4  Accounting and forecasting policy parameters for departmental external financial reporting

4.1 Explanatory note

To make the statements and forecasts of different departments comparable, and to ensure that the consolidated financial statements and forecasts of the Government reporting entity are prepared on a consistent basis, a department needs to report on a basis not materially different from the bases upon which other departments report. This is substantially achieved through all departments and the Government itself preparing their financial statements and forecasts within the same policy parameters.

The principles which must be used by departments when developing their accounting policies are outlined in Section 2 of the Treasury Instructions ("Principles for the development of accounting policies for external financial reporting").

This section of the Treasury Instructions focuses on the provision of information on the parameters within which departmental accounting policies must be developed, with particular reference, where appropriate, to:

• areas not yet specifically covered by generally accepted accounting practice;
• limiting choices in generally accepted accounting practice where this is necessary for consistency in the financial statements of the Government; and
• clarifying accounting treatments where generally accepted accounting practice and other legislative requirements may be in conflict.

4.2 Particular accounting policies: General

4.2.1 Statement of Responsibility

A department's financial report may be issued only when the Statement of Responsibility is signed by the department's Chief Executive and Chief Financial Officer.

4.2.2 Combination of sub-entities

Departments of the Crown must combine the results and financial position of all sub-entities. The sub-entities to be combined in a department's financial statements are those that fall within the definition provided by section 33 of the Act, which defines a department as including "any activities, bodies, or statutory offices that are funded by way of appropriation and that are not natural persons or separate legal entities”.

For all sub-entities that are not joint ventures (as defined by NZ IAS 31) the purchase method, as described in NZ IFRS 3 Business Combinations, and the consolidation procedures outlined in NZ IAS 27 Consolidated and Separate Financial Statements must be used in preparing the department's financial statements. This method of preparing consolidated financial statements is sometimes referred to as a line-by-line consolidation.

Sub-entities that are joint ventures shall be accounted for in accordance with NZ IAS 31 Interests in Joint Ventures as follows.

• Jointly-controlled operations: The department shall recognise the assets it controls, the liabilities and expenses that it incurs, and its share of the jointly-controlled operations' income.
• Jointly-controlled assets: The department shall recognise its share of the jointly-controlled assets, its share of any liabilities and expenses incurred jointly, any other liabilities and expenses it has incurred in respect of the jointly-controlled asset, and income from the sale or use of its share of the output of the jointly-controlled asset.
• Jointly-controlled entities: The department shall recognise its share in a jointly-controlled entity using the equity method.

In the preparation of financial statements, all intra-departmental transfers and transactions must be eliminated. Accordingly, each sub-entity must identify and record transactions with other parts of the department. If it is not possible to eliminate absolutely all such transactions, all material intra-departmental transactions must be eliminated.

4.2.3  Goods and Services Tax

Goods and Services Tax (GST) is an indirect tax on goods and services.

GST is collected at various stages of production and distribution by registered persons in respect of their taxable activities.

The following financial statements and the equivalent forecast statements must be prepared on a net of GST basis (i.e. on a GST exclusive basis):

• Statement of Financial Position (except for receivables and payables and any assets where GST input tax is irrecoverable);
• Statement of Financial Performance (for non-departmental revenues and expenses GST is included as a separate line item within the statement);
• Statement of Cash Flows;
• Statement of Service Performance;
• Statement of Commitments; and
• Statement of Contingent Liabilities.

As appropriations are on a GST exclusive basis, the Statement of Unappropriated Expenditure must also be prepared exclusive of GST.

For non-departmental expenses and capital expenditure, the item shall be recorded net of GST where money is being paid:

• on GST applicable products and services; and
• to a GST registered person.

In other words, if the recipient of the payment is required to account for GST on the amount received, the expense shall be recorded net of GST.

Care must be taken when deducting input tax to ensure that it is not related to making GST-exempt supplies. Exempt supplies include financial services, residential rent, supplies of fine metal, interest charges and supplies of donated goods and services. If a purchase is connected with an exempt supply, any full amount should be recognised as part of the related asset or, where the expenditure relates to an expense item, expensed.

