Financial Statements of the Government of New Zealand for the Year Ended 30 June 2018

Ministerial Statement#

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The year end results for 2017/18 demonstrate the Coalition Government's commitment to managing the economy well, together with prudent and effective fiscal policy. The books show an increasing OBEGAL surplus, a reduction in net core Crown debt, and rising net worth.

The Government is on track to deliver on the Budget Responsibility Rules while making the long-term, sustained investments needed to build infrastructure, lift productivity, and build a more sustainable and inclusive economy.

These results reflect a strong economy, with nominal GDP growing by 5.5% for the year ended 30 June 2018. Core Crown tax revenue was up 6.1 percent from the previous year with all major tax types increasing, reflecting more people in employment, increases in average wages, additional domestic consumption and higher corporate profits. Average wages rose 3.0% and the number of people in employment grew by 3.7%. The Treasury notes that growth in corporate taxation was due to profit growth amongst companies both large and small, and across most sectors of the economy.

Core Crown expenditure rose 5.6% from the previous year, growing at a slower rate than core Crown revenue. The increase in core Crown expenditure was largely due to investment in the health and education sectors, as well as spending on superannuation and other transfers. Expenditure as a percentage of GDP was 27.9 percent, which was below Treasury’s Budget 2018 forecast.

The operating balance before gains and losses (OBEGAL) reached a surplus of $5.5 billion, an increase of $1.5 billion when compared to 2016/17. This is $2.4 billion ahead of the OBEGAL position forecast at Budget 2018, and the largest surplus since 2008.

Gains on financial instruments consisted of investment gains of $5.3 billion, reflecting continuing strong investment performance (primarily in NZSF and ACC). Together with losses on non-financial instruments of $2.8 billion, the total Crown operating balance was $8.4 billion. Volatility in this measure reflects volatility in equity markets and long-term liability valuations.

The Crown's assets increased by $26.3 billion to $339.9 billion at 30 June, while total Crown liabilities only increased by $7.2 billion to $204.3 billion. Net worth attributable to the Crown increased by $19.1 billion to $129.6 billion, reflecting the operating result for the year and an upward valuation of the Crown's physical assets of $10.6 billion.

The restarting of contributions to the New Zealand Superannuation Fund and increased capital investment led to a slight decrease in the residual cash surplus, with the core Crown recording a residual cash surplus of $1.3 billion.

This lead to a decline in nominal net core Crown debt to $57.5 billion, a decline of $2.0 billion from 2016/17. In GDP terms, net core Crown debt fell from 21.7% in 2016/17 to 19.9% this year.

The year end statements represent a strong result. The Government is committed to continuing the disciplined fiscal approach that has supported this result, while improving New Zealanders’ living standards. Looking ahead we will take a broader approach in order to improve the wellbeing of current and future New Zealanders. Budget 2019 will detail this approach.

Hon Grant Robertson
Minister of Finance

1 October 2018

Statement of Responsibility#

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These financial statements have been prepared by the Treasury in accordance with the provisions of the Public Finance Act 1989. The financial statements comply with New Zealand generally accepted accounting practice and with Public Benefit Entity Accounting Standards (PBE standards) for the public sector.

The Treasury is responsible for establishing and maintaining a system of internal control designed to provide reasonable assurance that the transactions recorded are within statutory authority and properly record the use of all public financial resources by the Government Reporting Entity. To the best of my knowledge, this system of internal control has operated adequately throughout the reporting period.

Gabriel Makhlouf
Secretary to the Treasury

1 October 2018

I accept responsibility for the integrity of these financial statements, the information they contain and their compliance with the Public Finance Act 1989.

In my opinion, these financial statements fairly reflect the financial position of the Crown as at 30 June 2018 and its operations for the year ended on that date.

Hon Grant Robertson
Minister of Finance

1 October 2018

Commentary on the Financial Statements#

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Fiscal Overview#

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At a Glance#

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Core Crown tax revenue was $4.6 billion more than last year and was higher than the Budget 2018 forecast by $0.7 billion (page 9).

Core Crown expenses were $4.2 billion higher than last year, but $1.1 billion less than Budget 2018 forecast (page 11).

Residual cash was a surplus of $1.3 billion, down $1.3 billion from last year's residual cash surplus of $2.6 billion (page 15).

Core Crown gross debt increased nominally by $0.9 billion to $88.1 billion from the prior year, and also increased as a percentage of GDP to 30.4% (page 17).

Core Crown net debt decreased in nominal terms by $2.0 billion, while also continuing to decrease as a percentage of GDP (to 19.9%) (page 15).

The operating balance before gains and losses (OBEGAL) surplus of $5.5 billion, was $1.5 billion higher than last year, reflecting a 6.1% growth in core Crown tax revenue 0.5% higher than the increase in core Crown expenses (page 13).

The total Crown operating balance (excluding minority interests) was $8.4 billion as a result of the OBEGAL surplus and total Crown net gains of $2.9 billion (page 14).

Net worth attributable to the Crown increased $19.1 billion due to the operating balance, and uplifts on the Crown’s property plant and equipment (page 19).

The financial statements of the Government received an unmodified auditor's opinion for the year ended 30 June 2018.

1. Core Crown tax revenue is higher than total Crown tax revenue due to eliminations.
2. Gross sovereign-issued debt excluding Reserve Bank settlement cash and Reserve Bank bills.
3. Net core Crown debt excluding the New Zealand Superannuation Fund (NZS Fund) and advances.

A comparison of the year end results against Budget 2018 is included on pages 25 to 26.

These financial statements[1] contain the audited results for the financial year ended 30 June 2018. The results are compared against previous years and against forecasts for the 2017/18 year:

• Budget 2017 refers to the 2017 Budget Economic and Fiscal Update published in May 2017, and
• Budget 2018 refers to the 2018 Budget Economic and Fiscal Update published in May 2018.

This commentary should be read in conjunction with the financial statements on pages 37 to 130.

Summary#

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The economy remained strong…

Nominal GDP grew by 5.5% in the year to June 2018 to $289.3 billion. Total wage and salary income grew strongly during the year, with average wages up by 3.0% the numbers of people in employment up by 3.7%, and total hours worked increased by 4.4% on average over the year. The GDP growth was reflected in private consumption growth of 4.8%, plus strong contributions to economic growth from residential construction and inbound tourist spending, up by 6.6% and 8.4% respectively. The total population grew by 2.0%, boosted by a net inflow of nearly 65,000 migrants in the year to June.

Figure 1 - Core Crown revenue and core Crown expenses

Source:  The Treasury

... with core Crown tax revenue increasing...

Core Crown tax revenue was $80.2 billion, up $4.6 billion (6.1%) from the year before. The increase in core Crown tax revenue was broadly a result of more people in employment, increases in average wages, additional domestic spending and higher corporate profits.

Figure 2 - Operating balance before gains and losses (OBEGAL)

Source: The Treasury

... at a faster pace than growth in core Crown expenses resulting in an OBEGAL surplus...

As a share of the economy, core Crown expenses increased to 27.9% of GDP (27.8% of GDP in 2017); in nominal terms, core Crown expenses increased by $4.2 billion (5.6%) to $80.6 billion.

The largest drivers of growth in nominal core Crown expenditure were Budget 2017 decisions and the Government's mini-Budget decisions (which came into effect in 2017/18), as well as an increase in social assistance expenses. Additional increases were in the Transport sector and in relation to the Emissions Trading Scheme (ETS).

Overall the OBEGAL surplus of $5.5 billion increased by $1.5 billion from last year.

Figure 3 - Operating balance (excluding minority interests)

Source:  The Treasury

… with net gains leading to an operating balance surplus...

Investment gains were $5.3 billion in 2017/18. Most of the gains this year were from NZS Fund recording an investment gain of $3.6 billion in the current year (compared to a gain of $5.5 billion last year). In addition, ACC recorded investment gains of $1.7 billion (compared to $0.9 billion last year).

Offsetting the investment gains, actuarial losses in relation to long-term liability valuations for ACC and Government Superannuation Fund (GSF) totalled $2.4 billion (and compared to an actuarial gain of $1.4 billion last year).

When these results are combined with the OBEGAL surplus, the operating balance (after gains and losses) and excluding minority interests was a surplus of $8.4 billion ($3.9 billion lower than the 2017 operating balance surplus of $12.3 billion).

The Crown's operating balance is particularly sensitive to changes in some key assumptions used to value financial assets and liabilities and non-financial liabilities.

Figure 4 - Net worth attributable to the Crown

Source:  The Treasury

... which contributed to growth on the balance sheet alongside revaluation uplifts…

Alongside the operating balance of $8.4 billion, revaluation uplifts of the Crown's physical assets, increased by $10.6 billion, resulting in net worth attributable to the Crown increasing by $19.1 billion to be $129.6 billion.

Increases in property, plant and equipment and financial assets such as NZS Fund investments contributed to the growth in assets while borrowings and insurance liabilities were the main drivers in liability growth.

Total assets increased by $26.3 billion to $339.9 billion, while liabilities grew by $7.2 billion $204.3 billion.

Figure 5 - Core Crown residual cash

Source:  The Treasury

... and resulted in a core Crown cash surplus, reducing net core Crown debt.

Overall, a core Crown residual cash surplus of $1.3 billion was achieved, a decrease of $1.3 billion from last year's residual cash surplus of $2.6 billion.

The core Crown operating cash flow strengthened on last year, increasing by $1.0 billion, to $7.3 billion. This increase reflects the increase in core Crown tax receipts more than offsetting the growth in core Crown operating payments. Capital spending of $5.9 billion was higher than last year by $2.2 billion.

The capital spending largely consisted of net purchases of physical assets of $2.5 billion, investment in Crown entities of $2.8 billion and the resumption of Government contributions to NZS Fund of $0.5 billion.

Net core Crown debt decreased nominally by $2.0 billion from last year to be $57.5 billion, largely as a result of the residual cash surplus. As a percentage of GDP, net core Crown debt has continued to fall, from 21.7% in 2016/17 to 19.9% in 2017/18.

Figure 6 - Net core Crown debt¹

Source:  The Treasury

1. Net core Crown debt excluding the NZS Fund and advances.

Revenue#

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Total Crown revenue was $110.0 billion, an increase of $6.6 billion from last year largely due to increased core Crown tax revenue.

Core Crown Tax Revenue

Core Crown tax revenue was $80.2 billion, up $4.6 billion (6.1%) from the year before. The increase in core Crown tax revenue was broadly a result of more people in employment, increases in average wages, additional domestic spending and higher corporate profits.

Figure 7 - Core Crown tax revenue

Source:  The Treasury

Most major tax types increased over the year with the three most significant tax types making up most of the increase (Table 3):

• Source deductions increased by $2.1 billion (7.3%). This increase was due to growth in the number of people in employment on the back of population growth and the effect of rising average tax rates as wages increase.

• Goods and Services Tax (GST) was $1.3 billion (6.7%) higher than last year, with most of the growth coming via domestic consumption, which was up 4.8% on the previous year. Residential investment activity, ie, building new houses and adding to renovating existing houses, grew by 6.6%, accounting for $0.2 billion of the growth in GST.
• Corporate tax revenue increased by $0.8 billion (6.2%), mainly due to profit growth amongst companies both large and small, and across most sectors of the economy. Within corporate tax, tax paid by Portfolio Investment Entities (PIEs) increased by $0.2 billion (38%).

Source:  The Treasury

Other Revenue

Other revenue (Table 2) includes other fees and levies (eg, ACC levies), revenue from operations of Crown Entities (CEs) and State-owned Enterprises (SOEs), interest revenue and dividend revenue.

Core Crown other revenue, at $6.6 billion increased by $0.4 billion since last year. Around half of this increase was attributable to revenue from the New Zealand Emissions Trading Scheme (ETS) increasing from $0.5 billion in 2016/17 to $0.7 billion in the current year. This increase was owing to more carbon units being surrendered to the Crown and an increase in the price of these surrendered units.

The SOE and CE sectors (including inter-segment eliminations) recorded revenue of $23.2 billion, an increase of $1.6 billion from the prior year. This increase related largely to sales of goods and services in the SOE sector.

Figure 8 - Other revenue

Source:  The Treasury

Expenses#

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Total Crown expenses were $104.0 billion in the current year, $5.0 billion more than last year.

Core Crown Expenses

While nominal expenditure increased by $4.2 billion (almost double the previous year's growth), core Crown expenses as a share of the economy were slightly higher than the previous year at 27.9% of GDP (Figure 9).

Figure 9 - Core Crown expenses

Source:  The Treasury

This nominal growth is largely the result of the Government decisions made at Budget 2017 and the Government's mini-Budget. The largest decisions related to Health, Education and Law and Order, which came into effect in 2017/18 along with increased social assistance spending. Table 5 shows the largest contributors to the increase in core Crown expenses over the year:

• Social assistance expenses were higher than last year by $0.7 billion. This was owing to an increase in payments to New Zealand Superannuation recipients, as recipient numbers increased from around 716,900 in 2016/17, to 741,300 in 2017/18 and payment rates increased due to wage adjustments.
• Transport expenses increased by $0.4 billion from prior year, due to an increase in state highway maintenance, in particular relating to the Kaikōura alternate route, and work to address damage caused by significant weather events.
• ETS expenses increased by $0.4 billion compared to last year. This was due to the increased price of carbon units issued.

Source:  The Treasury

Figure 10 shows the composition of core Crown expenses by key areas of Government spending. Social security and welfare and health expenses make up just over half (53%) of the core Crown expenses, while education is the third highest area of expenditure (17%).

Other core Crown expenses (19%) includes a number of other areas of spending (eg, transport, economic, defence, environmental protection and finance costs) and this remained consistent with spending in the prior year.

Figure 10 - Composition of core Crown expenses

Source:  The Treasury

Other Expenses

The SOE and CE sectors (including inter-segment eliminations) recorded expenses that were $0.8 billion (3.4%) higher than 2016/17. The largest driver of the increase was DHB expenses being $0.5 billion higher than the previous year as a result of allocations to Health in Budget 2017.

