2   Principles for the development of accounting policies for external financial reporting

2.1  Introduction

This section provides guidance on the way in which the Crown and its departments must set their accounting policies for external financial reporting. Accounting policies are those broad concepts, rules and procedures that underlie the preparation and presentation of the financial statements of all entities.

When developing their accounting policies for external financial reporting, the Crown and its departments must comply with the requirements of the Act.

2.2  Legislative requirements

The Act requires that both the forecast and annual financial statements of the Government and its departments must be prepared in accordance with generally accepted accounting practice (sections 26H, 27, 41 and 45B).

2.3  New Zealand generally accepted accounting practice

New Zealand generally accepted accounting practice for the financial statements of the Government and its departments is defined by section 2 of the Act. It is defined in the first instance as approved financial reporting standards as far as such standards apply to the Crown. An approved financial reporting standard is one that has been approved by the Accounting Standards Review Board (ASRB).

The ASRB approves:

1. New Zealand equivalents to International Financial Reporting Standards (NZ IFRSs) comprising New Zealand equivalents to:
1. International Financial Reporting Standards;
2. International Accounting Standards; and
3. International Interpretations (IFRICs and SICs); and
2. Financial Reporting Standards (FRSs).

Consequently, where there is an approved New Zealand financial reporting standard that prescribes the accounting treatment for a particular accounting issue, the Crown's and departments's accounting policies for external financial reporting in relation to that particular accounting issue must comply with that financial reporting standard, unless that standard does not apply to the Crown or its departments.

In the absence of an applicable approved New Zealand financial reporting standard, and the absence of an applicable rule of law, the Act provides that generally accepted accounting practice means accounting policies that are appropriate in relation to the Crown and have authoritative support within the accounting profession in New Zealand.

NZ IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (NZ IAS 8) (paragraphs 10 to 12) provides guidance on developing accounting policies in the absence of a particular standard or an interpretation of a standard that specifically applies to a transaction, other event or condition. NZ IAS 8 requires that management use judgement in developing and applying an accounting policy that results in information that is relevant to the economic decision-making needs of users and reliable; it specifies what reliability means in the context of the financial statements. It also requires that management refer to and consider the applicability of the following sources of guidance, in descending order:

1. the requirements and guidance in standards, and interpretations dealing with similar and related issues; and
2. the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the New Zealand Equivalent to the IASB Framework for the Preparation and Presentation of Financial Statements (NZ Framework).

In making this judgement management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature, and accepted industry practices, to the extent these do not conflict with the sources described above.

The NZ Preface to NZ IFRSs (paragraph 38) explains that it is a matter of professional judgement in the circumstances of the entity as to which other sources of authoritative support should be considered, and how conflicts between other sources of authoritative support should be resolved in determining generally accepted accounting practice.

The NZ Preface (paragraph 39) gives examples of sources of authoritative support. Technical Practice Aids issued by the FRSB are an example of pronouncements of a recognised standard setting body and therefore are a source of guidance that may be used in developing and applying accounting policies. Other examples of pronouncements of standard-setting bodies include:

1. International Public Sector Accounting Standards (IPSASs) issued by the International Public Sector Accounting Standards Board (IPSASB) of the International Federation of Accountants (IFAC);
2. financial reporting standards issued by the Australian Accounting Standards Board (AASB); and
3. financial reporting standards issued by well-recognised bodies with the authority to promulgate financial reporting standards in jurisdictions such as Canada, the United Kingdom and the United States of America.

When developing accounting policies for accounting issues that are not covered by an applicable approved New Zealand financial reporting standard, the Crown and departments must exercise appropriate professional judgment in applying the requirements of NZ IAS 8, in determining the relative importance of sources of authoritative support and in resolving conflicts between different sources of authoritative support.

In such circumstances the Crown and its departments must ensure that the policy that is developed is consistent with the New Zealand Equivalent to the IASB Framework for the Preparation and Presentation of Financial Statements. Any such policy must:

• meet the objectives of general purpose financial reporting;
• be prepared with due regard to the assumptions that underlie general purpose financial reports;
• have the required qualitative characteristics of general purpose (external) financial reports; and
• adhere to the definitions of, and recognition criteria for, all financial elements.

New Zealand generally accepted accounting practice includes NZ IFRSs and any domestic Financial Reporting Standards that have been approved as financial reporting standards by the ASRB. These standards apply after an entity makes an explicit statement of compliance with NZ IFRSs for the first time. The Crown has applied NZ IFRSs in the forecast financial statements published in the 2007 budget, and will apply them in financial statements prepared for periods beginning on or after 1 July 2007.

