Financial Statements of the Government of New Zealand for the Year Ended 30 June 2007

Contents

Statement of Responsibility

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 generally accepted accounting practice.

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. To the best of my knowledge, this system of internal control has operated adequately throughout the reporting period.

 

John Whitehead
Secretary to the Treasury

28 September 2007

 

 

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 Government as at 30 June 2007 and its operations for the year ended on that date.

 

Hon Dr Michael Cullen
Minister of Finance

28 September 2007

Ministerial Statement

Continued economic growth and rising employment provide the means for New Zealand’s society to create a higher standard of living and a better quality of life.

The Government’s fiscal position is strong. This is no accident. It reflects many years of sound and prudent economic and fiscal management and a period of strong, sustained economic growth. This positive position is the result of the Government’s commitment over the last three terms to reduce debt and more recently build up financial assets.

The financial statements for the year ended 30 June 2007 will be the last set prepared on a current GAAP basis, with future reporting being on an NZ IFRS basis. They show an Operating Balance excluding Revaluations and Accounting Changes (OBERAC) surplus of $7.9 billion or 4.8 percent of gross domestic product (GDP). This compares with $8.6 billion (5.5 percent) for the previous year. After allowing for capital investment the government recorded a cash surplus of $2.6 billion, down from $3.0 billion in the year ended 30 June 2006. Most of the cash surplus has already been built into spending and tax plans.

The New Zealand Superannuation Fund earned $1.1 billion for the year ended 30 June 2007, once again exceeding expectation and meaning the Fund’s balance has grown faster than expected. At 30 June 2007 the NZS Fund assets stood at $13.0 billion.

Gross sovereign-issued debt (GSID) increased by $0.7 billion in 2006/07 to $36.2 billion, but fell as a percentage of GDP. At 21.7 percent of GDP, GSID is consistent with the Government’s long term debt objective of GSID broadly stable at 20 percent of GDP over the next 10 years, especially if looking through the Settlement Cash levels held by the Reserve Bank. When the Government took office in 1999 GSID was close to 35% of GDP – having met the challenge of reducing debt to prudent levels, the next challenge is to maintain fiscal discipline by keeping debt around current levels.

Net core Crown debt was $3.4 billion (2.1 percent of GDP). Including the assets of the NZS Fund, the Crown was in a net financial asset position of $9.6 billion (5.7 percent of GDP).

The financial results show the Government is implementing fiscal policy in line with its stated fiscal strategy of strengthening the fiscal position so that it is well placed to respond to future challenges such as those associated with population ageing and to have a buffer against external shocks. Along with some unexpected delays in departmental spending, progress against the Government’s fiscal intentions was faster than expected as a result of stronger economic activity and inflation over the latter part of the fiscal year. Allowing revenue to increase is consistent with our policy of letting automatic stabilisers operate and looking through the temporary effects of the economic cycle. The net result of these developments is that the Government was removing significantly more demand from the economy than forecast at Budget time – it would be difficult to argue that the Government is contributing to inflationary pressure.

Looking forward we will continue to strengthen our fiscal position to help meet future spending pressures, but at a much slower pace than experienced over recent years. We continue to expect the OBERAC surplus to fall and net cash flows to move from surplus to deficit over the forecast horizon reflecting a combination of policy intentions and solid but slower economic growth.

 

Hon Dr Michael Cullen
Minister of Finance

28 September 2007

Commentary on the Financial Statements

Introduction

The Government's fiscal strategy (outlined in more detail in the 2007 Fiscal Strategy Report) is to strengthen its fiscal position so that it is well placed to respond to future challenges such as those associated with population ageing. The strategy is summarised in Figure 1.

The Government intends to implement this strategy primarily by building up financial assets in the New Zealand Superannuation (NZS) Fund and maintaining gross debt at around 20% of GDP. In order to keep debt stable, the Government has said that it intends to run its core cash position so that core borrowing tracks in line with GDP over time. In practice, this means running operating surpluses sufficient to cover the contributions to the NZS Fund and some other capital spending needs.