4.3 Particular accounting policies: Statement of Financial Performance items

4.3.1 Revenue recognition

Where revenue arises from the rendering of services, the sale of goods or the use of department's assets by others NZ IAS 18 must be applied. Most other revenue of departments will result from non-exchange transactions.

In a non-exchange transaction, an entity either receives value from another entity without directly giving approximately equal value in exchange, or gives value to another entity without directly receiving approximately equal value in exchange. There are three factors relevant in determining whether departments render services in an exchange or receive revenue in a non-exchange transaction:

• whether the services are clearly specified;
• whether the value of the services is approximately equal to the funding; and
• whether the consideration that is provided is conditional on the services to be supplied.

The key requirements of NZ IAS 18 are:

• Revenue shall be measured at the fair value of the consideration received or receivable (NZ IAS 18 paragraph 9).
• Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied:
  • the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
  • the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
  • the amount of revenue can be measured reliably;
  • it is probable that the economic benefits associated with the transaction will flow to the entity; and
  • the costs incurred or to be incurred in respect of the transaction can be measured reliably (NZ IAS 18 paragraph 14).
• When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage of completion of the transaction at the balance sheet date. The outcome of a transaction can be estimated reliably when all the following conditions are satisfied:
  • the amount of revenue can be measured reliably;
  • it is probable that the economic benefits associated with the transaction will flow to the entity;
  • the stage of completion of the transaction at the balance sheet date can be measured reliably; and
  • the costs incurred for the transaction and the costs to complete the transaction can be measured reliably (NZ IAS 18 paragraph 20).
• When the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue shall be recognised only to the extent of the expenses recognised that are recoverable. (NZ IAS 18 paragraph 26).
• Interest revenue shall be recognised using the effective interest method as set out in NZ IAS 39, paragraphs 9 and AG5-AG8 (NZ IAS 18 paragraph 30).
• Revenue from royalties shall be recognised on an accrual basis in accordance with the substance of the relevant agreement (NZ IAS 18 paragraph 30).
• Revenue from dividends shall be recognised when the shareholder's right to receive payment is established (NZ IAS 18 paragraph 30).

If assets are received from a non-exchange transaction the following applies:

• Assets acquired through a non-exchange transaction shall initially be measured at their fair value as at the date of acquisition;
• An inflow of resources from a non-exchange transaction recognised as an asset shall be recognised as revenue, except to the extent that a liability is also recognised in respect of the same inflow; and
• As an entity satisfies a present obligation recognised as a liability in respect of an inflow of resources from a non-exchange transaction recognised as an asset, it shall reduce the carrying amount of the liability recognised and recognise an amount of revenue equal to that reduction.

4.3.2 Revenue and expense offsetting

Income and expenses shall not be offset unless required or permitted by a Standard or an Interpretation.

Departments undertake in the course of their ordinary activities transactions that do not generate revenue but are incidental to their main activities. The results of such transactions are presented, when this presentation reflects the substance of the transaction or other event, by netting any income with related expenses arising on the same transaction. This treatment is permitted under NZ IAS 1 Presentation of Financial Statements, paragraph 33.

Hence, if the department incurs an expense in anticipation of reimbursement, then any recovery must be recorded as a reduction in the expense. If, on the other hand, a department incurs an expense irrespective of any recovery, then the recovery is revenue to the department. For example, because the decision to claim (and award) legal costs is independent of the actual incurrence of those costs, income from court-awarded costs must be reported separately. On the other hand, discounts received are integral to the transaction and may be offset. This rule is used to determine the level of expense for appropriation purposes.

Departments should note however that NZ IAS 18 provides that revenue is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed. Similarly any expenses should be reported net of any discounts received.

4.3.2.1  Insurance proceeds

Revenue received from insurance proceeds should not be offset against repairs or impairment expenses. The insurance proceeds should be recognised as miscellaneous revenue (and a receivable recorded) when it is clear the proceeds are receivable. This will normally be when the claim has been accepted by the insurance company. Where a receivable cannot yet be recognised, departments should consider whether a contingent asset may need to be disclosed.