2.3.1  Asserting compliance with NZ GAAP

The financial statements of the Government and of each department must include an assertion of compliance with NZ GAAP. NZ IAS 1 paragraph NZ 13.1 requires that an entity shall disclose in the notes:

1. the statutory base, if any, under which the financial statements are prepared;
2. whether, for the purposes of complying with Generally Accepted Accounting Practice in New Zealand (NZ GAAP), it is a profit-oriented or public benefit entity;
if, for the purposes of complying with NZ GAAP, it is a qualifying entity and has applied differential reporting concessions. In accordance with NZ IAS 8, such an entity shall disclose the criteria which establish the entity as a qualifying entity for differential reporting and the extent to which the entity has applied available differential reporting concessions; and
a statement that the financial statements have been prepared in accordance with NZ GAAP, together with a description of the financial reporting standards applied by the entity.

Departmental financial statements must therefore include:

1. a reference to the Public Finance Act 1989 and any other legislation establishing financial reporting requirements;
2. a statement that for the purposes of complying with NZ GAAP it is a public benefit entity. All departments will be public benefit entities, although some components of departments may be profit-oriented; and
3. a statement that the financial statements have been prepared in accordance with NZ GAAP and that they comply with NZ IFRSs, and other applicable Financial Reporting Standards, as appropriate for public benefit entities.

2.3.2  Objectives of general purpose financial reporting

The NZ Framework (paragraphs 12 to NZ 14.2) discusses the objectives of general purpose financial statements and non-financial statements or supplementary information that accompanies financial statements. These objectives include:

• providing information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions;
• show the results of the stewardship of management, or the accountability of management for the resources entrusted to it; and
• assessing the reporting entity's compliance with legislation, regulations, common law and contractual arrangements. 2.3.2.1  The “going concern” concept

2.3.3  Assumptions underlying general purpose financial reports

Two assumptions underlie the development of general purpose financial reports:

• the “going concern” concept; and
• the accrual basis of accounting.

2.3.3.1  The accrual basis of accounting

Under the accrual basis of accounting, the effects of transactions and other events must be recognised when they occur (and not as cash or its equivalent is received or paid). The transactions must be recorded in the accounting records, and reported in the financial statements of the periods to which they relate. Financial statements prepared on the accrual basis inform users not only of past transactions involving the payment and receipt of cash, but also of obligations to pay cash in the future and of resources that represent cash to be received in the future. The Chief Executive of a department of the Crown must ensure that the financial statements of the department are prepared each year using the accrual basis of accounting.

2.3.3.2  The “going concern” concept

The “going concern ” concept is the accounting convention under which the financial statements are prepared on the assumption that the entity is a going concern and will continue in operation for the foreseeable future. As a consequence, items of property, plant and equipment must be depreciated over their anticipated useful lives, inventory is assumed to be realisable within the normal operating cycle, and liabilities are assumed not to fall due before their scheduled repayment date. Unless the Chief Executive of a department of the Crown receives clear evidence to the contrary, he or she must assume, for the purposes of preparing the financial statements in each year, that the Crown does not intend, nor is there a need for, a department to cease operations or to curtail them materially.

The concept that the entity will continue as a going concern underlies the preparation of the financial statements. If the assumption of the “going concern ” concept is no longer true, the financial statements may have to be prepared on a different basis (with that basis being disclosed) (NZ Framework paragraph 23).

NZ IAS 1 specifies required disclosures if:

1. the financial statements are not prepared on a going concern basis; or
2. management is aware of material uncertainties related to events or conditions that may cast significant doubt upon the entity's ability to continue as a going concern.

If the events or conditions requiring disclosure arise after the balance sheet date, NZ IAS 10 Events after the Balance Sheet Date should be used in determining the appropriate disclosures. If the going concern assumption is no longer appropriate NZ IAS 10 requires a fundamental change in the basis of accounting. However, it also notes that judgement is required in determining the impact of a change in the basis of accounting.

2.3.4  Qualitative characteristics of external financial reports

The NZ Framework states in paragraph 24 that qualitative characteristics are the attributes that make the information provided in financial statements useful to users. The four principal qualitative characteristics are understandability, relevance, reliability and comparability.