The Financial Statements of the Government provide a record of the Government's financial performance over the 2006/07 financial year and its financial position as at 30 June 2007. They provide a comparison with the fiscal forecasts in the 2007 Budget Economic and Fiscal Update and with the 2005/06 financial statements. These Financial Statements will be the last set prepared on a current GAAP basis, with future reporting being on an NZ IFRS basis. They also provide the public with a snapshot of the progress the Government has made in implementing its fiscal strategy, as set out in the Short Term Fiscal Intentions and Long Term Objectives of the Fiscal Strategy Report.

Figure 1 - Fiscal strategy at a glance

Summary

The Government has recorded an Operating Balance excluding Revaluation and Accounting Changes (OBERAC) of $7.9 billion compared to a Budget forecast of $7.4 billion.

Including revaluation changes the operating balance for the total Crown for 2006/07 was $8.7 billion against a Budget forecast of $6.6 billion.

Taxation revenue was $0.7 billion ahead of forecast, primarily in relation to GST ($0.3 billion) and corporate tax ($0.4 billion).

Core Crown expenses were $0.8 billion below forecast and net surpluses of State-owned enterprises and Crown entities were $0.7 billion ahead of forecast. Decreases in the valuations of the Accident Compensation Corporation (ACC) and Government Superannuation Fund (GSF) liabilities of $0.7 billion and $1.2 billion respectively had a significant impact on these variances.

Core Crown residual cash at $2.6 billion was $0.9 billion ahead of forecast.This was primarily due to higher than expected tax receipts of $0.5 billion, and core Crown operating and capital and underspending of $0.5 billion and $0.3 billion respectively. These variances were offset by lower than expected other operating receipts of $0.4 billion.

Gross sovereign-issued debt at $36.2 billion has increased by $0.7 billion since 2005/06, but fell as a percentage of GDP. At 21.7% of GDP this is consistent with the Government’s long term debt objective of GSID being broadly stable at 20% of GDP over the next 10 years. Looking through the Settlement Cash balances of $7.5 billion held by the Reserve Bank, GSID was $28.7 million or 17.2% of GDP.

Net core Crown debt has fallen to $3.4 billion, or 2.1% of GDP. Including the assets of the New Zealand Superannuation (NZS) Fund, the Government was in a net financial asset position of $9.6 billion or 5.7% of GDP. At 30 June 2007 NZS Fund assets stood at $13.0 billion, following the statutory contribution of $2.0 billion and income after tax of $1.1 billion.

 

Comparison with Estimated Actual

This section compares the actual 2006/07 financial results for key fiscal indicators with the 2007 estimated actual forecast released in the 2007 Budget Update.

It follows the fiscal strategy framework, looking first at variances in the operating balance for the whole of Crown ie, including SOEs and Crown entities [see page 6]. It then identifies adjustments to the operating balance necessary to strip out valuation and accounting changes (OBERAC changes), and how these have changed since the estimated actual forecast, and then looks at variances in residual cash compared with forecast.

How operating balance flows translate to OBERAC, which includes SOE and Crown entity activity, and then to the residual cash available to the core Crown is explained in the following table.

Revenue and Expenses

The key drivers of revenue and expense variances against forecast are as follows:

OBERAC

The operating balance of $8.7 billion includes the impact of revaluation and accounting changes. Removing these items gives us an OBERAC of $7.9 billion. The following table outlines the adjustments made to the operating balance to arrive at the OBERAC.

Residual cash

The operating balance represents the difference between total operating revenue and total operating expenses. Not all of the operating balance reported by the Government is available to assist in the Government’s capital expenditure programme. This is because:

• Some parts of the Government’s operations are restricted and are not available for redistribution. For example, the activity of the NZS Fund is retained by the Fund to help build assets to meet future NZS payments and SOE retain their surpluses for the purpose of achieving their long-term objectives.
• Some transactions do not materialise into cash. For example, depreciation and revaluations movements do not have any cash impact.

Net core Crown cashflows from operations represents the amount available for meeting contributions into the NZS Fund and for funding other capital initiatives.

