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Financial Statements of the Government of New Zealand for the Year Ended 30 June 2017

Independent Report of the Auditor-General

To the Readers of the Financial Statements of the Government of New Zealand for the Year Ended 30 June 2017

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 2017 using my staff, resources and appointed auditors and their staff. The financial statements of the Government on pages 28 to 125 comprise:

  • the annual financial statements that include the statement of financial position as at 30 June 2017, 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 2017, and other explanatory information;
  • a statement of unappropriated expenditure for the year ended 30 June 2017;
  • a statement of expenses or capital expenditure incurred in emergencies for the year ended 30 June 2017; and
  • a statement of trust money, administered by departments, for the year ended 30 June 2017.

In my opinion, the financial statements of the Government on pages 28 to 125:

  • present fairly, in all material respects the Government’s:
    • financial position as at 30 June 2017;
    • financial performance and cash flows for the year ended on that date;
    • borrowings as at 30 June 2017;
    • unappropriated expenditure for the year ended 30 June 2017;
    • expenses or capital expenditure incurred in emergencies for the year ended 30 June 2017; and
    • trust money administered by departments for the year ended 30 June 2017.
  • comply with generally accepted accounting practice in New Zealand, in accordance with Public Benefit Entity accounting standards.

My audit was completed on 29 September 2017. 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 comment on other information, and I 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 period. 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.

These matters were addressed in my audit of the financial statements of the Government as a whole, and in forming my opinion thereon.

Recognising tax revenue How we addressed this matter

The largest sources of revenue for the Government are income tax and goods and services tax. These revenue sources total $68.3 billion for the year ended 30 June 2017.

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.

I considered the recognition of tax revenue to be a key audit matter because of the significant assumptions and judgements applied.

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 $144.6 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 $23.8 billion at 30 June 2017 by an independent external valuer. The valuation is based on information from a number of databases that identify the asset components that make up the network (roads, bridges, culverts, etc.), and their expected useful lives. These asset components exclude land which is separately valued.

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 (e.g. 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. However, such costs before then cannot be reliably measured and are currently excluded from the valuation.

 

We obtained an understanding of how the state highway network is valued. 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 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 2017 is reasonable and consistent with valuation practices, and that the disclosures outline the uncertainties about the valuation.

Rail network

As outlined in note 16, the rail network has been valued at $939 million at 30 June 2017. 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 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 in New Zealand to consider KiwiRail's operating structure, capital requirements and funding mechanisms. This review is expected to be completed by 30 June 2018, and is likely to 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 $4.3 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 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 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, is reasonable, and that the disclosures 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 2017.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.

We also confirmed the underlying information held about assets by verifying asset purchases and disposals in the current period. This included testing whether there was adequate supporting documentation for those purchases and disposals. It also involved confirming the opening assets balances, and evaluating the related financial statement disclosures.

I am satisfied that the valuation of electricity generation assets at 30 June 2017 is reasonable, and the disclosures outline the sensitivity and the complexity of the valuation of electricity generation assets.

Social Housing

As outlined in note 16, the portfolio of social housing was revalued at 30 June 2017 at a fair value of $26.8 billion. The portfolio is valued on a “highest and best use” basis which is aligned to market prices for properties of a similar size and condition in the same geographical location.

As part of the Social Housing Reform Programme, the Government has been disposing of properties to other social housing providers. Prior to transferring properties to “held for sale”, the Government places encumbrances on the properties to ensure their purposes for social housing is maintained.

Encumbrances of this nature limit the highest and best use of the properties and mean their fair value is reduced.

The reduction in value has been calculated using a discounted cash flow model based on a series of assumptions about income and expenditure for the properties.

 

We assessed the competence, capability and objectivity of the valuer and challenged the valuation and approach adopted, which was consistent with prior years.

 We considered the extent to which the valuation appropriately took account of a wide range of significant factors, which included:

  • underlying movements in market prices in places where houses are located;
  • property acquisitions through to balance date;
  • sales experience during the year to 30 June 2017; and
  • the market implications of concentrations of social housing.

We reviewed the integrity of the data provided to the valuer on which its valuation has been based and assessed the appropriateness of the adjustments made to the valuation as a result of any timing differences between the date of the valuation and 30 June 2017. 

We assessed the appropriateness of the methodology and assumptions used to calculate the value of the properties held for sale that have encumbrances placed on them.

We engaged our own valuation experts to review the methodology and calculations to assess the appropriateness of the approach.

I am satisfied that the valuation of social housing, including properties held for sale, at 30 June 2017 is reasonable and that disclosures about the valuation are adequate.

I considered the valuation of property, plant and equipment to be a key audit matter because of the significant amounts involved and the judgements applied.

 
Valuing insurance and superannuation liabilities How we addressed this matter

The Government has insurance liabilities of $42.8 billion and public servants' superannuation liabilities of $11.0 billion as at 30 June 2017. 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 (ACC) outstanding claims liability

As outlined in note 11, ACC's outstanding claims liability has been valued at $37.7 billion at 30 June 2017 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 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 forecast.

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 2017 are reasonable, and that disclosures outline the sensitivity of the valuation to changes in assumptions.

Public servants' superannuation liability

As outlined in note 20, the Government's liability for public servants' superannuation entitlements for past and current members under the Government Superannuation Fund has been valued at $11.0 billion at 30 June 2017 by an independent actuary.

The present value of the liability is sensitive to the estimated return on assets owned by the Fund, expected rates of salary increases for public servants who are members of the Fund and estimated inflation and discount rates.

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 valuation specialists 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, which 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 liability for public servants' superannuation entitlements at 30 June 2017 is reasonable, and that the disclosures outline the sensitivities of the valuation to changes in assumptions.

I considered the valuation of insurance and superannuation liabilities to be a key audit matter because of the significant amounts involved and the judgements applied.

 
Valuing financial assets and liabilities How we addressed this matter

As outlined in note 26, as at 30 June 2017, the Government has financial assets of $133.4 billion, of which $75.3 billion are valued at fair value (and $58.1 billion are valued at amortised cost), and financial liabilities of $128.3 billion, of which $7.6 billion are valued at fair value (and $120.7 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 $3.3 billion and $66 million respectively.

I considered the valuation of financial assets and liabilities to be a key audit matter because of the significant amounts involved and the judgements applied.

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 which 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 2017 are reasonable and that the disclosures outline the significant judgements.

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 the 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 the use of 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:

  • eliminations 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 of the current period 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 26 and 127 to 133, 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 amaterial 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 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.

 

Greg Schollum
Deputy Controller and Auditor-General
Wellington, New Zealand

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