Operating Balance#

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1. Other gains and losses includes the net surplus from associates and joint ventures/operations.

OBEGAL (Operating Balance Before Gains and Losses)

The OBEGAL surplus of $5.5 billion is an improvement of $1.5 billion from last year.

Figure 11 shows the composition of OBEGAL from the different reporting segments of the Government. For the year ended 30 June 2018, the core Crown segment continued its upwards trend as a result of the strong tax outturn, outpacing the increase in core Crown expenses, as discussed earlier.

Figure 11 - Components of OBEGAL by segment

Source:  The Treasury

The SOE segment remained relatively stable, increasing slightly from a surplus of $0.5 billion in 2016/17, to a surplus of $0.7 billion in 2017/18.

Partially offsetting the core Crown results, the Crown entity segment reported a deficit of $0.8 billion, $0.3 billion less than the previous year's deficit of $1.1 billion. The primary driver of this improved result relates to lower insurance expenditure of $0.4 billion. Both ACC and Southern Response had lower insurance expenses compared to 2017 and this was partially offset by EQC's higher insurance expenses. In addition, higher District Health Boards expenditure also reduced the Crown entity segment's OBEGAL result.

Operating Balance#

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When the net gains/(losses) and the net surplus from associates and joint ventures ($0.4 billion) for the year are combined with the OBEGAL surplus, this resulted in a total Crown operating balance surplus of $8.4 billion, $3.9 billion lower than last year's operating balance surplus of $12.3 billion.

Total net gains for the year were $2.4 billion, $5.3 billion lower than the prior year's gains of $7.7 billion.

Gains on financial instruments consisted of investment gains of $5.3 billion ($1.0 billion lower than the prior year), reflecting continued strong investment performance (primarily in NZSF and ACC). The decrease from the prior year was mainly due to unfavourable movements in exchange rates.

Losses on non-financial instruments of $2.8 billion ($4.1 billion lower than the prior year's gains) largely consisted of actuarial losses on the ACC and GSF long term liabilities. These losses were due to decreases in the discount rates (used to value all outstanding claims in today's dollars). In addition, losses on the Emissions Trading Scheme of $0.5 billion were incurred primarily due to the valuation of carbon units at a higher price.

As can be seen from the volatility in Figure 12, the operating balance is particularly sensitive to the effect of gains and losses resulting from balance sheet movements and actuarial valuations. Note 2 (pages 53 to 58) of the financial statements discusses the key judgements and assumptions underpinning these financial statements.

Figure 12 - Operating balance (excluding minority interests)

Source:  The Treasury

Debt#

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1. Net debt is defined as core Crown net debt excluding the NZS Fund and advances.
2. Gross debt is defined as gross sovereign-issued debt excluding the Reserve Bank settlement cash and Reserve Bank bills.

Net Debt

Net debt has decreased by $2.0 billion from $59.5 billion in 2016/17 to $57.5 billion in the current year. This is largely owing to the residual cash surplus of $1.3 billion, explained below. As a share of the economy, net debt continued to fall (19.9% of GDP versus 21.7% of GDP a year earlier).

The fiscal overview, on pages 4 and 5, summarises the link from the OBEGAL (a total Crown measure of total revenue less total expenses) to net debt (a core Crown measure of debt).

Figure 13 - Net core Crown debt

Source:  The Treasury

Residual Cash

Net cash flows from core Crown operations for the year exceeded net capital spending, resulting in a residual cash surplus of $1.3 billion. This compares to a residual cash surplus of $2.6 billion last year. Table 8 summarises the key residual cash movements from last year to the current year.

• Tax receipts were $5.4 billion higher than last year which was in line with the improvement in core Crown revenue discussed on page 9.
• Operating payments (including interest) were $4.1 billion higher than last year, in line with the increase in core Crown expenses.
• Capital payments were up $2.2 billion from last year at $5.9 billion in 2017/18 (detailed on next page).

Source:  The Treasury

Capital spending for 2017/18 totalled $5.9 billion and included:

• Net purchase of physical assets of $2.5 billion, including $0.8 billion by the Ministry of Education in relation to school property, $0.5 billion for defence equipment and $0.3 billion by the Ministry of Health for hospitals.
• Net investments of $2.8 billion, the largest of which was the Crown’s $1.6 billion investment in NZTA for state highways. Other investments included $0.4 billion in KiwiRail, $0.3 billion in City Rail Link and $0.2 billion in Southern Response.
• Net advances were an outflow of $0.1 billion.
• Government contributions to the NZ Superannuation Fund were $0.5 billion resuming for the first time since 2009.

Figure 14 - Net core Crown capital cash flows

Source:  The Treasury

By analysing capital cash flows by sector, Figure 15 shows that 61% of capital spending ($3.3 billion) was within the transport and education sectors. The total spend in the transport sector was $2.5 billion (45%), largely owing to work on the state highway network. The education sector spent $0.9 billion (16%) purchasing physical assets, investing in schools and upgrading existing property to maintain the quality of the property portfolio.

Figure 15 - Profile of net core Crown capital cash flows

Source:  The Treasury

Gross Debt

Gross debt, which reflects the borrowings of the core Crown, increased nominally by $1.0 billion from $87.1 billion in 2016/17 to $88.1 billion (Figure 16). However, as a percentage of the economy, gross debt decreased by 1.4% to 30.4% of GDP (31.8% of GDP a year earlier).

The increase in nominal gross debt was predominantly due to the increase in derivatives of $0.8 billion as well as a small increase from the issuance of Government bonds.

Figure 16 - Gross debt

Source:  The Treasury

Total Crown borrowing

Overall total borrowing for the Government increased by $3.9 billion from $111.8 billion in 2016/17 year to $115.7 billion. For further information, please refer to page 18.

Net Worth Attributable to the Crown#

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Net worth attributable to the Crown primarily consists of the accumulation of past operating surpluses and deficits (referred to as taxpayers' funds) and revaluation uplifts in the value of the Crown's physical assets (the property, plant and equipment revaluation reserve).

Along with the Crown's operating balance surplus, revaluation uplifts of the Crown's physical assets resulted in an increase in the Crown's net worth in the 2017/18 year (for more information, please refer to page 20).

Net worth attributable to the Crown was $129.6 billion at 30 June 2018, an increase of $19.1 billion from a year earlier. As a share of the economy, net worth attributable to the Crown grew 4.5% from 40.3% of GDP in 2016/17 to 44.8% of GDP in the current year.

Figure 17 - Net worth attributable to the Crown

Source:  The Treasury

Figure 18 shows that, while the nominal level of net worth attributable to the Crown has recovered from the decline which began in 2009, the composition of net worth has changed. The property, plant and equipment revaluation reserve has shown steady growth over the last few years, the main driver of this has been the increase in land and building prices. The increase in the current year was mainly due to the revaluation of the state highway network, we have discussed this on page 23. Although the property, plant and equipment revaluation reserve grew by 12.6%, as a percentage of net worth attributable to the Crown it has decreased from 76.1% in 2016/17 to 73.1%.

Figure 18 - Composition of net worth attributable to the Crown

Source:  The Treasury

Taxpayers' funds, which is directly affected by the operating balance, increased from the prior year, growing by $8.4 billion. As a percentage of net worth attributable to the Crown, it has increased to 26.9% in the current year.

Net worth attributable to minority interests largely represents the share of net assets attributable to the investors in the mixed ownership companies (Air New Zealand, Genesis Energy, Mercury NZ and Meridian Energy). Net worth attributable to minority interests was in line with prior years at $6.0 billion in 2017/18 year.

Total Crown Balance Sheet

Total Crown assets were $339.9 billion at 30 June 2018, a $26.3 billion increase from last year. This growth was largely in social sector assets ($17.2 billion), while financial assets grew by $7.8 billion and commercial assets by $1.3 billion.

Total Crown liabilities were $204.3 billion, an increase of $7.2 billion from the previous year.

Social Assets and Liabilities

Social sector net worth at $156.8 billion was $14.3 billion higher than last year, driven largely by an increase in social assets.

The Crown's social assets were valued at $179.8 billion, a $17.2 billion increase since last year, and made up 52.9% of the Crown’s total assets. The largest uplifts related to the following:

• The value of state highways (including land) increased by $9.3 billion, mainly reflecting valuation improvements, the development of new state highway assets and improvements to existing state highway network (detailed on page 23).
• The housing portfolio increased by $1.7 billion of which $1.3 billion relates to an increase in housing stock and the revaluation of this stock. The revaluation increase included the effect of removing the encumbrances on the Christchurch and Invercargill housing stock.

Figure 20 - Total Crown balance sheet

Source:  The Treasury

Social liabilities were $23.0 billion, a $2.9 billion increase compared to 2016/17. This increase was largely due to increased borrowings across the social sector including $0.7 billion by Housing Corporation New Zealand (refer to page 18 for box on Government Financing).

Figure 21 - Social assets and liabilities

Source:  The Treasury

Financial Assets and Liabilities

Financial sector net worth decreased by $4.1 billion, from negative $44.9 billion last year to negative $49.0 billion in the current year. The financial sector includes the Treasury's Debt Management Office which manages the Crown's bond programme and therefore holds the majority of the Crown's debt (while the assets funded by the debt are largely in the social sector).

Figure 22 - Financial assets and liabilities

Source:  The Treasury

The value of financial assets and financial liabilities are particularly sensitive to changes in market prices. Note 2, on pages 53 to 58, sets out some of the sensitivities of the key assumptions regarding these assets and liabilities.

The Crown's financial sector assets were valued at $102.0 billion, a $7.8 billion increase compared to last year. The RBNZ recorded assets growing by $6.0 billion, which directly impacts the financial balance sheet.

Financial sector liabilities were $146.8 billion, $3.7 billion higher than the previous year, mainly due to increases in the value of RBNZ's and ACC's liabilities, offset by a decrease in the value of the Treasury's Debt Management Office liabilities.

Commercial Assets and Liabilities

Commercial sector net worth, at $23.6 billion, increased by $0.8 billion from last year.

The Crown's commercial assets were valued at $58.1 billion, a $1.3 billion increase over the year. This was spread over a number of entities. This increase mainly relates to net revaluation increases and purchases of property, plant and equipment.

Commercial liabilities, at $34.5 billion, increased by $0.6 billion from the prior year. This was largely related an increase in borrowings for the purchase of property, plant and equipment.

Figure 23 - Commercial assets and liabilities

Source:  The Treasury

Year End Results Compared to Budget 2018#

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The Budget Economic and Fiscal Update 2018 (Budget 2018) was published on 17 May 2018.

Core Crown Tax Revenue

Core Crown tax revenue was $0.7 billion (0.9%) higher than expected in Budget 2018, with the largest differences being:

• Source deduction revenue was $0.3 billion (1.1%) above forecast. Labour market data was in line with forecast, so this positive variance was the result of a higher-than-expected average effective tax rate.
• Corporate tax revenue was $0.3 billion (2.4%) above forecast. PIE tax was higher than forecast owing to better-than-expected investment fund profits. Provisional tax revenue was also above forecast, indicating that 2017/18 profits were higher than was forecast in Budget 2018.

Source:  The Treasury

The tax variance to forecast was below 1%. Overall, this is in line with prior variances as shown in Figure 24.

Figure 24 - Core Crown tax revenue variance to Estimated Actuals

Source:  The Treasury

Core Crown Expenses

Core Crown expenses were $1.1 billion (1.4%) lower than expected.

The lower than forecast result was largely owing to changes in demand for services (eg, lower than forecast expenses across the education sector and lower than expected year-end family tax credit claims); one-off factors such as lower than forecast impairments; and timing delays with expenditure now expected to be spent in the 2018/19 fiscal year (eg, Provincial Growth Fund and social housing expenses).

Figure 25 - Core Crown expenses variance to Estimated Actuals

Source:  The Treasury

OBEGAL

The OBEGAL surplus was $2.4 billion higher than Budget 2018 forecast. The majority of the variance against Budget 2018 relates to the favourable variances in core Crown revenue and core Crown expenses discussed earlier. In addition, KiwiRail had an improved OBEGAL result versus Budget 2018 of $0.3 billion, largely due to lower than forecast impairment expenses.

Operating Balance

The total Crown operating balance was $1.4 billion higher than forecast in Budget 2018, the primary reason for this is due to the favourable OBEGAL result, offset by increased actuarial losses from forecast.

Residual Cash

The residual cash surplus was $2.6 billion higher than Budget 2018 with cash flows from operations $1.8 billion higher than forecast and capital payments $0.8 billion lower than forecast.

Operating cash flows were favourable to forecast with operating payments making up $1.3 billion of this and tax receipts increasing by $0.6 billion. This is similar to the core Crown revenue and expenditure trends.

Capital payments were $0.8 billion lower than Budget 2018, driven by less than forecast purchase of physical assets and investments.

Net Debt

Net debt at $57.5 billion (19.9% of GDP) was $2.9 billion below forecast mainly driven by the residual cash surplus.

Gross Debt

Gross debt at $88.1 billion (30.4% of GDP) was broadly in line with forecast.

Total Borrowings

Borrowings at 30 June 2018 was $115.7 billion in line with the Budget 2018 forecast of $116.0 billion.

Net Worth Attributable to the Crown

The net worth attributable to the Crown was $12.0 billion stronger than Budget 2018 forecast mainly due to an upwards revaluation of physical assets of $10.7 billion and a favourable operating balance of $1.4 billion against Budget 2018.

Historical Financial Information#

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Time series information has been restated to ensure comparability with current year's information.

Independent Audit Report of the Controller and Auditor-General#

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

Opinion

I have audited the financial statements of the Government of New Zealand (the financial statements of the Government) for the year ended 30 June 2018 using my staff, resources, and appointed auditors and their staff. The financial statements of the Government on pages 38 to 141 comprise:

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

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

Basis for opinion

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

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

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

Key audit matters

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Other information

The Treasury is responsible for the other information. The other information comprises the information included on pages 1 to 152, but does not include the financial statements of the Government and my auditor's report thereon.