Residual cash is the balance after taking into account capital payments and therefore it is the flow that contributes to the change in net core Crown debt.

The following table key residual cash variances are as follows.

Application of core Crown Cash Flows

Application of core Crown Cash Flows

Debt indicators

Gross sovereign-issued debt (GSID) as at 30 June 2007 was $36.2 billion or 21.7 percent of GDP. Compared to forecast GSID was lower by $1.1 billion. Around $0.6 billion is due to a decline in demand for government securities near the end of the financial year, in part due to the Reserve Bank changes to collateral arrangements for banks. The remainder of the variance is a result of lower than expected Reserve Bank borrowing.

The increase in the current year residual cash position has not led to a change in the level of GSID at 30 June 2007, as the borrowing programme is generally set at the time of the Budget Update. However it does have a flow on impact to net core Crown debt, which can be seen in the increase in marketable securities and deposits.

Net core Crown debt was $3.4 billion or 2.1 percent of GDP, and $1.2 billion lower than forecast due primarily to the increase in the residual cash position since the time of the Budget Update.

Net Worth

Net worth was $95.8 billion as at 30 June 2007, which was higher than forecast by $7.4 billion.

An increase against forecast of $5.2 billion was due to the impact of revaluations of property, plant and equipment. These revaluations are not forecast beyond the base month used for deriving the estimated actual. The main factors that have caused the increases in valuation are continuing appreciation of property prices and price increases.

The rest of the increase against forecast has resulted from the higher than expected operating balance.

Prior Year Comparison

This section compares the 2006/07 financial results for the key indicators with the 2005/06 financial results.

Revenue and Expenses

The key revenue and expenses changes since the 2005/06 financial year are as follows:

Other indicators

Gross sovereign issued debt was $0.7 billion higher than last year. The main changes in debt this year were:

• An increase of around $5.5 billion due to the Reserve Bank raising the Settlement Cash Levels.
• A reduction of around $2.8 billion due to a reduction in the issuance of Treasury Bills.
• A reduction in debt due to repayments made during the year.

Net core Crown debt was $4.3 billion lower than last year due primarily to the flow on impact of the residual available from the current year cash flow.

Indicators of the Government’s Fiscal Performance

This section aims to help readers better understand the Government’s fiscal performance.

Each indicator gives valid insights into the government’s historical, current and forecast fiscal performance, but no one indicator gives a complete picture. Individual indicators do, however, come into greater or lesser focus as circumstances change.

When, for example, the New Zealand Government’s net worth was low and net and gross debt levels were high, much of the focus of government and public commentary at that time was on eliminating annual operating deficits and on the need to attain, and later to lock in, annual operating surpluses.

However, as net worth has risen, and gross and net debt levels have fallen, the Government in more recent years has increasingly focused on how to maintain debt levels around current levels and, accordingly, has given more focus to the Government’s annual cash balance.

Most of the indicators in this section may be useful regardless of the particular fiscal strategy being followed. In a few cases (such as the formulation of OBERAC excluding NZS Fund returns), the indicator is used to throw light on the impact of a particular fiscal strategy (in this case the build-up of financial assets in the NZS Fund).

Flow indicators

• Core Crown revenues – core Crown expenses + net surplus of SOEs (ie, after dividends) and Crown entities = Operating balance.
• Core Crown revenues are mainly taxes. Core Crown expenses represent most of the Government’s spending, but not all of it. There are the day-to-day spending (salaries, benefit payments, etc) that does not create Government assets. They also include the amount for new initiatives in forecast years.
• Operating balance – revaluation movements – accounting changes = OBERAC.
• The OBERAC is the residual from revenues and expenses less removal of valuation movements. The OBERAC and operating balance are the same in forecast years.
• OBERAC – retained items (eg, net surplus of SOEs/CEs and net investment returns of the NZS Fund) – non-cash items (eg, depreciation) = Core Crown net cash flow from operations.
• Retained items such as the net surplus of SOEs/Crown entities and the net investment returns of the NZS Fund are retained by these entities. The surpluses generated (unless withdrawn from the entities) cannot be used for other purposes so do not aid in funding other government spending.
• Depreciation expense is also removed as it is non-cash (it is captured in the actual purchase of assets below). Additionally, actual working capital movements such as payment of creditor impacts on the level of net cash flows from operations.
• Core Crown net cash flow from operations – net investing activities (eg, contributions to NZS Fund, purchases of assets, loans to others) = Residual cash.