In some instances insurance proceeds may not be received in the same financial year as the expense (the impairment of the damaged asset) is incurred. This may result in departments reporting a deficit in the year the expense is incurred and a surplus in the following year when the insurance proceeds are received. Where this situation occurs the department may seek approval to retain the surplus arising from the receipt of these insurance proceeds (refer section 4.4.3). For forecasting purposes it is highly likely approval will be given to departments to retain the surplus and this retention of surplus should be factored into the department's forecasts. In the event this is caused by a natural disaster where a number of departments are affected, Treasury may instigate a process to seek approval to retain surpluses for all affected departments.

4.3.3 Losses arising from natural disasters

A natural disaster (e.g. an earthquake) may impact on the operations of a department and result in losses being incurred. These losses may arise from departmental assets being destroyed or being damaged. This section outlines the accounting policies. Refer section 6.4.5 for details on the appropriation requirements.

4.3.3.1  Destroyed assets

Departmental assets that have been destroyed in a natural disaster will need to be written off.

If the assets are based on the cost model (i.e. carried at cost less any accumulated depreciation and any impairment losses) the full amount of the asset write-off will need to be recognised as an expense.

For assets carried at revalued amounts the accounting standards are unclear on the treatment. Treasury's recommendation is that the full amount of the asset write-off should be recognised as an expense. In addition, if the portion of the revaluation reserve that related to the destroyed assets is identifiable than this portion of the revaluation reserve should be transferred to general funds.

Parliamentary authority to replace destroyed departmental assets is provided by Section 24 of the Act, with approval processes and limits outlined in Cabinet Office circular CO(10)2. Refer section 6.5.5.2 for details on replacement of non-departmental assets.

4.3.3.2  Damaged assets

Assets that are damaged in a natural disaster may need to be impaired to reflect the extent of the damage. The recognition of any impairment will be dependent on the materiality of the damage. Ideally, the impairment will be recognised when the impairment event occurs. In some cases it may not be possible to estimate the damage at the time of the impairment event. However, once a reliable estimate of the damage can be made an impairment will need to be recognised.

The recording of impairments will depend on whether the assets are based on the cost model or carried at revalued amounts:

• If the assets are based on the cost model the asset impairment will need to be recognised as an expense.
• If the assets are carried at revalued amounts the impairment is treated as a revaluation decrease. The full amount of the impairment can be taken against the revaluation reserve if the reserve for the class of asset damaged is sufficient.
• If the revaluation reserve for the class of asset damaged is not sufficient to cover the impairment any residual amount would need to be recognised as an expense.

4.3.3.3  Repairing assets that have been impaired

Where an asset's service potential has been impaired, any repair costs incurred to restore that asset's service potential back to its pre-impaired condition may be capitalised.

In many instances repairs are likely to restore service potential and therefore be treated as departmental capital expenditure. However, if the costs are for damage that has not affected the service potential of an asset, the repair costs cannot be capitalised and will need to be expensed.

The decision to capitalise or expense costs will need to be determined by departments pragmatically on a case by case basis.

Where the repairs are able to be capitalised, then Parliamentary authority to repair the damaged departmental assets is provided by Section 24 of the Act, with approval processes and limits outlined in CO(10)2. Refer section 6.5.5.2 for details on replacement of non-departmental assets.

4.3.4 Capital charge

The capital charge is to be reported as an element of output expenses.

It is not to be accounted for as a financial instrument or a borrowing cost.

NZ IFRSs define what a financial instrument is and whether an instrument is a financial asset, financial liability or equity (these definitions are currently in NZ IAS 32 Financial Instruments: Presentation)). There were no equivalent definitions in current GAAP.

However, the definitions leave doubt as to whether capital charge is a financial instrument or related to a financial instrument.

The potential confusion surrounding capital charge was brought to the attention of the Financial Reporting Standards Board (FRSB). As a result, the FRSB (in its report to the Accounting Standards Review Board on NZ IAS 32 dated Oct 2004):

• noted that public sector capital charges represent a charge on the net assets employed by public sector entities, and do not relate to any financial instrument, either debt or equity, and that such an interpretation would be inappropriate;
• noted that the capital charge is designed to ensure that the costs of capital are included in the costs of services and to require that they be reported elsewhere would effectively thwart their purpose; and
• agreed not to include additional guidance for public benefit entities.