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

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

Independence

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

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

John Ryan
Controller and Auditor-General

Wellington, New Zealand

Audited Financial Statements of the Government of New Zealand#

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Statement of Financial Performance
for the year ended 30 June 2018#

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The accompanying notes (including accounting policies) are an integral part of these statements.

Analysis of Expenses by Functional Classification
for the year ended 30 June 2018#

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Social security and welfare has been restated from $30,599 million in 2017 to $29,794 million. Budget comparatives have also been restated. Due to income related rents payments for social housing tenants previously presented on a gross basis, this year this revenue and expenditure has been eliminated between Government reporting entities, as this payment is more like a subsidy than rental payments on behalf of tenants.

Below is an analysis of core Crown expenses by functional classification. Core Crown expenses include expenses incurred by Ministers, Departments, Offices of Parliament, the NZ Superannuation Fund and the Reserve Bank, but not Crown entities and State-owned Enterprises. Details of unappropriated expenditure can be found on page 131.

The accompanying notes (including accounting policies) are an integral part of these statements.

Statement of Comprehensive Revenue and Expense
for the year ended 30 June 2018#

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Statement of Changes in Net Worth
for the year ended 30 June 2018#

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The accompanying notes (including accounting policies) are an integral part of these statements.

Statement of Cash Flows
for the year ended 30 June 2018#

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The accompanying notes (including accounting policies) are an integral part of these statements.

Statement of Financial Position
as at 30 June 2018#

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The accompanying notes (including accounting policies) are an integral part of these statements.

Statement of Segments#

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Notes to the Financial Statements#

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Note 1: Basis of Reporting

Statement of compliance

These financial statements have been prepared in accordance with the Public Finance Act 1989 and with New Zealand Generally Accepted Accounting Practice (NZ GAAP) as defined in the Financial Reporting Act 2013.

These financial statements have been prepared in accordance with Public Sector PBE Accounting Standards (PBE Standards) - Tier 1. These standards are based on International Public Sector Accounting Standards (IPSAS).

For the purposes of these financial statements, the Government reporting entity has been designated as a public benefit entity (PBE). PBEs are reporting entities whose primary objective is to provide goods or services for community or social benefit and where any equity has been provided with a view to supporting that primary objective rather than for a financial return to equity holders.

The use of public resources by the Government is primarily governed by the Public Finance Act 1989, the State Sector Act 1988, the Crown Entities Act 2004 and the State-owned Enterprises Act 1986.

These financial statements were authorised for issue by the Minister of Finance on 1 October 2018.

Reporting period

The reporting period for these financial statements is for the year ended 30 June 2018.

Where necessary, the financial information for State-owned Enterprises and Crown entities that have a balance date other than 30 June has been adjusted for any transactions or events that have occurred since their most recent balance date and that are significant for the Financial Statements of the Government. Such entities are primarily in the education sector.

Basis of preparation

These financial statements have been prepared on the basis of historic cost modified by the revaluation of certain assets and liabilities, and prepared on an accrual basis, unless otherwise specified (for example, in the Statement of Cash Flows).

The financial statements are presented in New Zealand dollars rounded to the nearest million, unless separately identified.

The accounting policies included in these financial statements are the significant accounting policies for the Financial Statements of the Government and appear in grey shaded boxes. A full list of Crown accounting policies can be found at http://www.treasury.govt.nz/publications/guidance/reporting/accounting.

Comparatives

When presentation or classification of items in the financial statements are amended or accounting policies are changed voluntarily, comparative figures have been restated to ensure consistency with the current period unless it is impracticable to do so.

Comparatives referred to as Budget 2017 were 2018 forecasts published in the 2017 Budget Economic and Fiscal Update, while Budget 2018 were 2018 forecasts published in the 2018 Budget Economic and Fiscal Update. These forecasts include budget adjustments for new unallocated spending during the year (both operating and capital) and top-down adjustments which reduce the bias for forecast expenditure by departments to reflect maximum spending limits instead of forecast estimates.

Forecast new capital spending is an amount provided in the forecasts to represent the impact on the financial position and cash flowsof capital initiatives expected to be introduced over the forecast period. Forecast new operating spending is an amount included in the forecasts to provide for the operating balance impact of policy initiatives, changes to demographics, and other forecasting changes expected to occur over the forecast period. Top-down adjustment is an adjustment to expenditure forecasts to reflect the extent to which departments use appropriations (upper spending limits) when preparing their forecasts. As appropriations apply to the core Crown only, no adjustment is required to State-owned Enterprises or Crown entity forecasts.

Segment analysis

The Government reporting entity is not required to provide segment reporting as it is a public benefit entity. Nevertheless, information is presented for material institutional components and major economic activities within or undertaken by the Government reporting entity. The three major institutional components of the Crown are:

• Core Crown: This group, which includes Ministers, government departments, Offices of Parliament, the Reserve Bank of New Zealand and the New Zealand Superannuation Fund, most closely represents the budget sector and provides information that is useful for fiscal analysis purposes. Investments in Crown entities and SOEs are reported at historic cost in this segment with no impairment. This ensures losses in those entities are reflected in the appropriate segment.
• Crown entities: This group includes entities governed by the Crown Entities Act 2004. These entities have separate legal form and specified governance frameworks (including the degree to which each Crown entity is required to give effect to, or be independent of, government policy).
• State-owned Enterprises: This group includes entities governed by the State-owned Enterprises Act 1986, and (for the purposes of these statements) also includes Air New Zealand Limited, Mercury NZ Limited, Meridian Energy Limited and Genesis Energy Limited. This group represents entities that undertake commercial activity.

Functional analysis is also provided of a number of financial statements items. This functional analysis is drawn from the Classification of the Functions of Government as developed by the Organisation for Economic Co-operation and Development (OECD) and published by the United Nations Statistical Division.

Accounting Standards issued and not yet effective and not early adopted

Standards and amendments to standards, issued but not yet effective that have not been early adopted, and that are relevant to these Financial Statements are:

Financial Instruments

PBE IFRS 9: Financial Instruments was issued in January 2017 replacing the existing standard PBE IPSAS29 andNZ IAS 39, Financial instruments: Recognition and Measurement. The standard is effective for periods beginning on or after 1 January 2021. The Crown has resolved to early adopt this standard for non-hedge financial instruments from 1 July 2018 and has exercised the option under PBE IFRS 9 to continue to apply the hedge accounting requirements of PBE IPSAS 29.

The main changes under the standard for non-hedge financial instruments are:

• New financial asset classification requirements for determining whether an asset is measured at fair value or amortised cost.
• A new impairment model for financial assets based on expected losses, which may result in the earlier recognition of impairment losses.

While the impact of the adoption continues to be assessed the following are expected to be the key areas of impact:

• The measurement classification rules mean that student loans are now valued at fair value, rather than the previous basis of amortised cost. This will result in a one-off increase of $628 million to the value of the student loan asset based on the valuation at 30 June 2018. This uplift reflects the different points in time that the student loan asset is measured under the two different methods (refer to Note 15).
• The impact on impairment allowances in relation to Kiwibank loans and advances have been reviewed as part of the bank's NZ IFRS 9 conversion project. As at 30 June 2018 Kiwibank's best estimate on the impact of the transition, due to the application of the expected credit loss model, is a +/- $2 million movement in equity as at 1 July 2018.
• Enhanced and updated disclosures especially around credit risk management and exposure.

Consolidated Financial Statements

PBE IPSAS 35 Consolidated Financial Statements issued in December 2016 (replacing IPSAS 6 Consolidated and Separate Financial Statements) is effective for annual periods beginning on or after 1 January 2019, with earlier application permitted, but the Crown does not intend to adopt it before the 2019/20 Financial Statements of the Government.

The assessment to date of PBE IPSAS 35 against the entities in which the Government has an interest, suggests any significant impact on the entities consolidated in the financial statements is unlikely.

Employee Benefits

PBE IPSAS 39 Employee Benefits issued in January 2017 (updating the existing standard PBE IPSAS 25 Employee Benefits) is effective for annual periods beginning on or after 1 January 2019, with earlier application permitted, but the Crown does not intend to adopt it before the 2019/20 Financial Statements of the Government.

The new standard will have an impact on the way the Government Superannuation Fund defined benefit pension scheme is presented in the financial statements with actuarial gains/losses being presented in the Statement of Other Comprehensive Revenue and Expenses rather than as a gain or loss in the Statement of Financial Performance (refer to Note 10 for values).

Government Reporting Entity as at 30 June 2018

Reporting entity

The Government reporting entity as defined in section 2(1) of the Public Finance Act 1989 means:

• the Sovereign in right of New Zealand, and
• the legislative, executive, and judicial branches of the Government of New Zealand.

The description “Consolidated Financial Statements of the Government reporting entity” and the description “Financial Statements of the Government” have the same meaning and can be used interchangeably.

Basis of combination

These financial statements combine the following entities using the acquisition method of combination:

Core Crown entities

• Ministers of the Crown
• Government departments
• Offices of Parliament
• the Reserve Bank of New Zealand
• New Zealand Superannuation Fund

Other entities

• State-owned Enterprises
• Crown entities (excluding tertiary education institutions)
• Air New Zealand Limited
• Regenerate Christchurch
• Education Council of Aotearoa New Zealand
• Organisations listed in Schedule 4 and 4A (Non-listed companies in which the Crown is majority or sole shareholder) of the Public Finance Act 1989
• Organisations listed in Schedule 5 (Mixed ownership model companies) of the Public Finance Act 1989
• Legal entities listed in Schedule 6 (Legal entities created by Treaty of Waitangi Settlement Acts) of the Public Finance Act 1989

The Crown has a full residual interest in all the above entities with the exception of Air New Zealand Limited, Tāmaki Redevelopment Company Limited (listed in Schedule 4A of the Public Finance Act 1989), Regenerate Christchurch, City Rail Link Limited and the entities listed in Schedule 5 of the Public Finance Act 1989 (Mixed Ownership Model Companies).

Corresponding assets, liabilities, revenue and expenses, are added together line by line. Transactions and balances between these sub-entities are eliminated on combination. Where necessary, adjustments are made to the financial statements of controlled entities to bring the accounting policies into line with those used by the Government reporting entity.

These financial statements are for the Government Reporting entity as specified in Part 3 of the Public Finance Act 1989. This comprises Ministers of the Crown and the following entities (classified in the three institutional components used for segmental reporting). The following tables list the entities within each institutional component.

Core Crown Segment

Departments

1. Crown Law Office
2. Department of Conservation
3. Department of Corrections
4. Department of Internal Affairs
5. Department of the Prime Minister and Cabinet
6. Education Review Office
7. Government Communications Security Bureau
8. Inland Revenue Department
9. Land Information New Zealand
10. Ministry for Culture and Heritage
11. Ministry for Pacific Peoples
12. Ministry for Primary Industries
13. Ministry for the Environment
14. Ministry for Women
15. Ministry of Business, Innovation, and Employment
16. Ministry of Defence
17. Ministry of Education
18. Ministry of Foreign Affairs and Trade
19. Ministry of Health
20. Ministry of Justice
21. Ministry of Māori Development
22. Ministry of Social Development
23. Ministry of Transport
24. New Zealand Customs Service
25. New Zealand Defence Force
26. New Zealand Police
27. New Zealand Security Intelligence Service
28. Office of the Clerk of the House of Representatives
29. Oranga Tamariki, Ministry for Children
30. Parliamentary Counsel Office
31. Parliamentary Service
32. Serious Fraud Office
33. State Services Commission (Includes Social Investment Agency as a departmental agency)
34. Statistics New Zealand
35. Te KāhuiWhakamana Rua Tekau mā Iwa—Pike River Recovery Agency
36. The Treasury

Offices of Parliament

1. Controller and Auditor-General
2. Office of the Ombudsman
3. Parliamentary Commissioner for the Environment

Others

1. New Zealand Superannuation Fund
2. Reserve Bank of New Zealand

State-owned Enterprises Segment

State-owned Enterprises

1. Airways Corporation of New Zealand Limited
2. Animal Control Products Limited
3. AsureQuality Limited
4. Electricity Corporation of New Zealand Limited
5. KiwiRail Holdings Limited
6. Kordia Group Limited
7. Landcorp Farming Limited
8. Meteorological Service of New Zealand Limited
9. New Zealand Post Limited
10. New Zealand Railways Corporation
11. Quotable Value Limited
12. Solid Energy New Zealand Limited
13. Transpower New Zealand Limited

Mixed ownership model companies (Public Finance Act Schedule 5)

1. Genesis Energy Limited
2. Mercury NZ Limited
3. Meridian Energy Limited

Other

1. Air New Zealand Limited
2. Kiwi Group Holdings Limited (including Kiwibank)

Crown entities Segment

Crown entities

1. Accident Compensation Corporation
2. Accreditation Council
3. Arts Council of New Zealand Toi Aotearoa
4. Broadcasting Commission
5. Broadcasting Standards Authority
6. Callaghan Innovation
7. Children's Commissioner
8. Civil Aviation Authority of New Zealand
9. Commerce Commission
10. Crown Irrigation Investments Limited
11. Crown Research Institutes (7)
12. District Health Boards (20)
13. Drug Free Sport New Zealand
14. Earthquake Commission
15. Education New Zealand
16. Electoral Commission
17. Electricity Authority
18. Energy Efficiency and Conservation Authority
19. Environmental Protection Authority
20. External Reporting Board
21. Families Commission
22. Financial Markets Authority
23. Fire and Emergency New Zealand
24. Government Superannuation Fund Authority
25. Guardians of New Zealand Superannuation
26. Health and Disability Commissioner
27. Health Promotion Agency
28. Health Quality and Safety Commission
29. Health Research Council of New Zealand
30. Heritage New Zealand Pouhere Taonga
31. Housing New Zealand Corporation
32. Human Rights Commission
33. Independent Police Conduct Authority
34. Law Commission
35. Maritime New Zealand
36. Museum of New Zealand Te Papa Tongarewa Board
37. New Zealand Antarctic Institute
38. New Zealand Artificial Limb Service
39. New Zealand Blood Service
40. New Zealand Film Commission
41. New Zealand Lotteries Commission
42. New Zealand Productivity Commission
43. New Zealand Qualifications Authority
44. New Zealand Symphony Orchestra
45. New Zealand Tourism Board
46. New Zealand Trade and Enterprise
47. New Zealand Transport Agency
48. New Zealand Venture Investment Fund Limited
49. New Zealand Walking Access Commission
50. Office of Film and Literature Classification
51. Pharmaceutical Management Agency
52. Privacy Commissioner
53. Public Trust
54. Radio New Zealand Limited
55. Real Estate Agents Authority
56. Retirement Commissioner
57. School Boards of Trustees (2,406)
58. Social Workers Registration Board
59. Sport and Recreation New Zealand
60. Takeovers Panel
61. Te Reo Whakapuaki Irirangi (Māori Broadcasting Funding Agency)
62. Te Taura Whiri i te Reo Māori (Māori Language Commission)
63. Television New Zealand Limited
64. Tertiary Education Commission
65. Transport Accident Investigation Commission
66. WorkSafe New Zealand

