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Part 2: Our audit of the Government’s financial statements

Central government: Results of the 2017/18 audits

2.1
In this Part, we report the results of our audit of the Government's financial statements for 2017/18.

2.2
We discuss matters arising from our audit, including the audit opinion and the key audit matters in our audit report on the Government's financial statements.

2.3
We issued an audit report that included an unmodified audit opinion on the Government's financial statements for 2017/18.

2.4
We issued our audit report on 1 October 2018.5

Our audit opinion

2.5
The audit report appears on pages 30 to 36 of the Government's financial statements. It includes our opinion that those statements:

  • 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; and
  • comply with generally accepted accounting practice in New Zealand, in accordance with Public Benefit Entity accounting standards.

Key audit matters and other significant matters

2.6
This is the third year in which we have included key audit matters in our audit report. Key audit matters are those matters that, in the auditor's professional judgement, are of most significance in the audit of the financial statements.

2.7
In determining the key audit matters, we considered matters that, in our view, were complex, had a high degree of uncertainty, or were otherwise important to the public because of their size or nature. The key audit matters for 2017/18 were:

  • recognising tax revenue;
  • valuing property, plant, and equipment;
  • valuing insurance and superannuation liabilities;
  • valuing financial assets and liabilities; and
  • entitlements under the Holidays Act 2003.

2.8
We discuss these matters in paragraphs 2.14 to 2.61 below.

2.9
Accounting for and reporting these matters was not straightforward, not least because of the judgements, estimates, and assumptions underpinning their recognition and measurement. These included assumptions and judgements about the future, particularly the service benefits and cash flows that could be expected from existing assets and liabilities. They could also include assumptions about market prices, interest rates, foreign exchange rates, inflation rates, and discount rates.

2.10
We have included entitlements under the Holidays Act 2003 as a key audit matter for the first time this year because of the significant uncertainties associated with the obligations to remediate issues under the Act and the slow response across government as a whole to address this issue. There is public interest in this matter because it affects a significant number of people employed (and previously employed) in the public sector.

2.11
We have not included social housing as a key audit matter this year (as was done last year) because the Government has discontinued the sale of social houses. Accordingly, encumbrances placed on properties previously identified for sale were removed. The encumbrances had added a complicating factor to the valuation of those properties that required significant judgement. With the encumbrances removed, the valuation of these properties is more straightforward and aligns to market prices for properties of a similar size and condition in the same geographical location.

2.12
We have reproduced the complete audit report, including the key audit matters, in the Appendix.

Other significant matters arising from the audit

2.13
Other significant matters arising from the audit were related to:

  • treatment of income-related rent subsidy;
  • accounting for the Crown contribution to the City Rail Link development in Auckland; and
  • accounting for the mycoplasma bovis outbreak.

Key audit matters for 2017/18

Recognising tax revenue

2.14
The largest source of tax revenue for the Government is income tax. This totalled $51.8 billion for the year ended 30 June 2018. The calculation of revenue from income tax is subject to significant assumptions and judgements because of timing differences between the Government's financial statements being completed and when taxpayers file tax returns.

2.15
Judgement was applied in estimating income tax revenue, and the associated receivables and payables as at 30 June 2018, where taxpayers are yet to file their returns or where payments have been received but no provisional or final tax return has been filed.

2.16
We carried out detailed audit work on these estimates because errors in the underlying assumptions and judgements could result in significant inaccuracies in the Government's financial statements. Our audit work included obtaining an understanding of the systems, processes, and controls in place over the recording of tax revenue; testing underlying data; and assessing the reasonableness of estimation models by checking revenue received relating to previous years against estimates made in those years.

2.17
Inland Revenue has a significant project to develop a new tax system in stages. As part of the project, it will investigate alternative approaches to estimating income tax revenue. At this stage, Inland Revenue is designing a better model for estimating provisional tax revenue from 2018/19 at a taxpayer level. We support Inland Revenue's continuing efforts to improve its processes for estimating tax revenue.

2.18
Overall, we are satisfied that the assumptions and judgements applied in estimating tax revenue are reasonable.

Valuing property, plant, and equipment

2.19
The Government has physical assets of $159.0 billion at 30 June 2018. Some assets are more difficult than others to value because of the uncertainties inherent in their valuation, the quality of data available, and the benefits these assets provide. We identified the following significant assets where there were inherent uncertainties involved in the valuations:

  • rail network assets;
  • the state highway network; and
  • electricity generation assets.

2.20
We were pleased that some improvements were made to the valuations of the Government's assets in 2017/18; in particular, the valuation of the state highway network. Information from valuation improvements can be used for operational and investment planning purposes, and enhancing disclosures about assets service delivery to New Zealanders, condition, and risks and opportunities in achieving the Government's objectives.