Cash flows from core Crown operations (excluding the NZS Fund) are the cash equivalent of the operating surplus. They are available to assist funding the capital spending.

Net investment activities include: Contributions to the NZS Fund – the Government’s annual contribution to the NZS Fund to build up assets to contribute to future NZS payments; Purchase of assets – departments buy assets including computer equipment, new buildings (eg, prisons) and defence equipment; Loans to others (advances) – these are mainly student loans (the Government is committed to help students access tertiary education by funding student loans) and refinancing private sector debt of DHBs and HNZC; Net capital injections – investments in Crown entities such as DHBs and Reserve Bank reserves.

Residual cash is the amount that needs to be funded if there is a shortfall. Funding is provided by selling surplus financial assets (because of surplus cash from prior years) or borrowing more.

Stock indicators

• Gross sovereign-issued debt (GSID) = debt issued by the core Crown. (Residual cash available over time is the main factor affecting borrowing requirements and hence gross sovereign-issued debt.)
• Core Crown net debt = gross sovereign-issued debt – core Crown’s financial assets.
• Net worth (NW) = Crown’s total assets – Crown’s total liabilities.

Ratio of core Crown revenue to GDP

Ratio of core Crown revenue to GDP

The revenue collected is used to meet the Government’s spending needs. It is important to look at this alongside expenses, operating balance and gross debt indicators for insights into the sustainability of current policy settings.

Ratio of core Crown expenses to GDP

Ratio of core Crown expenses to GDP

This shows the day-to-day spending of the core Crown – ie, it excludes spending by SOEs and Crown entities – and highlights the size of government in the economy and potential scope for crowding out the private sector. This also excludes GSF valuation changes.

By reducing gross debt, the Government has also reduced finance costs.

Operating balance

Operating balance

The operating balance shows whether the government sector has generated enough revenues to cover its expenses in any given year.

This measure can be volatile from year to year due to events outside of the Government’s direct control (such as changes in interest rates and revaluations etc); therefore, it is generally not used as a measure of the Government’s short-term fiscal stewardship.

OBERAC

OBERAC

By excluding revaluations and accounting changes, or things that are outside of the Government’s direct control, the OBERAC gives a more direct indication of the underlying stewardship of the Government.

The current Government wishes to retain the NZS Fund investment returns in the Fund. Therefore, to ensure the Government is meeting its fiscal objectives, the Government has stated that it will be focusing on the OBERAC excluding NZS Fund returns.

Residual cash available and domestic bond programme

Residual cash available and domestic bond programme

The residual cash measure includes capital investment and NZS Fund contributions; therefore, it is the flow contributing to the changes in debt (in the current year net core Crown debt).

The domestic bond programme raises term debt for the Government, the proceeds of which contribute to funding operating and investing activity, and the repayment of maturing debt. The programme tends to be different to the cash residual figure in any given year as financing activity, such as the repayment of debt, needs to be considered.

Gross debt

Gross debt

Total gross debt and GSID are often expressed as a percentage of GDP to put the level of debt into perspective, in terms of a country’s ability to generate growth to repay the debt and/or income to service this debt.

Total gross debt represents the complete picture of whole-of-government obligations to external parties. However, debt issued by SOEs and Crown entities is not explicitly guaranteed by the Crown. The debt that is issued by the sovereign and guaranteed by the sovereign is in GSID. The Government’s long-term debt objective is formulated in terms of GSID.

A high ratio of debt to GDP can have an adverse impact on credit ratings and perceived sustainability of current policy settings. So as a general rule, a relatively low ratio is considered to be prudent. A low ratio of debt to GDP can also provide the Government with more flexibility in their accounts to respond to adverse shocks through increasing debt.