2.3.4.1 Understandability

An essential quality of the information provided in financial statements is that it is readily understandable by users. For this purpose, users are assumed to have a reasonable knowledge of an entity's activities and accounting and a willingness to study the information with reasonable diligence. However, information about complex matters should not be excluded merely on the grounds that it may be too difficult for certain users to understand.

2.3.4.2 Relevance

Information is considered to be relevant to users, if it can be used to confirm or correct prior assumptions or beliefs about past events, or if it can be used to assist in forming or revising expectations about future events. Timeliness is considered to be an important element of relevance, as information that is not available when it is needed is of no use.

2.3.4.4 Reliability

Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent (NZ Framework paragraph 31). Information may be relevant but so unreliable in nature or representation that its recognition may be potentially misleading (NZ Framework paragraph 32).

2.3.4.5 Comparability

Information is comparable when users are able to identify similarities and differences between that information and the information in other reports of the entity for different periods, or the reports of other entities. Compliance with NZ GAAP, including the disclosure of the accounting policies used by the entity, helps to achieve comparability.

2.3.5 Materiality

External financial reports must be prepared having due regard to the materiality of the information being provided. In particular, the inclusion of transactions, the level of disclosure and the effect of an accounting treatment should be considered in the light of an appropriate materiality level.

The relevance of information is affected by its nature and materiality. Guidance on the concept of materiality is contained in the NZ Framework and NZ IAS 1.

The NZ Framework states that information is material if:

• its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements (paragraph 30); and/or
• in the case of public benefit entities, its non-disclosure could influence the decision-making and evaluations of users about the allocation and stewardship of resources, and the performance of the entity, made on the basis of the financial statements (paragraph NZ 30.1).

Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement.

A number of groups rely upon the financial statements of departments of the Crown for accountability and for decision making. These groups include:

• Parliamentarians;
• Ministers;
• Treasury; and
• Media and the public.

Materiality must be considered in the light of the accountability requirements of, and decisions made by, these groups.

Where a specific disclosure is required as a result of a statutory obligation, regulation, or Treasury Instruction, that disclosure must be made regardless of the materiality of the item.

2.3.6 Financial elements

The NZ Framework defines five elements of financial statements and provides recognition criteria for each of them. The five elements are assets, liabilities, equity, income and expenses.

The NZ Framework uses the term “future economic benefits ”. In the case of public benefit entities, this term is to be read as having the same meaning as the term “service potential ” (NZ Framework paragraph NZ 49.1).

The NZ Framework also refers to contributions from, or distributions to, equity participants. In the context of public benefit entities such references should be read as contributions from, or distributions to, equity holders acting in their capacity as equity holders (NZ Framework paragraph NZ 70.1).

An item that meets the definition of an element should be recognised if:

1. it is probable that any future economic benefit (or service potential) associated with the item will flow to or from the entity; and
2. the item has a cost or value that can be measured with reliability (NZ Framework paragraph 83).

2.3.6.1 Assets

An asset is a resource controlled by the entity as a result of past events and from which future economic benefits (or service potential) are expected to flow to the entity.

2.3.6.2 Liabilities

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits (or service potential).

2.3.6.3 Equity (Taxpayers's funds)

Equity is the residual interest in the assets of the entity after deducting all its liabilities.

2.3.6.4 Income

Income is increases in economic benefits (or service potential) during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants (equity holders acting in their capacity as equity holders).

The definition of income includes both revenue from ordinary activities and gains.

The definition of revenue is very similar to the definition of income but it refers to inflows “arising in the course of the ordinary activities of an entity ” (NZ IAS 18 Revenue paragraph 7).

Gains represent other items that meet the definition of income, and may or may not arise in the course of the entity's ordinary activities (NZ Framework paragraph 75).

2.3.6.5 Expenses

Expenses are decreases in economic benefits (or service potential) during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants (equity holders acting in their capacity as equity holders).

The definition of expenses include expenses from ordinary activities and losses.

2.4  Accounting policies

The notes to general purpose financial statements must include a summary of significant accounting policies (NZ IAS 1 paragraph 108). This summary must include:

• the measurement basis (or bases) used in preparing the financial statements; and
• the other accounting policies used that are relevant to an understanding of the financial statements.

NZ IAS 8 specifies the disclosures required as a result of changes in accounting policies.

An entity must also disclose the judgements, apart from those involving estimations, management has made in the process of applying the entity's accounting policies that have the most significant effect on the amounts recognised in the financial statements (NZ IAS 1 paragraphs 113 and 116).