independent of the Government. Prior to commencing my role as Auditor-General on 2 July 2018, I was Deputy Director-General for the Ministry for Primary Industries. Thus, the Deputy Auditor-General deals with all matters relating to the Ministry for Primary Industries. Other than this matter, and in exercising my functions and powers under the Public Audit Act 2001 as the auditor of public entities, I have no relationship with or interests in the Government.

John Ryan
Controller and Auditor-General
Wellington, New Zealand

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CoverCentral government: Results of the 2017/18 audits

ISBN 978-0-478-44296-0