Core Crown financial assets

Core Crown financial assets

These are either cash or shares (equity) or a right to receive a financial instrument, which can be converted to cash. The assets of the New Zealand Superannuation (NZS) Fund are becoming the dominant feature of the Crown’s financial assets. The NZS Fund is the Government’s means of building up assets to partially pre-fund future NZS expenses. The Government’s contributions to the NZS Fund are calculated over a 40-year rolling horizon to ensure superannuation entitlements over the next 40 years can be met.

Established under the New Zealand Superannuation and Retirement Income Act 2001, the NZS Fund was created to partially provide for the future cost of NZS, which is expected to almost double in cost due to population ageing.

The Government plans to allocate around $2 billion a year to the NZS Fund over the next 20 years. The NZS Fund’s mandate is to invest money in a way that maximises its returns, without undue risk.

As the cost of providing NZS increases, future governments will draw on the NZS Fund to help smooth the impact of the cost of NZS on their finances.

Core Crown net debt

Core Crown net debt

By including financial assets, net debt can provide additional information about the sustainability of the Government’s accounts. Many international agencies believe the quantity of off-setting financial assets is important when determining the credit-worthiness of a country. That is, if a country has a high ratio of financial assets to GDP, they are better able to justify a high ratio of debt to GDP.

However, as some financial assets are not very liquefiable (or easily converted into cash), it is important to view net debt alongside GSID.

Net worth

Net worth

Total Crown net worth is one indicator of the degree to which current government activities are sustainable. This indicator should be considered alongside the Crown’s debt position, as relatively high debt to GDP ratios may still be considered sustainable if the Crown has relatively high ratios of saleable or commercial assets to GDP.

Building up net worth is also consistent with preparing for population ageing.

Historical Information

Report of the Auditor General

To the Readers of the Financial Statements of the Government of New Zealand for the year ended 30 June 2007

I have audited the financial statements of the Government of New Zealand for the year ended 30 June 2007, using my staff, resources and appointed auditors and their staff.

Unqualified opinion

In our opinion the financial statements of the Government of New Zealand on pages 30 to 100:

• comply with generally accepted accounting practice in New Zealand; and
• fairly reflect:

• the Government of New Zealand’s financial position as at 30 June 2007; and
• the results of its operations and cash flows for the year ended on that date.

The audit was completed on 28 September 2007, and is the date at which our opinion is expressed.

The basis of the opinion is explained below. In addition, we outline the responsibilities of the Government and the Auditor, and explain our independence.

Basis of opinion

We carried out the audit in accordance with the Auditor-General’s Auditing Standards, which incorporate the New Zealand Auditing Standards.

We planned and performed our audit to obtain all the information and explanations we considered necessary in order to obtain reasonable assurance that the financial statements did not have material misstatements, whether caused by fraud or error.

Material misstatements are differences or omissions of amounts and disclosures that would affect a reader’s overall understanding of the financial statements. If we had found material misstatements that were not corrected, we would have referred to them in our opinion.

The audit involved performing procedures to test the information presented in the financial statements. We assessed the results of those procedures in forming our opinion.

Audit procedures generally include:

• determining whether significant financial and management controls are working and can be relied on to produce complete and accurate data;
• verifying samples of transactions and account balances;
• performing analysis to identify anomalies in the reported data;
• reviewing significant estimates and judgements made;
• confirming year-end balances;
• determining whether accounting policies are appropriate and consistently applied; and
• determining whether all financial statement disclosures are adequate.

We did not examine every transaction, nor do we guarantee complete accuracy of the financial statements.

We evaluated the overall adequacy of the presentation of information in the financial statements. We obtained all the information and explanations we required to support our opinion above.

Responsibilities of the Government and the Auditor

The Treasury is responsible for preparing financial statements for the Government in accordance with generally accepted accounting practice in New Zealand. Those financial statements must fairly reflect the financial position of the Government as at 30 June 2007. They must also fairly reflect the results of its operations and cash flows for the year ended on that date. The Minister of Finance is responsible for forming an opinion that those financial statements fairly reflect the financial position and operations of the Government for that year. The responsibilities of the Treasury and the Minister of Finance arise from the Public Finance Act 1989.