Organisations listed in schedule 4 of the Public Finance Act 1989

1. Agricultural and Marketing Research and Development Trust
2. Asia New Zealand Foundation
3. Fish and Game Councils (12)
4. Game Animal Council
5. Leadership Development Centre Trust
6. Māori Trustee
7. National Pacific Radio Trust
8. New Zealand Fish and Game Council
9. New Zealand Game Bird Habitat Trust Board
10. New Zealand Government Property Corporation
11. New Zealand Lottery Grants Board
12. Ngāi Tahu Ancillary Claims Trust
13. Pacific Co-operation Foundation
14. Pacific Island Business Development Trust
15. Reserves Boards (21)
16. Te Ariki Trust

Non-listed companies in which the Crown is majority or sole shareholder (Public Finance Act Schedule 4A)

1. Crown Asset Management Limited
2. Crown Infrastructure Partners Limited (previously Crown Fibre Holdings Limited)
3. Education Payroll Limited
4. Ōtākaro Limited
5. Predator Free 2050 Limited
6. Research and Education Advanced Network New Zealand Limited
7. Southern Response Earthquake Services Limited
8. Tāmaki Redevelopment Company Limited
9. The Network for Learning Limited

Legal entities created by Treaty of Waitangi settlement Acts (Public Finance Act Schedule 6)

1. Te Urewera

Others

1. Education Council of Aotearoa New Zealand
2. Regenerate Christchurch
3. Christ Church Reinstatement Trust

Other entities not fully consolidated into the financial statements of the Government with only the Crown's interest in them being included

Crown entities

1. Tertiary Education Institutions (27)

Non-listed companies in which the Crown is majority or sole shareholder (Public Finance Act Schedule 4A)

1. City Rail Link Limited

Tertiary education institutions are equity-accounted for the reasons explained in note 17 and City Rail Link Limited is reported as a joint operation as a consequence of the agreements with Auckland Council in these financial statements for the period ended 30 June 2018. This treatment recognises these entities' net assets, including asset revaluation movements, surpluses and deficits.

Subsidiaries of SOEs, Crown entities and other government entities are consolidated by their parents and not listed separately in this table.

Note 2: Key Assumptions and Judgements

These financial statements reflect the Government's financial position (service potential and financial capacity) as at 30 June 2018, and the financial results of operations and cash flows for the year ended on that date. Underpinning these financial statements are a number of judgements, estimations and assumptions. These include assumptions and judgements about the future, in particular, the service benefits and future cash flows in relation to existing assets and liabilities.

Key assumptions

The assumptions in these financial statements are based on the best information available at the time of their preparation. Given the inherent uncertainty of predicting the future, actual events are likely to differ from these assumptions, which may have a material impact on the results reported in these financial statements Key assumptions are discussed below.

With respect to the asset purpose assumption, the valuation of the Rail Freight Network is particularly uncertain at present. Treated as a for-profit asset since 2012, this asset has a carrying value of $186 million (2017: $96 million). The Crown is currently conducting a review to consider KiwiRail's structure, capital requirements and funding mechanisms within the context of rail's purpose within a multi modal transport system. This review may change the assumptions underlying the future valuations of KiwiRail's Rail Freight Network.

Decisions from this review, expected in early 2019, may affect the mix of assets and operations, the extent of the rail network, and which of the entities within the Crown might own those assets and/or perform those operations. That in turn could result in some or all of the freight assets being revalued using the optimised depreciated replacement cost methodology that was used prior to 2012. The potential impact of this revaluation could increase the asset value up to $5.1 billion and result in the reversal of some or all of the $1.4 billion impairment expense previously recognised. For further information, see note 16.

A number of long-term assets and liabilities are valued by estimating future cash flows which are then discounted to present value. Some of the cash flows, in particular those relating to long-term liabilities (eg, ACC and GSF obligations) use assumptions to predict cash flows as far as 80 years into the future. Therefore, changes in a number of economic variables can have a significant impact on the Government’s financial position and performance. The most significant of these are:

Sensitivity of key assumptions

The tables below outline the sensitivity of the key assumptions discussed above on the significant valuations included in the statement of financial position. They do not include second or third-order effects on forecast revenues and expenses. A negative impact on the Operating Balance is designated by the use of brackets.

The value of financial assets and financial liabilities are particularly sensitive to changes in market prices and account for a significant portion of the financial position. At 30 June 2018 financial assets totalled $142.5 billion (2017: $133.3 billion) while financial liabilities totalled $131.4 billion (2017: $128.4 billion).

In relation to assumptions concerning property prices, land and buildings account for 57% (2017: 58%) of total property, plant and equipment and 67% (2017: 68%) of the asset revaluation reserve. A significant decline in property prices would not impact the operating balance but would reduce net worth.

Long term liabilities such as the ACC claims liability $43.3 billion (2017: $40.3 billion) and the GSF retirement plan $11.0 billion (2017: $11.0 billion) are particularly sensitive to the assumptions associated with estimating discounted cash flows. The table below outlines the sensitivity of those liabilities to key assumptions:

Areas of significant estimation

These financial statements include estimated amounts that have a number of uncertainties (discussed below).

Other uncertainties

In addition to those items in the statement of financial position there are a number of liabilities or assets that may arise in the future but are not currently recognised. This is because they are dependent on uncertain future events occurring or the liability/asset cannot be measured reliably. If these contingencies crystallise, there will be an associated impact on the operating balance and net worth of the Crown. These contingencies are reported in note 25 of these financial statements.

Risk management

The Crown's financial position at balance date is exposed to risks through possible changes in the key assumptions and judgements described above that could materially impact on the value of the Crown's assets and liabilities.

The Crown's current risk management framework generally involves holding individual government reporting entities responsible for managing the risks that they individually face, subject to legislation and central guidance such as the Public Finance Act 1989 and Treasury Instructions. Government-wide financial resilience is supported through relatively low debt levels, a strong financial position and effective budgeting.

With respect to its financial portfolios, the Government's financial instrument holdings expose it primarily to the financial risks of changes in interest rates, foreign exchange rates, risk of default and liquidity risk. These risks are managed at portfolio level consistent with the policy purpose of the portfolio and risk management objectives. Detailed information on the exposure to market risk and policies for managing this risk are available in the separate financial statements prepared by the entities who manage each portfolio.

The Government's exposure to market risk reflects the combination of these portfolio management practices. These practices include use of Value-at-Risk (VaR) limits and stop-loss limits to manage risk. While the Treasury and the Reserve Bank's activities collectively manage the core Crown's exposure to foreign exchange, there is no other centralised management of market or other risk.

There has been no significant change from the previous year to the manner in which the Government reporting entities that manage the Government's portfolios, manage and measure risks.

Derivative financial instruments are often used across the portfolios to manage exposure to interest rate, and foreign currency risk. Refer to pages 123 and 124 for further derivative information.

Note 3: Sovereign Revenue

1 Includes customs excise-equivalent duty.

More detailed unaudited information on tax revenue and receipts can be found at www.treasury.govt.nz/government/revenue/taxoutturn

The Government provides many services and benefits that do not give rise to revenue. Further, payment of tax does not of itself entitle a taxpayer to an equivalent value of services or benefits, since there is no relationship between paying tax and receiving Crown services and transfers. Such revenue is received through the exercise of the sovereign power of the Crown in Parliament.

Note 4:  Sales of Goods and Services

Note 5:  Investment Income/(Expense)

Student loans are advanced on an interest-free basis, therefore they are discounted to reflect their fair value. The interest unwind reflects the increase in value as the period to repayment reduces (refer note 15).

Note 6:  Other Revenue

Income related rents for social housing tenants were presented gross in previous financial years. This year this revenue and expenditure has been eliminated between Government reporting entities, as this payment is more like a subsidy than rental payments on behalf of tenants. Rental revenue in 2017 has been restated from $1,380 million to $575 million. Budget comparatives have also been restated.

Note 7:  Transfer Payments and Subsidies

Income related rent payments for social housing tenants were presented gross in previous financial years. This year this revenue and expenditure has been eliminated between Government reporting entities, as this payment is more like a subsidy than rental payments on behalf of tenants. Due to a change in accounting policy in the current year, income related rent subsidy has been restated from $815 million in 2017 to $10 million. Budget comparatives have also been restated.

Note 8:  Personnel Expenses

Key management personnel compensation was $11 million (2017: $10 million). This reflects salaries, benefits and allowances. Key management personnel are the 28 Ministers of the Crown who are members of the Executive Council (including the Prime Minister).

The Ministers' remuneration and other benefits are set out by the Remuneration Authority under the Members of Parliament (Remuneration and Services) Act 2013. Members of Parliament, including members of the Executive,have access to other non-cash entitlements as determined by the Speaker of the House of Representatives. Details of these entitlements (eg, travel discounts) can be found on the New Zealand Parliament website (www.parliament.govt.nz).

Note 9:  Other Operating Expenses

Other operating expenses relate to those expenses incurred in the course of undertaking the functions and activities of entities included in the financial statements of the Government, excluding those expenses separately identified in the statement of financial performance and other notes.

Audit fees paid to the Controller and Auditor-General

Fees paid to the Controller and Auditor-General (including independent auditors providing services on behalf of the Controller and Auditor-General) for the audit of the financial statements of the Government and its reporting entities were $42.0 million (2017: $41.8 million). These fees include $0.2 million (2017: $0.2 million) for the audit of these financial statements. Audit fees for assurance and related services paid to the Controller and Auditor-General were $1.5 million (2017: $0.8 million). As the Controller and Auditor-General is part of the Government reporting entity, these fees are eliminated on consolidation.

Note 10:  Net Gains and Losses on Non-Financial Instruments

Note 11: Insurance

At 30 June 2018 the total amount paid or payable for damage in relation to the Canterbury earthquakes was reassessed and is now expected to be lower than previously expected. This reduction is recognised as a credit in the claims expense for Southern Response.

Further information on these liabilities may also be found in the annual reports of each of these entities and on their respective websites. The objectives, policies and procedures for managing these risks are set out in the governing statutes and policy documents of each entity.

All assets held by the three insurance entities are considered available to back present and future claims obligations. There are no deferred acquisition costs (eg, marketing costs) in respect of insurance obligations at the reporting date. In addition each of these entities is backed by a guarantee from the Crown.

The outstanding claims liability is the present value of the central estimate of expected payments for claims incurred plus a risk margin. The unearned premium liability represents premiums received to provide insurance cover after 30 June 2018. The unearned premium liability deficiency is the extent that the unearned premium liability is insufficient to cover expected future claims (ie, payments for future accidents within the period covered by the premiums received).

The remainder of this note provides detailed analysis of the ACC insurance expense and liability. ACC's insurance obligations arise primarily from the accident compensation scheme provision of no fault personal injury cover for all New Zealand citizens, residents and temporary visitors to New Zealand.

Net claims incurred in the table below refers to the adjustment in the liability arising from claims incurred in the current financial year and reassessment of claims incurred in previous years. This reassessment results from new information on these claims (including new claims relating to incidents incurred in previous years) and changes in assumptions.

The underwriting surplus / (deficit) below represents the net effect on the statement of financial performance from claims incurred and premiums levied during the year. It includes actuarial gains / (losses).

Analysis of ACC insurance liability

An independent actuarial estimate by Taylor Fry, consulting actuaries, has been made of the future expenditure relating to accidents that occurred prior to balance date, whether or not the claims have been reported to or accepted by ACC. The Taylor Fry actuarial report is signed by Mr Alan Greenfield, Fellow of the Institute of Actuaries of Australia and Mr Ross Simmonds, Fellow of the New Zealand Society of Actuaries. Mr Ross Simmonds is also a Fellow of the Institute and Faculty of Actuaries (UK).

Claims development historical analysis

The following table shows the development of ACC's undiscounted claims cost estimates for the seven most recent accident years.

Key assumptions

The key assumptions and the methodology applied in the valuation of the outstanding ACC claims obligation are as follows:

(i) Risk-free discount rates

The projected cash flows were discounted using a series of forward discount rates at the balance date derived from the yield curve for New Zealand government bonds. The equivalent single effective discount rate taking into account ACC's projected future cash flow patterns is a short term discount rate of 3.51% (2017: 3.8%) and a long term discount rate of 4.75% beyond 39 years (2017: 4.75% beyond 39 years).

(ii) Risk margin

The outstanding claims liability includes a risk margin that relates to the inherent uncertainty in the central estimate of the present value of expected future payments. The overall risk margin is intended to achieve a 75% probability of sufficiency in meeting the actual amount of liability to which it relates.

(iii) Inflation and indexation

ACC claims and costs are subject to inflation. Some costs are assumed to increase faster than the general rate of inflation (referred to as superimposed inflation) due to factors such as innovation in medical treatment.

(iv) Rehabilitation rate

Assumptions for rehabilitation rate were set with reference to past observed experience with allowance for expectations of the future that is believed to be reasonable under the circumstances.