Accordingly, the capital charge is to be treated as an expense when entities are reporting to Treasury.

NZ IAS 23 Borrowing Costs states that “borrowing costs are interest and other costs incurred by an entity in connection with the borrowing of funds”. IPSAS 5 Borrowing Costs, which is based on IAS 23, states that “Where jurisdictions apply a capital charge to individual entities, judgement will need to be exercised to determine whether the charge meets the definition of borrowing costs or whether it should be treated as an actual or imputed cost of net assets/equity” (IPSAS 5 paragraph 4).

The capital charge, as applied to departments, is not a borrowing cost in accordance with NZ IAS 23.

Details regarding the capital charge regime and the applicable capital charge rate can be found on the Treasury website: http://www.treasury.govt.nz/publications/guidance/mgmt/mgmt/capitalcharge.

4.4 Particular accounting policies: Statement of Financial Position items

4.4.1 Property, plant and equipment

The appropriate accounting treatment for items of property, plant and equipment is provided in NZ IAS 16 Property, Plant and Equipment. NZ IAS 16 does not apply to the following types of property, plant and equipment:

• property, plant and equipment classified as held for sale in accordance with NZ IFRS 5 Non-current Assets Held for Sale and Discontinued Operations;
• biological assets related to agricultural activity (see NZ IAS 41 Agriculture);
• the recognition and measurement of exploration and evaluation assets (see NZ IFRS 6 Exploration for and Evaluation of Mineral Resources); and
• mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources.

In addition, specific accounting policies apply to the following types of assets:

• investment properties (once initial construction or development is complete NZ IAS 40 Investment Property is relevant); and
• licences and patents (NZ IAS 38 Intangible Assets is relevant).

Departments involved in any of the above activities should consult with the Treasury.

NZ IAS 16 applies in part to leasehold interests in property and assets being acquired under hire purchase and other financing arrangements, including options and other rights to purchase such assets. However, departments are prohibited by the Act from entering into such arrangements by the Act unless approved by the Minister of Finance.

All individual assets or groups of assets must be capitalised if their historical cost is $NZ5,000 or greater. This threshold must be regarded as the upper limit. Departments may, with due consideration to their particular circumstances, set lower or multiple limits. However once established, these limits must be consistently applied in future periods. Where the value of items is less than $NZ5,000 (or such lower threshold as has been set by the department), assets must be expensed. However, where the value of an individual item is less than the threshold, but such item is part of a group of similar items (for example loose tools or instruments), these may either be expensed on purchase or be capitalised at an aggregate amount. In the latter case, cost is the initial purchase price of the class of items, with the cost of subsequent replacements being written off as they are acquired.

Where an item of property, plant and equipment that has been revalued is disposed of, any revaluation surplus in respect of that item of property, plant and equipment must be transferred from the revaluation reserve to Taxpayers' Funds.

4.4.2 Intangible assets

Intangible assets must be accounted for in accordance with NZ IAS 38 Intangible Assets .

Section 3.5.12 of Treasury Instructions ("Intangible Assets") sets out the key requirements of NZ IAS 38.

Additional guidance on the capitalisation thresholds for software and accounting for web site costs is provided in this section.

4.4.2.1  Computer software

Computer software must be classified as an intangible asset and accounted for in accordance with NZ IAS 38 unless it is an integral part of hardware, such as an operating system, in which case it is classified as property, plant and equipment and accounted for in accordance with NZ IAS 16.

The transaction costs associated with identifying and reporting the cost of internally generated software are likely to be significantly greater than the transaction costs associated with identifying and reporting the cost of other assets. As a result it is appropriate to apply a higher capitalisation threshold to these assets than other assets.

In determining whether the cost of an internal software development can be capitalised the requirements of NZ IAS 38 and NZ SIC 32 must be complied with. All individual software developments that meet these requirements must be capitalised if their historical cost is $50,000 or greater. This threshold must be regarded as the upper limit. Departments may, with due consideration to their particular circumstances and in particular considerations of materiality, set lower limits. However once established, these limits must be consistently applied in future periods. Where the value of items is less than $NZ50,000 (or such lower threshold as has been set by the department), the costs of internally generated software developments must be expensed.