We are responsible for expressing an independent opinion on the financial statements and reporting that opinion to you. This responsibility arises from section 15 of the Public Audit Act 2001 and section 30 of the Public Finance Act 1989.

Independence

The Auditor-General, as an Officer of Parliament, is constitutionally and operationally independent of the Government. Other than in exercising functions and powers under the Public Audit Act 2001 as the auditor of public entities, the Auditor-General has no relationship with or interest in the Government.

 

K B Brady
Controller and Auditor-General
Wellington
New Zealand

 

Financial Statements

Statement of Financial Performance

(for the year ended 30 June 2007)

The accompanying notes and accounting policies are an integral part of these statements.

Analysis of Expenses of the Statement of Financial Performance

(for the year ended 30 June 2007)

Below is an analysis of total Crown expenses and core Crown expenses by functional classification.

This information reconciles with the segment information within the Statement of Segments.

The accompanying notes and accounting policies are an integral part of these statements.

Statement of Cash Flows

(for the year ended 30 June 2007)

The accompanying notes and accounting policies are an integral part of these statements.

Reconciliation of Net Cash Flows From Operations to Operating Balance

(for the year ended 30 June 2007)

The accompanying notes and accounting policies are an integral part of these statements.

Statement of Financial Position

(as at 30 June 2007)

The accompanying notes and accounting policies are an integral part of these statements.

Analysis of Key Components of the Statement of Financial Position

(as at 30 June 2007)

Following is an analysis of the New Zealand Superannuation (NZS) Fund and Gross and Net Debt information.

The notes to the financial statements provide a breakdown of other key balance sheet items.

New Zealand Superannuation Fund (NZS Fund)

Within marketable securities, deposits and equity investments is the NZS Fund (except for cross holdings of investments with other parts of the Crown, for example the NZS Fund may hold NZ Government Stock). The following information includes all investments and income, including cross-holdings of NZ Government Stock and accrued interest on such stock.

Gross and Net Debt information

Definitions of debt:

Total Crown gross debt is the total borrowings (both sovereign guaranteed and non-sovereign guaranteed) of the total Crown. This equates to the amount in the total Crown balance sheet and represents the complete picture of whole-of-Crown debt obligations to external parties (ie, after eliminations of internal cross-holdings).

The balance sheet splits total Crown debt into sovereign-guaranteed and non-sovereign-guaranteed debt. This split reflects the fact that debt held by SOEs and Crown entities is not explicitly guaranteed by the Crown. Any such debt that may be guaranteed is included in the sovereign-guaranteed total. No debt of SOEs and Crown entities is currently guaranteed by the Crown.

Gross sovereign-issued debt is debt issued by the sovereign (ie, core Crown) and includes Government stock held by the NZS Fund, GSF, ACC or EQC for example. In other words, the gross sovereign-issued debt indicator does not eliminate any internal cross-holdings of entities listed above. The Government's debt objective uses this measure of debt.

Net core Crown debt is borrowings (financial liabilities) less cash and bank balances, marketable securities and deposits, and advances (financial assets). Net core Crown debt excludes the assets of the NZS Fund and GSF because they are restricted in their use. It is a measure of the core Crown.

The accompanying notes and accounting policies are an integral part of these statements.

Statement of Movements in Equity

(for the year ended 30 June 2007)

The accompanying notes and accounting policies are an integral part of these statements.

Statement of Borrowings

(as at 30 June 2007)

The accompanying notes and accounting policies are an integral part of these statements.

Statement of Commitments

(as at 30 June 2007)

The accompanying notes and accounting policies are an integral part of these statements.

Statement of Quantifiable Contingent Liabilities and Contingent Assets

(as at 30 June 2007)

Note 21 contains a breakdown of the material contingent liabilities and a description of non-quantifiable contingent liabilities and contingent assets.

The accompanying notes and accounting policies are an integral part of these statements.