(v) Liability adequacy test

An unearned premium liability deficiency is recognised when the amount of the present value of expected future claim cash outflows, plus a risk margin, exceeds the unearned premium liability.

Sensitivity Analysis

The present value of the ACC claims obligation is sensitive to underlying assumptions such as the discount rate, inflation rates and expected medical costs. These assumptions are closely linked. For example, a change to the discount rate may have implications on the inflation rate used. Therefore, when calculating the present value of claims it is unlikely that an assumption will change in isolation.

If the assumptions described above were to change in isolation, this would impact the measurement of the ACC claims obligation as per the table below:

Undiscounted outstanding claims liability

The reported outstanding claims liability (before risk margin) of $35,952 million (2017: $33,405 million) represents the net present value of estimated cash flows associated with this obligation. The following table represents the timing of future undiscounted cash flows for claims to 30 June 2018. These estimated cash flows include the effects of assumed future inflation.

Note 12: Receivables

Receivables from taxes, levies and fines (and any penalties associated with these activities) as well as social benefit receivables which do not arise out of a contract are collectively referred to as sovereign receivables.

In determining the recoverability of a tax or other sovereign receivables, the Government uses information about the extent to which the tax or levy payer is contesting the assessment and experience of the outcomes of such disputes, from lateness of payment, and other information obtained from credit collection actions taken. Due to the size of the tax base, the concentration of credit risk is limited and this is not a risk that is actively managed.

The Government does not hold any collateral or any other credit enhancements over receivables which are past due.

Tax receivables, ACC levy receivables and social benefit receivables are considered to be short term, so their carrying value represents a reasonable approximation of their fair value.

Other levies, fines and penalty receivables comprise debtor portfolios administered by Ministry of Justice (ie, court fines) and Inland Revenue (ie, child support). These receivables are recorded at fair value, which on initial recognition represent the face value of the amount owed to the Crown, adjusted to reflect the amount expected to be recoverable. For the current year the initial adjustment from face value to fair value of these receivables was $201 million (2017: $201 million), with $137 million (2017: $129 million) of the adjustment relating to child support debt administered by Inland Revenue.

Social benefit receivables comprise benefit overpayments, advances on benefits and recoverable special needs grants primarily administered by the Ministry of Social Development.

Trade and other receivables are relatively short term, with $5,668 million (2017: $4,567 million) expected to be settled in the next year. Their carrying amount provides a reasonable approximation of their fair value.

The Inland Revenue Department (IRD) administers the majority of the tax receivable portfolio. The recoverable amount of the portfolio is calculated by forecasting the expected repayments based on analysis of historical debt data, deducting an estimate of service costs and then discounting at the current market rate of 5.0% (2017: 5.0%).

If the recoverable amount of the portfolio is less than the carrying amount, the carrying amount is reduced to the recoverable amount. Alternatively, if the recoverable amount is more, the carrying amount is increased.

Tax receivables are classified as past due when any outstanding tax is not paid by the taxpayer's due date. IRD has debt management policies and procedures to actively manage the collection of past due debt.

Note 13: Marketable Securities, Deposits and Derivatives in Gain

Marketable securities comprise bonds, commercial paper, debentures and similar tradable financial assets held by the Government for the purposes of realising capital gains or interest revenue. Long-term deposits are instruments with maturities greater than three months that are not traded in an active market.

Further information is provided on these financial assets in note 26.

Note 14: Share Investments

Further information is provided on these financial assets in note 26.

Note 15: Advances

Further information on the management of risks associated with these financial assets is provided in note 26.

Kiwibank loans and advances are measured at amortised cost. The fair value of Kiwibank loans and advances is $18,350 million (2017: $17,824 million). This fair value is based on a discounted cash flow model with reference to market interest rates, prepayment rates and estimated credit losses.

The maximum loss due to default on Kiwibank loans and advances is the carrying value reported in the statement of financial position. Collateral is obtained to mitigate any risk of loss, which in the case of Kiwibank loans and advances are primarily in the form of properties. The fair value of the collateral provided is sufficient to ensure that the entire amount owing over the life of the mortgage will be recovered and there is reasonable assurance that collection efforts will result in payment of the amounts owed in a timely manner.

The student loan scheme is intended to provide a cost effective means of enabling a wide range of people to access tertiary education, gaining knowledge and skills that enhance the economic and social wellbeing of New Zealand. No interest on loans to New Zealand residents is charged and there are no repayments required from those with very low incomes. Loans of those who die or become bankrupt are written off.

The Student loan valuation model reflects current student loan policy and macroeconomic assumptions. As such, the carrying value is sensitive to changes in a number of underlying assumptions, including future income levels, repayment behaviour and macroeconomic factors such as inflation and discount rates used to determine the effective interest rate on new borrowers.

In contrast to the amortised cost approach described above, fair value is the amount for which the loans could be exchanged between knowledgeable, willing parties in an arm's-length as at 30 June 2018. It is determined by discounting the cash flows at an appropriate rate.

The fair value differs from the carrying value by $628 million due to changes in market interest rates at reporting date. The carrying value is not adjusted for such changes as it is valued using the effective interest rate determined when the loan was initially drawn. In contrast, the fair value is calculated on a discount rates that are current at 30 June 2018. At that date the fair value was calculated on a discount rate (including expenses) of 5.6% (2017: 5.7%) whereas a weighted average effective interest rate of 6.8% (2017: 6.8%) was used for the carrying value.

The Crown has resolved to early adopt PBE IFRS-9: Financial Instruments from 1 July 2018. This new accounting standard will have a material impact on the value of the Student Loan book due to a change in its measurement basis. Refer to Note 1 for further discussion of the expected impact of the move to this standard.

Through everyday operations of the student loan scheme the Government is exposed to the risk that borrowers will default on their obligation to repay their loans or die before their loan is repaid. The student loan scheme does not require borrowers to provide any collateral or security to support their borrowings. As the total sum advanced is widely dispersed over a large number of borrowers, the scheme does not have any material concentrations of credit risk. The credit risk is reduced by collection of repayments through the tax system.

The Student Loan Scheme Annual Report contains more information on the student loan scheme. This can be found at: http://www.educationcounts.govt.nz/publications/series/student_loan_scheme_annual_reports

Note 16: Property, Plant and Equipment

The total amount of property, plant and equipment under construction is $2,960 million (2017: $2,247 million).

Under Section 55 of the Public Finance Act 1989, borrowing by the Crown is a charge on the revenue of the Crown equally and rateably. Therefore, no property, plant and equipment owned by the Crown has been pledged as security for liabilities. Government-owned property, plant and equipment is, however, subject to a significant number of legislative and policy restrictions with respect to its use and disposal. Property, plant and equipment owned by State-owned Enterprises and mixed ownership companies has been pledged to secure borrowings and finance lease obligations of $3,761 million (2017: $3,348 million).

These carrying values critically depend on judgements of useful lives to determine depreciation and the assumptions used in revaluations. Depreciation rates are affirmed to be appropriate each year by those responsible for managing the assets, whereas assurance on the assumptions used in valuations is provided by the use of independent valuers as noted below.

The value of the land underneath state highways and the rail network, as well as land set aside for cultural and heritage purposes (ie, national parks, forest parks, conservation areas and recreational facilities) is included in the Land category.

The property, plant and equipment revaluation reserve arises on the revaluation of physical assets. Where revalued property, plant or equipment is sold, the portion of the property, plant and equipment revaluation reserve that relates to that asset is effectively realised, and is transferred to taxpayer funds.

Net revaluations in the note above exclude movements attributable to minority interests and includes the shares of associates revaluation of physical assets. It will therefore differ from the movements on pages 78 and 79.

The remainder of this note provides detailed analysis and information about Property, Plant and Equipment.

Land and Buildings - Page 81

State Highways - Page 83

Electricity Generation Assets - Page 85

Specified Cultural and Heritage Assets - Page 87

Rail Network - Page 88

Public Private Partnerships - Page 90

Accounting Policies - Page 91

Land and Buildings

Valuation Information

Carrying value of other asset classes subject to revaluation

State Highways (excluding land)

Valuation information

WSP Opus, an independent valuer, determined the valuation of the state highway as at 30 June 2018 by assigning replacement costs to the components of the state highway reported in the Road Assessment and Maintenance Management (RAMM) database and other databases as at 30 June 2017. The net capital expenditure for the year to 30 June 2018 was added to this data. The costs assigned are adjusted depending on the region and the type of terrain. The replacement cost is also adjusted for depreciation to reflect the current age and condition of the physical components. The major components of the state highway network and the optimised depreciated replacement cost of those components are shown in the table below:

Due to the unique nature of the state highway network, the value of the assets cannot be measured with precision. Significant estimates and assumptions have been applied to the valuation, which include assumptions on: quantities used in the construction of state highway components, the unit cost to apply and the life of the assets. Changes to these underlying estimates and assumptions can cause a material movement in the valuation and are reviewed on a periodic basis. The main assumptions affecting the state highway valuation are:

The range of costs in the above table reflect regional variation and the differing costs of construction depending on terrain.

In addition, assumptions are made about the completeness of the RAMM database. These assumptions are used in determining additional items to be added so the complete network is valued. RAMM also contains assumptions to ensure appropriate allocation of all assets by region and terrain type, and on matters such as base course depth, subbase depth, shoulder formation, base course and retaining walls.

The following sensitivity analysis represents possible impacts on the state highway network valuation based on changes to estimates. There is a risk the valuation is understated for overhead factors, particularly for external professional fees (which is a focus for the 2018/19 improvement plan) and therefore, the sensitivity table reflects this:

WSP Opus has performed simulation analysis on the valuation to quantify the range of valuation outcomes that could occur as a result of changes in the different valuation inputs.

WSP Opus has concluded that the overall valuation is between -7.5% to +10% of the current value (-$2.3 billion to +$3.1 billion) excluding the impact of brownfield costs. (Refer to Note 2 for additional discussion on brownfield costs).

Electricity generation assets

Valuation and sensitivity information

There are a number of key assumptions used to value electricity generation assets. These assumptions relate to future maintainable earnings derived from revenue streams and expenses and generation volumes, as well as the discount rate used to calculate the present value of those revenues and expenses.

The following tables provide information on each of the entities' key assumptions as disclosed in the individual annual reports of the individual electricity generation companies (part of the State-owned Enterprises segment). The electricity price path assumptions, stated below, for each electricity generation company are substantially the same. However, the Meridian Energy and Mercury NZ assumption is conveyed in real terms while Genesis Energy's assumption is in nominal terms. For further information on the valuation of electricity generations assets, refer to the individual annual reports of each entity.

Meridian Energy

Genesis Energy

Mercury NZ

Specified cultural and heritage assets

Specified cultural and heritage assets

Rail network

The rail network comprises around 4,000 kilometres of track (excluding yards and sidings) and is used primarily for freight transport. In addition to freight, the network is used by KiwiRail for long distance passenger transport and access is provided to two regional authorities, Greater Wellington Regional Council and Auckland Transport for metro passenger services. Some tracks are dual purpose (ie, used for both freight and metro), however there are a number of tracks which serve metro transport only (eg, the Johnsonville line). The rail infrastructure earns revenue from freight and long distance passenger charges. In addition, network access charges are collected from the two regional authorities in relation to the metro services.

Prior to the restructuring of KiwiRail as a profit-oriented entity, the total rail network infrastructure was measured on an optimised depreciated replacement cost basis reflecting the previous focus on it as a non-cash generating asset. If the value of the rail network was still measured using that approach, then a notional depreciation amount of $292 million (2017: $210 million) could be calculated, representing an estimate of the amount of “wear-and-tear” or consumption of the network asset over the year. This estimated “wear-and-tear” compares to the total maintenance and renewal expenditure of $161 million (2017: $258 million) on the rail network during the year.

Since the restructuring of KiwiRail as a profit-oriented entity, there have been challenges in making investment decisions, marrying the duality of commercial “for profit” activities that align with an SOE's commercial mandate with other “public benefit” activities that deliver social benefits rather than commercial returns, and integrating relatively short-term funding commitments with prudent investment decisions for long-life assets such as rail infrastructure. The Government has therefore initiated a review which includes determining the appropriate structure, capital requirements and funding mechanisms of the KiwiRail Group in relation to the purpose of rail in a multi-modal transport system, including the outcomes and objectives for rail that the government seeks. Decisions from this review, expected in early 2019, are likely to affect the mix of assets and operations, the extent of the rail network, and which of the entities within the Crown might own those assets and/or perform those operations. These decisions could affect how much of the rail network is valued at ODRC (if fully valued at ODRC the rail infrastructure would be valued at $6,202 million (2017: $5,210 million) and how much is valued at recoverable amount if fully valued at recoverable amount the rail infrastructure would be valued at $206 million (2017: $105 million)).

Rail network

Other valuation information

Specialist military equipment

Aircraft

Public Private Partnerships

A public private partnership (also known as a service concession arrangement) is an arrangement between the Government and a private sector partner. The Crown's obligation to pay for these assets is included in other borrowings.

Movements in carrying value for Public Private Partnerships

Details on individual PPP's can be found in the annual reports of individual agencies (Ministry of Education, New Zealand Transport Agency and the Department of Corrections).

Note 17: Equity Accounted Investments

Tertiary Education Institutions (TEIs)

TEIs are Crown entities, and the Government has a number of legislative powers with respect to them in the interests of public accountability and has some significant reserve controls in the event of an institution facing financial risk. However, the Government does not determine the operating and financing policies of TEIs, if they are not at financial risk, but rather is committed to safeguarding their academic freedom and autonomy. By so doing, the Government obtains the benefits of an effective tertiary education sector. Their relationship to the Crown is managed by a plan agreed between them and the Tertiary Education Commission.

Summarised financial information in respect of TEIs is set out below:

Kaingaroa Timberlands Partnership

The New Zealand Superannuation Funds has a 42% ownership interest (2017: 42%) in Kaingaroa Timberlands Partnership (KTP). For the year ended 30 June 2018, KTP recognised revenue of $555 million (2017: $457 million), profit of $1,033 million (2017: $688 million), assets of $4,701 million (2017: $4,055 million), liabilities of $33 million (2017: $30 million) and equity of $4,668 million (2017: $4,026 million).