In determining whether software development costs, including upgrades, should be capitalised, departments' attention is drawn in particular to the following requirements paraphrased from NZ IAS 38 and NZ SIC 32:

• Costs associated during the research phase of a software development should not be capitalised, but must be expensed (NZ IAS 38 paragraph 54). Activities occurring in the research phase include the search for and selection of alternatives (NZ IAS 38 paragraph 56).
• Software development can only be capitalised if it is technically feasible to complete the development, the software is intended to be, and can be, used or sold, if the usefulness or market value of the software can be demonstrated, and if the expenditure attributable to the software development can be measured reliably (NZ IAS 38 paragraph 57).
• The cost of a software development includes costs of materials and services used or consumed in generating the software, employee costs including the cost of employee benefits, fees to register the software, and amortisation of patents and licences used to generate the software (NZ IAS 38 paragraph 66).
• The cost of a software development does not include overhead expenditure, identified inefficiencies and initial operating costs incurred before the software achieves planned performance, and expenditure on training staff to operate the asset (NZ IAS 38 paragraph 66).
• The nature of intangible assets is such that, in many cases, there are no additions to such an asset or replacements of part of it. Accordingly most subsequent expenditures are likely to maintain the future economic benefits or service potential embodied in an existing intangible asset rather than meet the definition of an intangible asset and the recognition criteria (NZ IAS 38 paragraph 20).

In determining whether the usefulness or market value of the software can be demonstrated reference should be able to be had to a business case where measurable economic benefits or service potential from the development are identified.

In determining whether subsequent expenditure on software represents an addition to the software the following factors are likely to be useful in making a judgment as to whether the subsequent expenditure should be capitalised:

• Conventional maintenance that does not change the characteristics of the software does not create additional benefits or service potential and should be expensed.
• Changes to software that permit it to be used in the same way under normal operating conditions, such as repairing faults introduced by bugs, should not be capitalised.

When software is updated or upgraded, the costs of the upgrade should only be capitalised when the increased usefulness or increased market value of the software can be demonstrated.

4.4.3 Provision for return of operating surplus

Section 22(1) of the Act states that “Except as agreed between the Minister and the Responsible Minister for a department, the department must not retain any operating surplus that results from its activities”.

The calculation of the provision for the operating surplus to be paid to the Crown is:

This calculation above first applies to the 2011/12 financial year.

The rationale for the adjustments to the operating surplus is as follows:

• Other expenses are excluded from surpluses to be returned to ensure that operating activities are not subsidising, or being subsidised by, ownership actions or decisions.
• Some departments have been granted approval, under section 21 of the Act, to incur output expenses up to the amount of revenue expected to be earned by that class of outputs from parties other than the Crown. Any deficits associated with any approved section 21 activities are added onto the operating surplus to avoid subsidisation by the Crown of third party activities.
• Unrealised remeasurements that are reported in the Statement of Financial Performance primarily relate to unrealised foreign exchange gains and losses, and impairments of property plant and equipment. Such items are not intended to affect the surplus repayable.
• Surpluses on third-party funded services that are subject to memorandum accounts are deducted from the operating surplus to avoid the Crown being subsidised by third party activities and because the surplus will be required to fund expenses on these third party services in a subsequent (deficit) year. Deficits on third-party funded services that are subject to memorandum accounts are added to the operating surplus to avoid third party activities being subsidised by the Crown.

Departments need to make a provision for the repayment of their surplus in their Statement of Financial Position. The recognition of a provision for repayment of surplus is in accordance with NZ IAS 10 Events After Balance Sheet Date. The obligation to repay the surplus is a condition that existed at the balance date. Where a department is in deficit, no provision is required.

Payment of surpluses is to be made by 31 October following the end of the financial year.

Requests to retain surpluses should be sought from the Responsible Minister and forwarded to the Minister of Finance as soon as the amount to be retained is known. Requests are to be made no later than three weeks after the year-end.

The agreement of the Minister of Finance and Responsible Minister is required before a department can retain any operating surpluses (section 22(1) of the Act refers).