Statement of Segments

Statement of Financial Performance (institutional form)

for the year ended 30 June 2007 (actual to forecast)

Statement of Financial Position (institutional form)

as at 30 June 2007 (actual to forecast)

Statement of Segments (continued)

Statement of Financial Performance (institutional form)

for the year ended 30 June 2007 (actual to forecast)

Statement of Financial Position (institutional form)

as at 30 June 2007 (actual to forecast)

Statement of Segments (continued)

Statement of Financial Performance (institutional form)

for the year ended 30 June 2007 (compared with actual 30 June 2006)

Statement of Financial Position (institutional form)

as at 30 June 2007 (compared with actual 30 June 2006)

Statement of Segments (continued)

Statement of Financial Performance (institutional form)

for the year ended 30 June 2007 (compared with actual 30 June 2006)

Statement of Financial Position (institutional form)

as at 30 June 2007 (compared with actual 30 June 2006)

Statement of Segments (continued)

Statement of Financial Performance (functional classification)

for the year ended 30 June 2007

Statement of Financial Position (functional classification)

as at 30 June 2007

Statement of Accounting Policies

Reporting Entity

The Financial Statements of the Government of New Zealand have been prepared in accordance with the requirements of the Public Finance Act 1989.

The Government reporting entity as specified in Part III of the Public Finance Act 1989 comprises:

• Ministers of the Crown
• Reserve Bank of New Zealand
• Offices of Parliament
• State owned enterprises
• Crown entities
• Departments
• Government Superannuation Fund
• New Zealand Superannuation Fund
• Air New Zealand Limited

A more detailed listing of the components of the Government reporting entity is set out in the supplementary information on pages 102 and 103.

Accounting Policies

These financial statements comply with generally accepted accounting practice. The measurement base applied is historical cost adjusted for revaluations of certain property, plant and equipment, commercial forests and marketable securities held for trading purposes. The accrual basis of accounting has been used unless otherwise stated.

Reporting and forecast period

The reporting and forecast period for these financial statements is the year ended 30 June 2007.

The Budget forecast is the original forecast for the financial year, as presented in the 2006 Budget on 18 May 2006. The estimated actual forecast, as presented in the 2007 Budget on 17 May 2007, has been prepared using actual data which was available at the time of the finalisation of the Budget forecasts (9 May 2007).

Basis of combination

Ministers of the Crown, departments, Offices of Parliament, the Reserve Bank of New Zealand, the GSF, the NZS Fund, SOEs (including Air New Zealand Limited) and Crown entities (excluding TEIs) are combined using the purchase method of combination. Corresponding assets, liabilities, revenues and expenses are added together line by line. Transactions and balances between these sub-entities are eliminated on combination.

TEIs are equity accounted, which recognises these entities’ net assets, including asset revaluation movements and surpluses and deficits.

Note 13 outlines in more detail why there is a difference in the accounting treatment of TEIs from other Crown entities.

Revenue

Revenue levied through the Crown’s sovereign power

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, as there is no direct relationship between paying tax and receiving Crown services and transfers.

Such revenue is received through the exercise of the Crown’s sovereign power. Where possible, revenue is recognised at the time the debt to the Crown arises.

Revenue earned through operations

If revenue has been earned by the Government in exchange for the provision of outputs (products or services) to third parties, the Government receives its revenue through operations. Such revenue is recognised when it is earned.

Investment income

Investment income is recognised in the period in which it is earned.

Premiums and discounts

Premiums arising on the issue of a debt instrument are treated as a reduction in finance cost. Discounts arising on the purchase of a monetary asset are treated as an increase in investment income.

Premiums and discounts are recognised in the Statement of Financial Position on issue, and are amortised over the period of the instrument on a yield-to-maturity basis.

For floating rate debt instruments, the amortisation is over the first interest period. Discounts on monetary assets deemed short-term securities are amortised on a straight-line basis.

The forward margin associated with forward foreign-exchange contracts is amortised over the period of the contract on a straight-line basis.

Gains

Realised gains arising from sales of assets or the early repurchase of liabilities are recognised in the Statement of Financial Performance in the period in which the transaction occurs.