City Rail Link Limited

City Rail Link Limited (CRLL) is a jointly controlled Crown entity, co-funded by the Crown and Auckland Council, for the purpose of designing and constructing of the Auckland City Rail Link (an underground rail line between the city centre and the existing western line). The expected costs of the project are $3.4 billion, which will be confirmed once all the contracts are finalised. The maximum funding limits for the project agreed by the Sponsors totals $3.6 billion. Therefore, the Government's maximum share of costs is $1.8 billion.

For the year ended 30 June 2018, CRLL recognised revenue of $3 million (2017: $Nil) and a deficit of $8 million (2017: $Nil), assets of $625 million (2017: $Nil) liabilities of $11 million (2017: $Nil) and equity of $614 million (2017: $Nil).

New Zealand Local Government Funding Agency (NZLGFA) (included in other)

The Government holds $5 million of the $25 million paid-up capital of NZLGFA.

For the year ended 30 June 2018, NZLGFA recognised revenue of $343 million (2017: $321 million) and a surplus of $12 million (2017: $11 million). NZLGFA's assets and liabilities were $8,835 million (2017: $8,478 million) and $8,771 million (2017: $8,424 million) respectively. The Crown's share of the net assets is $13 million (2017: $11 million). The Crown is not a guarantor of the NZLGFA and has no share of any contingent liabilities of the NZLGFA.

Note 18: Payables

Note 19: Borrowings

This note constitutes a Statement of Borrowings as required by the Public Finance Act 1989.

All principal, interest and other money payable in relation to money borrowed by the core Crown is a charge on, and payable out of, the revenues of the core Crown equally and rateably with all other general borrowing obligations of the core Crown.

The Government is not liable to contribute towards the payments of debts of Government entities, their subsidiaries or any entity in which the Government has an interest or that is controlled or wholly owned by the Government. Exceptions to this rule only occur for items the Government is liable for under any Act, any guarantee given by the Government, by virtue of an action a creditor has against the Government, or liability the Government has to a creditor of the Reserve Bank.

Government Bonds

The fair value of Government bonds measured at amortised cost is $67,289 million (2017: $68,611 million). This valuation is based on observable market prices. The valuation of Government bonds reported at fair value is also based on observable market prices.

New Zealand Government bonds are rated Aaa by Moody's and AA+ by S&P and Fitch. The rating outlook is stable with Moody's, S&P and Fitch.

Kiwibank customer deposits

The fair value of Kiwibank customer deposits measured at amortised cost is $16,172 million (2017: $15,970 million). For fixed term deposits by customers, fair values have been estimated using a discounted cash flow model with reference to market interest rates. For other deposits by customers, the carrying amount is a reasonable estimate of fair value.

Kiwibank customer deposits exclude deposits held by other government reporting entities and will therefore differ from the total customer deposits reported by Kiwibank.

Settlement deposits with Reserve Bank

Settlement deposits with the Reserve Bank represent the amount of money deposited with the Reserve Bank by commercial banks. They act as a liquidity mechanism used to settle wholesale obligations amongst the banks and provide the basis for settling most of the retail transactions that occur every working day between corporates and individuals.

Settlement deposits with the Reserve Bank are technically a form of borrowing by the Reserve Bank, where the liability is matched by a corresponding financial asset (reported as an element of marketable securities and deposits). Settlement deposits are reported at amortised cost, which is equivalent to the amount payable to depositors given the short term (ie, overnight) nature of these liabilities.

Settlement accounts are administered through the Exchange Settlement Account System (ESAS). ESAS account holders generally receive interest at the Official Cash Rate on their end-of-day balances. The Reserve Bank provides collateralised overnight borrowing facilities for banks, at an interest rate set at a margin over the Official Cash Rate.

Treasury bills

Treasury bills are reported at amortised cost. As these are short-term sovereign-issued instruments, the carrying value is not materially affected by changes in Sovereign credit risk and the carrying value approximates the amount payable at maturity.

Other borrowings

Other borrowings includes $3,090 million (2017: $2,636 million) of sovereign-guaranteed debt administered by the Reserve Bank and the Treasury.

The fair value of other borrowings measured at amortised cost is $12,924 million (2017: $11,556 million). The fair value of financial liabilities with standard terms and conditions traded on active liquid markets was determined by reference to quoted market prices. Where such prices are not available, use is made of estimated discounted cash flow models with reference to market interest rates.

For those other borrowings measured at fair value through the profit and loss, the value of these instruments will be affected by changes in interest rates due to credit risk and broader market influences.

The table above identifies the difference between the carrying value and amount payable at maturity as well as the extent that fair value movements have resulted from changes in credit risk of the issuing entity. The carrying value can differ from the amount actually payable on maturity where the effect of discounting cash flows is material.

Note 20: Retirement Plan Liabilities

The Government operates a defined benefit superannuation plan for qualifying employees who are members of the Government Superannuation Fund (GSF). The members' entitlements are defined in the Government Superannuation Fund Act 1956. Contributing members make regular payments to GSF and in return, on retirement, receive a defined level of income. GSF is closed to employees who were not members at 1 July 1992.

The GSF obligation has been calculated by GSF's actuary as at 30 June 2018. A Projected Unit Credit Method, based on balance-date membership data, is used for the valuation. This method requires the benefits payable from the GSF in respect of past service to be estimated and then discounted back to the valuation date.

Amounts recognised in the statement of financial position in respect of GSF are as follows:

Amounts recognised in the statement of financial performance in respect of GSF are as follows:

The Government expects to make a contribution of $727 million (2017: $741 million in the year ending 30 June 2018) to GSF in the year ending 30 June 2019. In addition to its obligations to past and present employees, because GSF is liable for income tax, the Crown will be required to make additional contributions equivalent to the tax on future investment income.

The principal assumptions used for the purposes of the GSF actuarial valuations are as follows:

Assumed inflation increases of 1.7% each year to year 19, then gradually increases, reaching 2.0% in year 37.

The defined benefit obligation increased in the year to 30 June 2018 by $286 million, mainly due to a decrease in the short and medium term discount rates over the last year.

The discount rate used to present value the pension cash flows associated with this obligation has a risk-free rate based on the market yield curve of New Zealand Government Bonds. Given the short-term nature of market data on Government Bonds in New Zealand, we also assume a single long-term equilibrium risk-free interest rate of 4.75% based on macroeconomic extrapolation. Discount rates are then smoothed over a minimum of 10 years from the end of the market yield curve to that long-term rate.

The major categories of GSF plan assets at 30 June are as follows:

The expected rate of return on the plan assets of 5.0% (2017: 5.0%) has been calculated by taking the expected long-term returns from each asset class, reduced by tax (using the current rates of tax).

The actual return on plan assets for the year ended 30 June 2018 was 11.1%, or $466 million (2017: 12.7% or $490 million).

Sensitivity Analysis

The present value of the GSF obligation is sensitive to underlying assumptions such as the discount rate, inflation rates and expected salary increases. These assumptions are closely linked. For example, a change to the discount rate may have implications on the inflation rate used. Therefore, when calculating the present value of pension payments, it is unlikely that an assumption will change in isolation.

If the discount rate was to change in isolation, this would impact the measurement of GSF obligation as per the table below.

The plan's assets are exposed to share price risks arising from its holding of equity instruments. Equity instruments are reported at fair value. Movements in share prices therefore directly translate into movements in the value of the share investment portfolio.

The sensitivity analysis below has been determined based on GSF's exposure to share price risks at the reporting date.

Historical Analysis

Actuarial gains and losses comprise experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred in the year) and the effects of changes in actuarial assumptions on valuation date. The history of the present value of the unfunded defined benefit obligation and experience adjustments is as follows:

Undiscounted defined benefit obligation

The reported GSF defined benefit obligation of $15,558 million (2017: $15,272 million) represents the net present value of estimated cash flows associated with this obligation. The following table represents the timing of future undiscounted cash flows for entitlements to 30 June 2018. These estimated cash flows include the effects of assumed future inflation.

Note 21: Provisions

Employee entitlements  

The provision for employee entitlements represents annual leave, accrued long service leave, retiring leave, and sick leave entitlements accrued by employees. Probability assumptions about continued future service affecting entitlements accrued as at reporting date have been made using previous employment data. For entitlements that vest over a period exceeding one year discount rates applied rise from 1.78% (2017: 1.97%) next year to 4.75% (2017: 4.75%) in later years.

Emissions Trading Scheme

The Emissions Trading Scheme (ETS) was established to encourage a reduction in New Zealand's greenhouse gas emissions. The carbon price used to calculate the ETS provision at 30 June 2018 is $NZ21.10 (2017: $NZ17.20). The ETS provision represents the tradeable NZ units outstanding, that will be accepted by the government as emitters honour the emissions obligations under the ETS. The carbon price used by the Ministry for the Environment is determined by the quoted NZU spot price at the end of the reporting date as published by OM Financial Limited on their website: https://commtrade.co.nz

National Provident Fund guarantee

The Government has guaranteed superannuation schemes managed by the National Provident Fund (NPF). Included in the provision is the NPF's DBP Annuitants Scheme unfunded liability position of $835 million (2017: $856 million), represented by a gross estimated pension obligation of $871 million (2017: $892 million) with net investment assets valued at $36 million (2017: $36 million).

Aircraft lease return costs

Where a commitment exists to maintain aircraft held under operating lease arrangements, a provision is made during the lease term for the lease return obligations specified within those lease arrangements. The provision is based upon historical experience, manufacturers' advice and, where appropriate, contractual obligations.

Other provisions

Other provisions are recognised where there is a present obligation as a result of a past event, where it is probable that this obligation will be settled and the liability can be reliably estimated. Other provisions include rehabilitation and restoration provisions.

Note 22: Minority Interests

Transactions with minority interests include dividend payments and dividend reinvestments. Other minority interests consists of minority interests in New Zealand Superannuation Fund investments and the KiwiBank Group capital notes issued. Crown Infrastructure Partners minority interest in 2017 no longer exists for 30 June 2018.

Note 23: Capital Objectives and Fiscal Policy

The Government's fiscal policy is pursued in accordance with the principles of responsible fiscal management set out in the Public Finance Act 1989:

• reducing total debt to prudent levels so as to provide a buffer against factors that may impact adversely on the level of total debt in the future by ensuring that, until those levels have been achieved, total operating expenses in each financial year are less than total operating revenues in the same financial year
• once prudent levels of total debt have been achieved, maintaining those levels by ensuring that, on average, over a reasonable period of time, total operating expenses do not exceed total operating revenues
• achieving and maintaining levels of total net worth that provide a buffer against factors that may impact adversely on total net worth in the future
• managing prudently the fiscal risks facing the Government
• when formulating revenue strategy, having regard to efficiency and fairness, including the predictability and stability of tax rates
• when formulating fiscal strategy, having regard to the interaction between fiscal policy and monetary policy
• when formulating fiscal strategy, having regard to its likely impact on present and future generations, and
• ensuring that the Crown's resources are managed effectively and efficiently.

Further information on the Government's fiscal strategy can be found in the Fiscal Strategy Report published with the Government's budget.

The Government's fiscal strategy is expressed through its long term objectives and short term intentions for fiscal policy.

Long Term Fiscal Objectives - Fiscal Strategy Report 2018

Debt

Maintain total debt at prudent levels. The Government will reduce the level of net core Crown debt to 20% of GDP within five years of taking office, and maintain it at prudent levels thereafter.

Operating balance

The Government will deliver a sustainable operating surplus across an economic cycle.

Operating expenses

The Government will maintain its expenditure to within the recent historical range of spending as a ratio of GDP. The Government will take a prudent approach to ensure expenditure is phased, controlled, and directed to maximise its benefits, in particular prioritising investments to address the long-term financial and sustainability challenges facing New Zealand.

Operating revenues

The Government will ensure a progressive taxation system that is fair, balanced, and promotes the long-term sustainability and productivity of the economy.

Net worth

The Government will strengthen net worth consistent with the debt and operating balance objectives.

Note 24: Commitments

1. The 2017 comparative for state highways has been restated from $6.1 billion to $5.1 billion due to non-contractual future outflows being included in commitments.

Note 25:  Contingent Liabilities and Contingent Assets

Contingent liabilities are:

• costs that the Crown will have to face if a particular event occurs, or
• present liabilities that are unable to be measured with sufficient reliability to be recorded in the financial statements (unquantifiable liabilities).

Typically, contingent liabilities consist of guarantees and indemnities, legal disputes and claims, and uncalled capital. The contingent liabilities facing the Crown are a mixture of operating and balance sheet risks, and they can vary greatly in magnitude and likelihood of realisation.

In general, if a contingent liability was realised, or the amount becomes sufficiently reliable to record as a liability, it would reduce the operating balance and net worth and increase net core Crown debt. However, in the case of some contingencies (eg, uncalled capital), the negative impact would be restricted to net core Crown debt.

Contingent assets are possible assets that have arisen from past events but the amount of the asset, or whether it will eventuate, will not be confirmed until a particular event occurs.

Contingent liabilities and contingent assets involving amounts of over $20 million are separately disclosed. Any quantifiable contingencies less than $20 million are included in the “other quantifiable” total. Some contingencies of the Crown are not able to be quantified; these unquantifiable contingent liabilities and contingent assets are disclosed as at 30 June 2018 where they are expected to be material but not remote. Where there is an obligation under New Zealand GAAP, amounts have been recognised in the financial statements.