2.21
Overall, we are satisfied that the valuations of these assets are reasonable and consistent with valuation practices. The disclosures in the Government's financial statements appropriately outline the basis of valuation and the uncertainties associated with the valuations.

Rail network assets

2.22
One of the key assumptions used in preparing the Government's financial statements is that assets will continue to be held for their intended purpose. For accounting purposes, this determines the basis on which these assets are valued; either on a for-profit basis or on a public benefit basis.

2.23
Assets that are held with the primary purpose of making a profit are valued commercially, based on the income that can be generated from the asset or what the asset can be sold for. Assets that are held for public benefit purposes are generally valued at the cost of replacing all the components of the asset, less an amount that reflects the age and condition of those components.6

2.24
Since 2012, as part of the restructuring of New Zealand Railways Corporation, the assets relating to the freight part of the network that were transferred to KiwiRail Holdings Limited (KiwiRail) have been valued on the basis that their intended use is to generate a commercial return. These assets had a value of $186 million as at 30 June 2018. The network assets not used for freight (metro assets) have been valued on a different basis because these assets are considered to provide a broader public benefit. These assets had a value of $871 million as at 30 June 2018.

2.25
The extent to which the freight part of the network is commercial is open to debate. If it were not considered commercial, the basis for valuing these assets would change to reflect a public benefit nature. This would result in the overall rail network assets increasing in value by up to $5.0 billion.

2.26
For the freight part of the network, we considered the evidence supporting a for-profit (commercial) valuation basis for financial reporting purposes against that supporting a public benefit valuation basis. As in past years, this showed mixed results. The evidence considered as part of our review included the State-Owned Enterprises Act 1986, KiwiRail strategy documents, forecast results, correspondence setting out Ministers' expectations, and KiwiRail Board minutes.

2.27
The Ministry of Transport is currently leading a review of rail, considering rail's purpose in New Zealand's transport system. The outcome of that review will be critical to deciding whether valuing the freight part of the network on a commercial basis in the Government's financial statements remains appropriate.

2.28
Overall, largely because of the current review, we are satisfied that the judgement applied to the valuation of the freight part of the network on a commercial basis, although marginal, remains reasonable. We are also satisfied that the disclosures in the Government's financial statements appropriately outline the significant judgements.

State highway network

2.29
The valuation of the state highway network (excluding land), as at 30 June 2018 was $31.7 billion. The valuation was carried out by an independent valuer.

2.30
The valuation is based on information from several databases of the New Zealand Transport Agency (the Agency), which identify the components that make up the network and their expected useful lives.

2.31
Because of the unique nature of the network, the value of the components cannot be measured with precision. Significant estimates and assumptions have been applied to the valuation, which include assumptions on quantities used in the construction of network components, the estimated remaining lives of the components, and the costs of the components. Changes to the underlying estimates and assumptions can cause a material movement in the valuation of the network.

2.32
Some of the costs associated with road construction (for example, traffic management) in urban areas might potentially be undervalued. An allowance to recognise these costs has been included since 2014 where a reliable estimate can be made.

2.33
During 2017/18, the Agency continued its programme of improving the valuation process and reviewing certain valuation inputs. This in-depth review resulted in significant changes being made to certain estimates and assumptions, including preliminary and general costs and the costs applied to components. Overall, the valuation increased by $5.6 billion (excluding land).

2.34
Although the Agency's programme of work during 2017/18 has reduced the likelihood of an understatement in the valuation of the network, further work is planned to improve the valuation process.

2.35
We acknowledge that the current disclosures in the Government's financial statements are comprehensive, recognise uncertainties and risk of variability in future valuations, and provide a good basis for explaining potential future changes in the valuation.

2.36
We have recommended that the Agency continue to improve the valuation process and we support the Treasury liaising with the Agency, so that the Treasury can update the disclosures in the Government's financial statements in future years.

2.37
Overall, we are satisfied that the value of the state highway network as at 30 June 2018 is reasonable and consistent with accepted valuation practices, and that the disclosures in the Government's financial statements outlining the inherent uncertainties in the valuation are appropriate.

Electricity generation assets

2.38
Electricity generation assets, which are at least 51% owned by the Government, were valued at $15.9 billion as at 30 June 2018. The valuation of these assets is carried out by specialist valuers because of the complexity and significance of assumptions about the future prices of electricity, the generation costs, and the generation volumes that these assets will create.

2.39
Small changes to assumptions, such as the forecast price of electricity and discount rates used to determine the present value of these prices, could significantly change the reported value of these assets.

2.40
The specialist valuers of each of the generation companies have different assumptions and make different disclosures about the valuation of electricity generation assets.