Departments seeking approval to retain surpluses need to explain why this approach is more appropriate than seeking a capital injection. Where a capital injection is considered to be more appropriate then a cabinet paper with a detailed business case will need to be submitted for approval by Cabinet. Departments should discuss the intention to seek approval to retain surpluses (or a capital injection where appropriate) with their Vote Analyst.

4.4.4 Liability for capital withdrawals

Where a department forecasts a capital withdrawal leading to a reduction in equity in the Estimates, the level of projected net assets will be higher at the start of the year than would be permitted at the end of the year.

The requirement that the projected level of net assets set out in the Appropriation (Main Estimates) Act or in the Appropriation (Supplementary Estimates) Act is not exceeded (section 22(3) of the Public Finance Act) combined with the obligation created by the agreement over the amount and timing of repayment of equity, creates an obligation to make repayment of equity during the year and therefore a liability for capital withdrawal.

To ensure a breach of the Act does not occur, departments that forecast capital withdrawals during that year in the Appropriation (Main Estimates) Act or in the Appropriation (Supplementary Estimates) Act, and that have agreed the amount and timing of repayment of the equity with the Treasury, must recognise a liability to the Crown in the Statement of Financial Position until the capital withdrawal has occurred.

4.4.5 Commitments

Commitments are future expenses and liabilities to be incurred on contracts that have been entered into at balance date.

Information on non-cancellable commitments must be disclosed in the Statement of Commitments.

Cancellable commitments that have penalty or exit costs explicit in the agreement on exercising the option to cancel must be included in the Statement of Commitments at the value of that penalty or exit cost (i.e. the minimum future payments).

Commitments must be classified as:

• Capital commitments: aggregate amount of capital expenditure contracted for but not recognised as paid or provided for at period end. NZ IAS 16 (paragraph 74(c)) requires the disclosure of contractual commitments for the acquisition of property, plant and equipment.
• Non-cancellable operating leases with a lease term of more than one year (as required by NZ IAS 17 Leases). These must be classified into liabilities due under the lease in the following periods:
  • not later than one year;
  • later than one year and not later than five years; and
  • later than five years.
• Other non-cancellable commitments: these may include consulting contracts, cleaning contracts and ship charters. These must be classified into liabilities due in the following periods:
  • not later than one year;
  • later than one year and not later than five years; and
  • later than five years.

Interest commitments on debts and commitments relating to employment contracts must not be included in the Statement of Commitments.

4.5 Forecasting Policies

This section sets out requirements in policies with regard to forecasting.

Departments' forecasts are a crucial part of the annual Budget and fiscal management cycle. Consolidated forecasts are used to:

• feed into the government's decisions around their fiscal strategy;
• assist Ministers' decision making about the affordability of the Budget package at the whole of Crown level; and
• determine the amount and timing of the Government's borrowing programme.

Given the importance of fiscal forecasts in the decision-making process, departments' forecast processes must be robust to produce supportable and credible forecasts. This covers both accrual and cash forecasts. Departments' own management review and quality assurances of the forecasts are a vital part of the process and Chief Executives are required to sign-off on the forecasts in the form of a statement of representation.

4.5.1 General forecasting policies

Forecasts (both departmental and non-departmental) are to be prepared on a midpoint estimates basis using best professional judgment, reflecting information and circumstances at the date the forecasts are provided. Appropriate quality analysis of the forecast is required before submitting to Treasury. When updating forecast information (both the five-year forecasts and monthly forecast tracks), departments should use their best estimate of the actual spending patterns. Treasury recommends that these forecast tracks are prepared at the same time as preparing the five-year fiscal forecasts where possible.

For departments, forecasts should be based on expected results rather than appropriation limits. Typically, expenditure forecasts should be less than approved appropriation levels (which are maximum levels).