Contingent Liabilities

a) Uncalled Capital

As part of the Crown's commitment to a multilateral approach to ensure global financial and economic stability, New Zealand, as a member country of the organisations listed below, contributes capital by subscribing to shares in certain institutions. The capital (when called) is typically used to raise additional funding for loans to member countries, or in the case of the quota contributions to directly finance lending to members. For New Zealand and other donor countries, capital contributions comprise both “paid-in” capital and “callable capital or promissory notes”.

i) Asian Development Bank (ADB)

New Zealand was a founding-regional member of the ADB, whose aim is to accelerate economic development in developing countries in Asia and the South Pacific. New Zealand is a regional member but as a donor is not entitled to borrow from the Bank. Accordingly, New Zealand is in a similar position to a non-regional member, and contributes to the ADB's resources only as required by ADB.

ii) IMF Promissory Notes

New Zealand's subscription to the IMF is partly paid in cash and partly in promissory notes (being uncalled capital). The respective levels of called and uncalled capital change when calls are made by the IMF under the Financial Transactions plan to provide loan packages to borrowing countries. Even though promissory notes are technically “at call”, they are treated as contingent liabilities, as there are significant restrictions on the actual ability to call them, and there is no realistic estimate of either the amount or the timeframe of any call.

iii) International Bank for Reconstruction and Development (IBRD)

The IBRD is the main lending organisation of the World Bank Group. New Zealand, along with 188 other countries, is a member country and shareholder in the World Bank Group. The percentage of ownership is determined by the size of the economy and the amount of capital contributed to support the Bank's borrowing activities among international capital markets. Accordingly, as New Zealand is a member, we contribute to the IBRD only as required by the IBRD.

iv) IMF arrangements to borrow

The Crown has agreed to make funds available to the IMF to support international financial systems in the event of a significant crisis. This is a contingent liability as it will depend upon uncertain trigger events occurring and the IMF calling the funds.

v) Asian Infrastructure Investment Bank (AIIB)

New Zealand was a founding-regional member of the AIIB. AIIB is a Chinese-initiated multilateral investment bank aimed at addressing the significant gap in infrastructure investment across Asia. The Crown has agreed to make funds available to the AIIB, the occurrence and amounts of which will depend upon uncertain trigger events and AIIB calling the funds.

Southern Response Earthquake Services Ltd

The Crown has agreed to provide an uncalled capital facility of $230 million to Southern Response Earthquake Service Limited (SRES) to support the Christchurch earthquake recovery process. Of this amount $113 million has been called, leaving $117 million as a contingent liability. This capital support will increase core Crown net debt when called.

b)  Guarantees and Indemnities

Guarantees are legally binding promises made by the Crown to assume responsibility for a debt, or performance of an obligation of another party, should that party default. Guarantees generally relate to the payment of money but may require the performance of services.

Indemnities are legally binding promises where the Crown undertakes to accept the risk of loss or damage that another party may suffer and to hold the other party harmless against loss caused by a specific stated event.

i)  New Zealand Export Credit Office guarantees

The New Zealand Export Credit Office provides a range of guarantee products to assist New Zealand exporters manage risk and capitalise on trade opportunities around the globe. The obligations to third parties are guaranteed by the Crown and are intended to extend the capacity of facilities in the private sector.

ii)    Air New Zealand letters of credit and performance bonds 

The letters of credit are primarily given in relation to passenger charges and airport landing charges. Guarantees are also provided in respect of credit card obligations. The performance bonds are primarily given in respect of engineering contracts.

iii)    The Body Laid Bare Exhibition indemnity

From March to July 2017, the Auckland Art Gallery Toi o Tāmaki hosted the exhibition The Body Laid Bare: Masterpieces from the Tate Gallery. The exhibition was indemnified under the Government Indemnity of Touring Exhibition Scheme from 7 February 2017 to 28 July 2017 to cover the period of transit and display of these valuable works of art. This indemnity no longer exists at 30 June 2018.

c) Legal proceedings and disputes

The amounts under quantifiable contingent liabilities for legal proceedings and disputes are shown exclusive of any interest and costs that may be claimed if these cases were decided against the Crown. The amount shown is the the maximum potential cost; it does not represent either an admission that the claim is valid or an estimation of the possible amount of any award against the Crown.

i)  Legal tax proceedings 

When a taxpayer disagrees with an assessment issued following the dispute process, the taxpayer may challenge that decision by filing proceedings with the Taxation Review Authority or the High Court. This contingent liability represents the maximum liability Inland Revenue has in respect of these cases.

ii)  Kiwifruit vine disease Psa-V

A post-harvest operator has filed a claim against the Ministry for Primary Industries alleging it is liable for damages they suffered from the kiwifruit vine disease, Psa-V. This plaintiff filed a notice of particulars of loss in September 2016, which quantifies its loss as $93 million. The Ministry defended the claim. On 27 June 2018 the High Court found that the Ministry did not owe a duty of care to Seeka. Strathboss and Seeka filed a cross-appeal on 7 August 2018.

iii)  Customs legal dispute

Customs assesses duty payable by taxpayers. Taxpayers may apply for refunds, drawbacks or remission of duty or may challenge the amount of duty assessed. Parties may challenge assessments or refusal of refund applications in the Customs Appeal Authority. The liability is shown as the maximum liability the Crown faces.

iv)  Ministry of Education - Contractual disputes

Legal proceedings and disputes represent the amounts claimed by plaintiffs in relation to the performance of the Ministry of Education's statutory role.

d) Other quantifiable contingent liabilities

i) Unclaimed monies

Under the Unclaimed Money Act 1971, entities (eg, financial institutions, insurance companies) hand over money not claimed after six years to Inland Revenue. The funds are repaid to the entitled owner on proof of identification.

ii) Air New Zealand partnership

The Air New Zealand Group has a partnership agreement with Pratt and Whitney in relation to the Christchurch Engine Centre (CEC), holding a 49% interest. By the nature of the agreement, joint and several liabilities exist between the two parties; the contingent liability represents Air New Zealand's share of CEC's liabilities.

iii) Ministry for Primary Industries - Bonamia ostreae

Under section 162A of the Biosecurity Act 1993 compensation may be payable as a result of the exercise of powers to manage or eradicate organisms. Compensation is payable where there are verifiable losses as a result of the damage or destruction of a person's property or restrictions on the movement of a person's goods. The Ministry has been notified compensation will be sought for Bonamia Ostreae. These claims can be quantified but do not meet the tests for recognising a provision.

iv) Land Information New Zealand - Quake outcasts

On 21 August 2018 the Minister for Greater Christchurch Regeneration announced that the Crown would pay former residential red zone owners 100% of the 2007/08 rateable value for uninsured homes. This payment is for those property owners who have not already received a payment for their uninsured improvements. The total cost of these ex gratia payments is estimated at $12 million. In addition, the Crown will purchase privately-owned red zone properties if owners are interested in selling their property. The Crown offer would be on the basis of 100% of the 2007/08 rateable value for land and improvements, regardless of insurance status.

Unquantifiable Contingent Liabilities

This part of the statement provides details of those contingent liabilities of the Crown which are not quantified, excluding those that are considered remote, reported by the following categories: indemnities, legal disputes and other contingent liabilities.

Indemnities

Indemnities are legally binding promises where the Crown undertakes to accept the risk of loss or damage that another party may suffer and to hold the other party harmless against loss caused by a specific stated event.

A number of these indemnities are provided to organisations within the Crown's control. If these indemnities were to crystallise, the Crown would compensate the individual entity for the loss and there would likely be an adverse impact on core Crown expenses and core Crown net debt.

Legal claims and proceedings

There are numerous legal actions that have been brought against the Crown. However, in the majority of these actions it is considered a remote possibility that the Crown would lose the case, or if the Crown were to lose it would be unlikely to have greater than a $20 million impact. Based on these factors, not all legal actions are individually disclosed. The claims that are disclosed individually, while they cannot be quantified, have the potential to exceed $20 million in costs.

i) Accident Compensation Corporation (ACC) litigations 

Litigation involving ACC arises almost exclusively from challenges to operational decisions made by ACC through the statutory review and appeal process. No accrual has been made for contingent liabilities which could arise, as these disputes are issue based and ACC's active management of litigation means that it will be either settling or defending, depending on the merits of the issue in dispute. ACC's Board believes the resolution of outstanding appeals will not have any material effect on the financial statements of ACC and therefore are not material for the Crown.

ii) Ministry for Primary Industries - Biosecurity Act compensation

Under section 162A of the Biosecurity Act 1993 compensation may be payable as a result of the exercise of powers to manage or eradicate organisms. Compensation is payable where there are verifiable losses as a result of the damage or destruction of a person's property or restrictions on the movement of a person's goods. The Ministry has been notified compensation will be sought for incursions including Mycoplasma bovis, fruit fly, pea weevil, bonamia ostreae and myrtle rust. Due to the complexity and uncertainty of the amount of these claims the amounts are unquantified. To the extent that an obligation can be quantified, provision has been made in these accounts.

iii) Treaty of Waitangi claims

Under the Treaty of Waitangi Act 1975, any Māori may lodge certain claims relating to land or actions counter to the principles of the Treaty with the Waitangi Tribunal. Where the Tribunal finds a claim is well founded, it may recommend to the Crown that action be taken to compensate those affected. The Tribunal can make recommendations that are binding on the Crown with respect to land that has been transferred by the Crown to a State-owned enterprise (SOE) or tertiary institutions, or is subject to the Crown Forest Assets Act 1989.

On occasion, Māori claimants pursue the resolution of particular claims against the Crown through higher courts. Failure to successfully defend such actions may result in a liability for historical Treaty grievances in excess of that currently anticipated.

iv) Kiwifruit vine disease Psa-V

Approximately 210 growers have filed a claim against the Ministry for Primary Industries alleging it is liable for damages they suffered from the kiwifruit vine disease, Psa-V. The plaintiffs have not quantified their losses, but have publicly claimed it is in the vicinity of $380 million, citing total industry losses of $885 million. The Ministry defended the claim. On 27 June 2018 the High Court found that the Ministry owed a duty of care to Strathboss and claimants; that it breached its duty of care at the import permit stage; and that the breach caused the Psa-V incursion. An appeal was filed by the Crown on 24 July 2018.

v) Canterbury insurance disputes

Southern Response Earthquake Services Limited (SRESL) from time to time receives notification of legal claims and disputes in relation to claim settlements as a commercial outcome of conducting its business.

A representative action proceeding was filed against SRESL on 29 May 2018. The financial statements make no allowance for the outcome of these proceedings, as the range of possible outcomes cannot be reliably quantified at this time. These claims are being defended.

Other unquantified contingent liabilities

i) Criminal Proceeds (Recovery) Act

The Ministry of Justice is responsible for administering the Criminal Proceeds (Recovery) Act 2009. The Act requires the Crown to give an undertaking as to damages or costs in relation to asset restraining orders. In the event that the Crown is found liable, payment may be required.

ii) Environmental liabilities

Under common law and various statutes, the Crown may have a responsibility to remedy adverse effects on the environment arising from Crown activities. Entities managing significant Crown properties have implemented systems to identify, monitor and assess potential contaminated sites.

In accordance with PBE IPSAS 19: Provisions, Contingent Liabilities and Contingent Assets any contaminated sites for which costs can be reliably measured have been included in the statement of financial position as provisions. Where costs cannot be reliably measured, they are disclosed as an unquantified contingent liability.

iii) Remediation of Per- and Poly- Fluoroalkyl Substances Contamination

Local and central government entities are investigating per- and poly-fluoroalkyl substances (PFAS) contamination from the historic use of specialised firefighting foam at sites on, and in the vicinity of, airports, New Zealand Defence Force bases, fuel storage facilities and other sites. Various government agencies have been undertaking a programme to review, investigate and develop a comprehensive approach to manage the impact of PFAS at sites around New Zealand. Once a response is agreed, it is possible the Crown may incur costs for the response to PFAS contamination, however these costs cannot be estimated without the agreed response being finalised, so an unquantified contingent liability has been disclosed.

iv) Treaty of Waitangi claims - settlement relativity payments

The Deeds of Settlement negotiated with Waikato-Tainui and Ngāi Tahu include a relativity mechanism. Now that the total redress amount for all historical Treaty settlements exceeds $1.0 billion in 1994 present-value terms, the mechanism provides that the Crown is liable to make payments to maintain the real value of Ngāi Tahu's and Waikato-Tainui's settlements as a proportion of all Treaty settlements. The agreed relativity proportions are 17% for Waikato-Tainui and approximately 16% for Ngāi Tahu. There is a risk that the timing and amount of the expense for the relativity payments may differ from that included in the fiscal forecasts. There is also uncertainty on how various disputes concerning the interpretation of the mechanism will be resolved.

v) Holidays Act and other relevant legislation

A number of entities have commenced a review of payroll calculations over the past six years in order to ensure compliance with the Holidays Act 2003 and other relevant legislation. Where possible, a provision has been made in these financial statements for obligations arising from those reviews. Further work continues to be undertaken by a number of entities including the Ministry of Education, District Health Boards, the Department of Corrections and KiwiRail Holdings Limited. These entities have complexities that are taking longer to resolve. To the extent that an obligation cannot reasonably be quantified at 30 June 2018, there is an unquantified contingency.

Contingent Assets

i) Tax disputes

A contingent asset is recognised when the Inland Revenue has advised a taxpayer of a proposed adjustment to their tax assessment. The taxpayer has the right to dispute this adjustment and a disputes resolution process can be entered into. The contingent asset is based on the likely cash collectable from the disputes process based on experience and similar prior cases, net of losses carried forward.

ii) Transpower New Zealand Limited

Transpower operates its revenue setting methodology within an economic value (EV) framework that analyses economic gains and losses between those attributable to shareholders and those attributable to customers. Under Commerce Commission regulations, Transpower is required to pass onto or claim from customers over time the economic value of the gains or losses. Transpower's contingent asset included the provisional balance from the EV accounts at 30 June 2017.

iii) New Zealand Defence Force Earthquake Insurance Recoveries

There are quantifiable contingent assets in relation to claims with NZDF insurers for material damage, business interruption and rental savings of $46 million as at 30 June 2018.

As at 30 June 2018, there are unquantifiable contingent assets in relation to claims with NZDF insurers for business interruption and loss of the fixtures and fittings in Defence House following the 2016 Kaikōura/Hurunui Earthquakes. A further contingent asset relates to a claim with the Defence House landlord for historical contributions to the landlord for build costs.