2.41
The Government accepts the different assumptions and disclosures about these assets because:

  • The business models for each of the electricity generation companies are different because they apply different mixes of energy source (such as hydroelectric, geothermal, and wind) to meet electricity demand.
  • Information in the Government's financial statements should be consistent with other information available in the market.
  • Disclosures relating to electricity generators are based on information disclosed by each of the relevant electricity generation companies. Each company is expected to use the best information available to forecast its future cash flows, based on its own circumstances and expectations. These judgements are supported by experts engaged by each company and have been audited.

2.42
We assessed the appropriateness of using different valuation approaches and assumptions in the Government's financial statements for the valuation of electricity generation assets as well as the related disclosures, and we will continue to do so.

2.43
To assist our assessment, and possibly enhance the disclosure in the Government's financial statements, we have recommended that the Treasury carry out work to better understand the differences in assumptions about common valuation inputs (such as the forecast price of electricity), to ascertain whether they could be standardised for valuations for the Government's financial statements.

2.44
Overall, we are satisfied that the valuation of electricity generation assets at 30 June 2018 is reasonable, and that the disclosures in the Government's financial statements appropriately outline the sensitivity of assumptions and the complexity of the valuation of these assets.

Valuing insurance and superannuation liabilities

2.45
The valuation of the Government's long-term liabilities is complex and requires actuaries to estimate their fair value, based on assumptions about the future. The two significant long-term liabilities at 30 June 2018 are:

  • Accident Compensation Corporation (ACC) – outstanding claims liability of $45.3 billion; and
  • Government Superannuation Fund (GSF) – government employees' superannuation liability of $11.0 billion.

2.46
These liabilities are significant by value, and there are inherent uncertainties in valuing them that require a high degree of judgement and estimation.

2.47
The assumptions used to calculate the value of ACC's outstanding claims liability include estimating the time for rehabilitation from injuries, the amounts of cash payments and when they will be made, and the inflation and discount rates.

2.48
The assumptions used to calculate the value of the government employees' superannuation liability for past and current members of the GSF include estimating the return on assets owned by the GSF, expected rates of salary increases for currently employed members of the GSF, inflation and discount rates, and mortality rates.

2.49
The Government's financial statements set out the sensitivity of assumptions.7 There can be a large effect on the size of these liabilities when there are changes in the assumptions, which has a corresponding effect on the amount of actuarial gains and losses.

2.50
We evaluated the appropriateness of the main assumptions (such as inflation and discount rates) used in valuing the long-term liabilities. For discount rates and inflation assumptions, the Treasury determines a table of risk-free discount rates and inflation assumptions each year, using an agreed methodology. These are required to be consistently applied to valuations of long-term liabilities. We reviewed the table of risk-free discount rates and inflation assumptions as at 30 June 2018 and concluded that they had been calculated in keeping with the agreed methodology.

2.51
We have asked the Treasury to consider the recommendations from our review of the methodology as part of its own annual review process.

2.52
Overall, we are satisfied that the assumptions and judgements applied in estimating the Government's long-term liabilities as at 30 June 2018 are reasonable, and that the disclosures in the Government's financial statements outline the sensitivity of the valuations to changes in assumptions.

Valuing financial assets and liabilities

2.53
The Government has financial assets of $142.5 billion, of which $80.3 billion are measured at fair value. It also has financial liabilities of $131.2 billion, of which $10.2 billion are measured at fair value. The financial assets and financial liabilities measured at fair value include marketable securities, share investments, advances, and derivatives.

2.54
The fair value of some of the financial assets and financial liabilities cannot be measured using quoted market prices and, instead, must be estimated by applying an appropriate valuation model. Market data is used as an input to the models when available; otherwise, non-market data is used, which requires the exercise of significant judgement. We paid particular attention to evaluating the appropriateness of inputs to models that had been derived from non-market data.

2.55
We are satisfied that the fair values for financial assets and financial liabilities are reasonable and that the disclosures in the Government's financial statements outline the significant judgements.

Entitlements under the Holidays Act 2003

2.56
Many public organisations have reviewed, or are in the process of reviewing, historical payroll calculations to determine whether they have complied with the Holidays Act 2003 (the Act) and other related legislation, or have an obligation to pay more to past and present employees. Some public organisations have quantified their obligation and made payments. Others have been able to reasonably estimate the amounts to be paid, and have recognised a liability.

2.57
There are still several public organisations (with large numbers of past and present public servants) continuing to work on calculating the potential liability. The Government's financial statements disclose an unquantifiable contingent liability as at 30 June 2018 for these organisations' past non-compliance with the Act.