Entities should confirm material forecast inter-entity balances (i.e. over $10m) with the counter-party, and if the transactions are to occur over a period, then this confirmation should include the phasing of the expenditure. Both sides to a material inter-entity transaction must have the same basis for their forecasts. For further guidance on eliminating inter-entity transactions and balances refer to Treasury's elimination framework available on the Treasury website at: http://www.treasury.govt.nz/publications/guidance/reporting/accounting

In general, forecasts of assets and liabilities should use the valuations as recorded in the Financial Statements of the Government for the prior year and any additional valuations that have occurred up to the forecast reference date. As a consequence, no further realised or unrealised gains or losses are forecast for the entire forecast period. An exception to this general policy is that expected physical growth changes in agricultural assets and long term rates of return (as set out in section 4.5.2 below) should be forecast.

Treasury provides departments with feedback on their forecasting performance at the end of each financial year.

4.5.2 Forecasting policies for financial assets and liabilities

Forecast sales and purchases of bonds and other liquid instruments are assumed to be issued at par value, with no discounts or premiums forecasted. Generally, financial assets and financial liabilities held at the forecast reference date are assumed to be held until they mature.

Forecasts of instruments that have non-market elements (e.g. low or no interest rates with long maturities such as student loans or social benefit receivables) should include the forecast write-down to fair value on initial recognition and the revenue from the effective interest unwind.

Interest income and interest expense is recognised using the effective interest rate method (which in most instances will equal the coupon rate for future instruments).

Forecasts use the exchange rates, interest rate curves and electricity pricing curves prevailing at the forecast reference date. As a consequence, no additional realised or unrealised foreign exchange gains or losses are forecast for the entire forecast period.

Gains and losses reflect long run rate of return assumptions appropriate to the forecast portfolio mix, after adjusting for interest income and interest expense (recognised separately using the effective interest rate method).

4.5.3 Forecasting policies for derivatives

Only the value of derivatives as at the forecast reference date may be realised - no additional realised or unrealised derivative gains or losses are recognised over the forecast period. Forward margins on forward foreign exchange contracts existing at the start of the forecast period are amortised over the period of the contract on a straight line basis.

Forecasts for derivatives should only include those that exist at the forecast reference date, and then only to their maturity. That is, by the end of the forecast period only those derivatives existing at the forecast reference date with a maturity beyond the end of the period should be recognised in the financial statements.

Future derivative activity should not be included in forecasts. This is because fair value forecasts of future derivatives is zero due to forecast exchange rates being fixed at the rate at the forecast reference date, as are interest rate curves and other assumptions (e.g. electricity pricing curves) affecting the value of derivatives.

4.5.4 Forecasting policies for property plant and equipment

Forecasts of the value of property, plant and equipment (including state highways and rail infrastructure), must use the valuations as recorded in the Financial Statements of the Government for the prior year and any additional valuations that have occurred up to the forecast reference date. As a consequence, no further realised or unrealised gains or losses are forecast for the entire forecast period.

The cost of forecast leasehold improvements is capitalised and amortised over the forecast unexpired period of the lease or the estimated useful life of the improvements, whichever is shorter.

Entities should review forecasts for the purchase of physical assets to ensure they show a realistic profile across all forecast years (analysis of prior year forecasts shows forecasts for purchases of such are typically below actual results).

4.5.5 Forecasting departmental net assets

Section 22(3) of the Act states that net asset holdings in a department must not exceed the most recent projected balance of net assets for that department at the end of the financial year.

The Details of Projected Movements in Departmental Net Assets (the “net assets table”) is included for each department in the Estimates of Appropriations. When a Budget forecast is prepared this net assets table is populated automatically from the department's forecast Statement of Financial Position. This table consists of the opening balance of net assets, plus/minus capital injections and withdrawals, plus surplus to be retained or deficit incurred plus other movements.

Some departments forecast a deficit rather than a surplus. A deficit will generally result in reducing the department's projected net asset position. However, if a department's deficit is lower than forecast (i.e. it forecast a deficit of $100, but actually ended up with a deficit of only $70) then it will end the year with a higher than projected net asset balance resulting in a breach of the Act. This may then also impact on the following year's net asset balance. If a department has projected a deficit then they should contact the Treasury for further guidance on how to make an adjustment to maintain the level of net assets and prevent a breach of the Act.

4.5.6 Other forecasting policies

Forecast operating lease revenues and expenses are recognised in a systematic manner over the forecast term of the lease.