Unquantifiable Contingent Assets

Social Housing - Crown Residual Interest (CRI)

The Crown has the contractual right to receive the return of the Crown Residual Interest (CRI) in relation to social housing properties released from capacity contracts with registered Community Housing Providers via a cash payment. The CRI is an asset created to provide protection to the Crown in the event that a property is no longer needed for social housing.

Note 26:  Financial Instruments

The Government has devolved responsibility for the financial management of its financial portfolios to its sub-entities such as the Treasury, Reserve Bank, New Zealand Superannuation Fund, Inland Revenue, Kiwi Group Holdings Limited and ACC. The financial management objectives of each of these portfolios are influenced by the purpose and associated governance framework for which the portfolio is held. The purposes of a portfolio may cover:

• Funding purposes. Primarily financial assets and liabilities are held to finance the Government's borrowing requirements and provide funds to Government entities. Examples include Government bonds and Treasury bills. Financing activity exposes the Government to financial risks from interest rates and global demand for New Zealand Government bonds.
• Social policy purposes. Primarily held to achieve social policy objectives. A large portion of the financial instruments for social policy purposes relates to student loans to support tertiary education policy. The associated risk for the Student Loan portfolio is that borrowers will default on their obligation.
• Investment purposes. Primarily held for the purpose of generating returns to assist in funding long-term obligations. The main investment portfolios are managed by ACC and the NZ Superannuation Fund. Associated risks include performance of the New Zealand and global markets.
• Central bank purposes. Primarily held for the Reserve Bank's foreign reserve management and market operations. The main financial risks to which the Reserve Bank is exposed includes foreign exchange risks, liquidity risks and financial stability risks.
• Commercial purposes. Primarily held by entities that operate on a commercial basis, who will hold financial instruments arising from their normal business activity. The main examples are State-owned Enterprises (including the mixed ownership model companies). Associated risks include interest rates risks, foreign exchange risks and price risks.

These purposes are not mutually exclusive, with portfolios typically established for, or arising from, a public policy objective, such as pre-funding future superannuation expenses, but in doing so are managed to maximise economic returns consistent with the policy objective.

Reporting to Ministers on these portfolios is done on a portfolio-by-portfolio basis. Detailed risk management policy disclosure of Government reporting entities can be found in an individual entity's Annual Report.

The institutional frameworks and policy objectives of these portfolios are reviewed periodically. Otherwise, reporting on the consolidated financial management and performance of these portfolios is done in the context of the interim and annual Financial Statements of the Government, the forecasts reported in the Half Year and Budget Economic and Fiscal Updates, and a more in-depth analysis of the Crown's assets in regular Investment Statements.

This note provides the following details of the Crown's financial instruments:

• Non-derivative financial instrument policies (pages 118 to 119)
• Classification of financial assets and financial liabilities (pages 120 to 121)
• Fair value measurement (page 122)
• Derivative disclosures (pages 123 to 124)
• Risk management (pages 124 to 128), and
• Sensitivity analysis (pages 128 to 129).

Classification of financial assets and financial liabilities

Financial instruments are measured at either fair value or amortised cost. Financial instruments measured at fair value are further classified into three designations; available for sale, held for trading and fair value through the operating balance. Changes in the value of an instrument may be reported in the statement of financial performance or directly in other comprehensive revenue and expense depending on its designation.

Financial assets

As at 30 June 2018, the carrying value of financial assets that had been pledged as collateral was $2,418 million (2017: $888 million). These transactions are conducted under terms that are usual and normal to standard securities borrowing. The amount will fluctuate depending on the market values of derivatives held that are in a loss position at 30 June 2018 and that require collateral to be posted as per the terms. The increase in collateral pledged is largely as a result of securities pledged as collateral by the Reserve Bank and the New Zealand Superannuation Fund. For more information, refer to the individual entity's annual report.

Financial liabilities

Fair Value Measurement

The following hierarchy details the basis for the valuation of financial assets and financial liabilities measured at fair value. This includes financial assets and financial liabilities that are available for sale, held for trading, or fair value through the operating balance. Fair value is the amount for which an asset could be exchanged or a liability settled, between knowledgeable, willing parties in an arm's length transaction. Fair value may be determined using different methods depending on the type of asset or liability. Fair values are determined according to the following hierarchy:

• Quoted Market Price - Financial instruments with quoted prices for identical instruments in active markets (level 1).
• Valuation Technique Using Observable Inputs - Financial instruments with quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in inactive markets, and financial instruments valued using models where all significant inputs are observable (level 2).
• Valuation Technique with Significant Non-observable Inputs - Financial instruments valued using models where one or more significant inputs are not observable (level 3).

Fair Value Financial Instruments by Measurement Hierarchy

Significant non-observable inputs

The following table details movements in the fair value of financial instruments measured using significant non-observable inputs.

Derivatives

Derivative financial instruments are used across the portfolios to manage exposure to interest rate, foreign currency and electricity sector risk. These transactions do not generally involve any principal exchange at commencement, they are an agreement to change the characteristics of the underlying transactions. The credit exposure is therefore limited to the net market value movement resulting from changes in relevant interest rates, currencies or electricity price and volume. The notional value is therefore a reference to the calculation base, not a reflection of the counterparty exposure.

Derivatives liquidity analysis

Derivative financial instruments are recognised both initially and subsequently at fair value. They are reported as either assets or liabilities depending on whether the derivative is in a net gain or net loss position respectively. Recognition of the movements in the value of derivatives depends on whether the derivative is designated as a hedging instrument and, if so, the nature of the item being hedged (see Hedging section below).

Derivatives that are not designated for hedge accounting are classified as held-for-trading financial instruments with fair value gains or losses recognised in the statement of financial performance. Such derivatives may be entered into for risk management purposes, although not formally designated for hedge accounting, or for tactical trading.

Individual entities consolidated within the Government reporting entity apply hedge accounting after considering the costs and benefits of adopting hedge accounting, including:

i) whether an economic hedge exists and the effectiveness of that hedge

ii) whether the hedge accounting qualifications could be met, and

iii) the extent to which it would improve the relevance of reported results.

Interest rate risk

The Government is exposed to interest rate risk as entities in the Government reporting entity borrow and invest funds at both fixed and floating interest rates. This risk is managed at the entity level in accordance with their capital objectives and risk management policies. These objectives and policies include maintaining an appropriate mix between fixed and floating rate borrowings.

Foreign currency risk

The Government undertakes transactions denominated in foreign currencies, hence exposures to exchange rate fluctuations arise. Exchange rate exposures are managed within approved policy parameters utilising forward exchange contracts and cross currency interest rate swaps. The carrying amounts of the Government's foreign currency denominated financial assets and financial liabilities translated to NZD at the reporting date are as follows:

Credit risk

Credit risk refers to the risk that a counterparty will default on its contractual obligations resulting in financial loss to the Government. The carrying value of financial assets equates to the maximum exposure to credit risk as at balance date. Credit risk is managed at the entity level in accordance with their capital objectives and risk management policies. These objectives and policies include limits to individual and industry counterparty exposure, collateral requirements, and counterparty credit ratings.

Of the financial assets held by the Government at 30 June 2018, the fair value of collateral held that could be sold or repurchased was $20,415 million (2017: $17,194 million). The majority of this relates to Kiwibank Limited, who can enforce their collateral in satisfying the debt in the event of the borrower failing to meet their contractual obligations.

Concentrations of credit exposure classified by credit rating, geography and industry of the counterparty are provided in the following tables.

Kiwibank loans and advances consist mainly of residential lending. Therefore, these financial assets have been classified as non-rated and individuals for the purposes of credit risk.

Concentration of credit exposure by credit rating (using Standard & Poor's ratings)

At 30 June 2018, 15.1% (2017: 15.1%) of student loan borrowers were overseas. As the total advanced is widely dispersed over a large number of borrowers, the scheme does not have any material individual concentrations of credit risk.

Liquidity risk

Liquidity risk refers to the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities.

Liquidity risk is managed on an individual entity basis generally by maintaining adequate reserves, banking facilities and reserve borrowing facilities, by continuously monitoring forecast and actual cash flows.

The following table details the Government's remaining contractual maturity for its financial liabilities. The table was compiled based on:

• the undiscounted cash flows of financial liabilities based on the earliest date on which the Government can be required to pay, and
• both interest and principal cash flows.

The Government holds loan commitments of $3,158 million (2017: $3,378 million) which primarily all have contractual cash flows of less than two years.

In addition to the above financial liabilities, the Crown has entered into various financial guarantees and indemnities totalling $224 million (2017: $702 million) which expose the Crown to liquidity risk. These guarantees are classified as contingent liabilities and are set out in note 25. For all these guarantees, the earliest period which the Crown would be required to pay if the guarantees are called upon is less than one year.

The Government has access to financing facilities, of which the total unused amount at 30 June 2018 was $885 million (2017: $959 million). The Government expects to meet its obligations from operating cash flows, from the results of bond tenders, and proceeds of maturing financial assets.

Sensitivity analysis

The sensitivity of the fair value of the Government's financial assets and liabilities to changes in interest rates, New Zealand exchange rate and share prices are shown below. Any change would impact the operating balance and net worth of the Government.

Interest rate sensitivity

The effect on the operating balance is primarily from changes in interest revenue and interest expense on floating rate instruments and changes in the value of instruments measured at fair value through profit and loss. The Government does not have material exposure to foreign interest rates.

The sensitivity analysis has been determined based on the exposure to interest rates for both derivatives and non-derivative financial instruments at the balance sheet date. The effect of exposure to interest rates on the valuation of non-financial instruments, such as the ACC liability and GSF defined benefit plan, are provided in the relevant notes to the financial statements.

Movements in interest rates affect the financial results of the Government in the following manner:

• the resulting valuation changes for fixed interest instruments that are measured at fair value through the operating balance will affect the operating balance, while the valuation changes of fixed interest instruments designated as available-for-sale will affect equity reserves
• the resulting changes in interest expense and interest revenue on floating rate instruments will affect the operating balance, and
• where derivatives are designated as cash flow hedges of floating rate instruments, equity reserves will be affected by the resulting changes in the fair value of these derivatives.

If interest rates had been 100 basis points higher/ (lower) at balance date and all other variables were held constant, the effect of financial instruments would increase/ (decrease) the Government's financial results as outlined in the table above. The impact is net of any hedging by way of interest rate derivatives.

The Government's sensitivity to interest rates has increased since last year. Interest rate sensitivity on financial instruments have a minor impact compared with other longer-dated obligations such as ACC outstanding claims liability and the GSF defined benefit obligations (refer note 11 and note 20 for sensitivity information for these long-term liabilities).

Foreign currency sensitivity

The sensitivity analysis is net of hedging via foreign exchange derivatives, but does not include the impact on prices of goods and services purchased or sold in foreign currencies.

The Government's sensitivity to foreign currency has increased during the current period. This change is largely in relation to financial instrument portfolios held by NZS Fund and ACC offset by changes in relation to the financial instrument portfolio managed by the Treasury.

Equity market sensitivity

Share investments are reported at fair value. Movements in share prices therefore directly translate into movements in the value of the share investment portfolio.

The sensitivity analysis above has been determined based on the exposure of the NZS Fund and ACC to share price risks at the reporting date. These portfolios combined make up 99% of the Government's total share investments (2017: 99%).

The Government's sensitivity to share prices has increased from the prior year in line with an increase in the level of share investments held.

Note 27: Related Parties

Related parties of the Government include key management personnel, and their close family members. Key management personnel are Ministers of the Crown, and their close family members are their spouses, children and dependants. Transactions between these related parties and a Government entity are disclosed in these financial statements only if they have taken place within a Minister's portfolio and they are not transactions entered into in the same capacity as an ordinary citizen.

Tertiary Education Institutions, joint ventures and the Government Superannuation Fund are also related parties of the Government due to the Government's influence over these entities. Transactions between these entities and Government entities are separately disclosed where material.

There are no other related parties as no other parties control the Government, and no other parties are controlled by the Government, other than those that are consolidated into the Financial Statements of the Government.

The Government comprises a large number of commonly controlled entities. Transactions between these entities are eliminated in these financial statements and therefore not separately disclosed.

Transactions where the financial results may have been affected by the existence of a related party relationship are disclosed in the financial statements.

Related party relationships are a normal feature of commerce. Therefore, the Government will transact with related parties as a matter of course.

Given the breadth of Government activities these related parties transact with the government sector in the same capacity as ordinary citizens. Such transactions include the payment of taxes and user charges (such as purchase of electricity), and the receipt of entitlements and services (such as access to education). These transactions have not been separately disclosed in this note.

Other transactions with these related parties can include the employment of Ministers' spouses, children and dependants by a Government entity, including ministerial offices, departments, Crown entities and State-owned Enterprises, receipt of grants from, or the purchase or sale of goods and services to, a Government entity by Ministers, their spouses, children and dependants, or private-sector entities they own or jointly control. Such related party transactions will be disclosed if they have taken place within the Minister's portfolio or if they involve lending or guaranteeing Ministers.

Taking the above paragraphs into account, there are no related party transactions to be separately disclosed.

Note 28: Events Subsequent to Balance Date

Boeing P-8A Poseidon Aircraft

After balance date, Cabinet approved the purchase of four Boeing P-8A Poseidon maritime patrol aircraft from the United States Government. The new P-8As, training systems, infrastructure and introduction into service costs will total $2.346 billion. The purchase is not included in the Statement of Commitments because the approval was given after balance date.

Nurses Pay Offer

On 7 August 2018, nurses accepted a pay offer from the Government (excluding pay equity) of $0.5 billion between 4 June 2018 and 31 July 2020, with an ongoing cost of $0.2 billion per year thereafter.

Waikeria Prison

On 17 September 2018, a Public Private Partnership contract was signed with Cornerstone Infrastructure Partners LP to develop a facility at Waikeria Prison. The facility can accommodate 500 prisoners with the capability to provide mental health treatment for a further 100 offenders. The agreement is not included in the Statement of Commitments as it was entered into after balance date.

Other than those noted above, there have been no material events subsequent to balance date.