2.58
We obtained an understanding of the progress made by some of the most affected organisations (for example, the Ministry of Education, district health boards, the Department of Corrections, and KiwiRail) in resolving the payroll calculation issues.

2.59
There are complexities in some sectors, and the liability is taking longer than expected to calculate.

2.60
The slow response in addressing non-compliance with the Act and the resulting obligations is a matter of concern because it has a direct effect on many people employed (and previously employed) in the public sector. Furthermore, the delay in settling these obligations and ensuring continuing compliance adds to the overall liability of the Government.

2.61
We would like the Treasury to continue to work with sector leaders, including other central agencies, to support public organisations that continue to disclose an unquantified contingent liability, to focus on settling the obligations and ensure continuing compliance.

Other significant audit matters

Treatment of income-related rent subsidy

2.62
In the Government's 2016/17 financial statements, payments by the Ministry of Social Development (the Ministry) to Housing New Zealand Corporation and Tāmaki Regeneration Limited for income-related rent subsidies were treated as rental income by Housing New Zealand and Tāmaki Regeneration, and as non-departmental output expenses by the Ministry.

2.63
The Government's 2016/17 financial statements reflected these transactions as both income and expenditure, on the basis that the subsidy is equivalent to a benefit payment to the tenant. This resulted in the Government's financial statements recognising rental income at market levels, even though the rentals received from tenants might not be at a market rate.

2.64
Last year, we raised concerns about the clarity of the underlying documentation to support the accounting treatment of the income-related rent subsidy in the Government's 2016/17 financial statements. We recommended that the Treasury work with the Ministry, Housing New Zealand, and Tāmaki Regeneration to review the evidence to support the accounting treatment applied.

2.65
The Treasury reviewed the underlying documentation to support the income-related rent subsidy accounting treatment in 2017/18 and concluded that a fairer reflection would be to eliminate the payments between the Ministry and the Crown-owned housing providers in the Government's financial statements. As a result, the comparative figures for 2016/17 relating to income-related rent subsidy revenue and expenditure have been restated in the Government's 2017/18 financial statements.

2.66
We agree with the Treasury's current treatment of income-related rent subsidy revenue and expenditure as recorded in the Government's 2017/18 financial statements and the relevant disclosures on this matter.

Accounting for the Crown contribution to the City Rail Link development in Auckland

2.67
City Rail Link Limited is a jointly controlled non-listed company of which the Crown is the majority shareholder, co-funded by the Crown and Auckland Council, for the purpose of designing and constructing the Auckland City Rail Link (an underground rail line between the city centre and the existing western line). City Rail Link was established in 2016/17 after a heads of agreement was signed by the Crown and Auckland Council, which includes sharing the costs incurred by City Rail Link.

2.68
In keeping with advice provided by the Treasury and agreed by us, the Ministry of Transport is recognising the value of the Crown's investment in City Rail Link at its share of the joint operation, using the equity method of accounting. This is consistent with how Auckland Council is accounting for its interest in City Rail Link.

2.69
We are satisfied that the value of the Crown's interest in City Rail Link is fairly stated in the Government's financial statements.

Accounting for the mycoplasma bovis outbreak

2.70
The Government's decision to cull cows on farms infected by mycoplasma bovis generated significant public interest.

2.71
After the decision, we discussed with the Ministry for Primary Industries8 and the Treasury when to recognise a liability (relating to claims that might be made by affected farmers). We concluded that the appropriate recognition point for the liability was when an infection notice was issued to farmers. As at 30 June 2018, a provision of $52.6 million was recognised in the Government's financial statements.

2.72
An unquantified contingent liability for farms that might become infected after 30 June 2018 has also been disclosed in the Government's financial statements.

2.73
The decision to cull infected cows resulted in expenditure being incurred by the Ministry for Primary Industries in excess of its appropriation. This has been disclosed in the Statement of Unappropriated Expenditure.

2.74
We are satisfied that the accounting for the consequences of the Government's decision on the mycoplasma bovis outbreak is reasonable and that the disclosures are appropriate.


5: This is within the statutory deadline as determined by section 35(6) of the Interpretation Act 1999.

6: Assets valued in this manner are referred to as being valued at their optimised depreciated replacement cost.

7: Note 2 to the Financial Statements of the Government of New Zealand for the year ended 30 June 2018 sets out the key judgements, estimates, and assumptions, and the sensitivity of the assumptions.

8: The current Controller and Auditor-General was, before starting in that role on 2 July 2018, the Deputy Director-General – Corporate Services for the Ministry for Primary Industries. The Deputy Auditor-General has therefore dealt with all matters relating to the Ministry for Primary Industries.

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Report details

CoverCentral government: Results of the 2017/18 audits

ISBN 978-0-478-44296-0