Unrealised foreign-exchange gains on monetary assets and liabilities, and unrealised gains on marketable securities held for trading purposes and listed equity investments, are recognised in the Statement of Financial Performance.

Unrealised and realised gains related to hedging activity are recognised in the Statement of Financial Performance in the same period in which losses on the underlying hedged position are recognised.

Unrealised gains arising from changes in the value of property, plant and equipment are recognised in the Statement of Financial Performance to the extent that a gain reverses a loss previously charged to the Statement of Financial Performance. Otherwise, gains are credited to an asset revaluation reserve for that class of asset.

Unrealised gains arising from changes in the value of commercial forests are credited to the Statement of Financial Performance.

Unrealised gains (excluding foreign-exchange gains) arising from changes in the value of investments and marketable securities held for investment and unlisted equity investments are recognised only to the extent that they reverse a loss previously charged to the Statement of Financial Performance. Gains effecting such a reversal are credited to the Statement of Financial Performance.

Expenses

General

Expenses are recognised in the period to which they relate.

Welfare benefits

Welfare benefits are recognised in the period when an application for a benefit has been received and the eligibility criteria met.

Grants and subsidies

Where grants and subsidies are discretionary until payment, the expense is recognised when the payment is made. Otherwise, the expense is recognised when the eligibility criteria have been met and notice has been given to the Government.

Discounts and premiums

Discounts arising on the issue of a debt instrument are treated as an increase in finance cost. Premiums arising on the purchase of a monetary asset are treated as a reduction in investment income.

Discounts and premiums are recognised in the Statement of Financial Position on issue, and are amortised over the period of the instrument on a yield-to-maturity basis.

For floating rate debt instruments, the amortisation is over the first interest period. Premiums on monetary assets deemed short-term securities are amortised on a straight-line basis.

The forward margin associated with forward foreign-exchange contracts is amortised over the period of the contract on a straight-line basis.

Losses

Realised losses arising from sales of assets or the early repurchase of liabilities are recognised in the Statement of Financial Performance in the period in which the transaction occurs.

Unrealised foreign-exchange losses on monetary assets and liabilities, and unrealised losses on marketable securities held for trading purposes and listed equity investments, are recognised in the Statement of Financial Performance.

Unrealised and realised losses related to hedging activity are recognised in the Statement of Financial Performance in the same period in which gains on the underlying hedged position are recognised.

Unrealised losses (excluding foreign-exchange losses) arising from changes in the value of property, plant and equipment (including state highways), and investments and marketable securities held for investment and unlisted equity investments are recognised at balance date. Unrealised losses are first applied against any revaluation reserve for that class of asset. The balance, if any, is charged to the Statement of Financial Performance.

Unrealised losses arising from changes in the value of commercial forests are charged to the Statement of Financial Performance.

Foreign-currency transactions

Short-term transactions covered by forward exchange contracts are translated into New Zealand dollars using the forward rates specified in those contracts.

Other transactions in foreign currencies are translated into New Zealand dollars using the exchange rate on the date of the transaction. Exchange differences arising on settlement of these transactions are recognised in the Statement of Financial Performance.

Outstanding foreign-exchange contracts are translated at the closing exchange rate. Exchange gains and losses are included in the Statement of Financial Performance in the period in which they arise.

Depreciation

Depreciation is charged on a straight-line basis at rates calculated to allocate the cost or valuation of an item of property, plant and equipment, less any estimated residual value, over its estimated useful life. Typically, the estimated useful lives of different classes of property, plant and equipment are as follows:

Goodwill amortisation

Goodwill and identifiable intangible assets are amortised on a systematic basis to the Statement of Financial Performance over their period of expected benefit. The maximum period of amortisation is 20 years.

Assets

Foreign monetary assets

Where short-term foreign monetary assets are subject to forward exchange contracts, they are translated into New Zealand dollars at the contract rate. Otherwise, foreign monetary assets are translated at the closing exchange rate.

Exchange gains and losses are included in the Statement of Financial Performance in the period in which they arise.

Receivables and advances excluding student loans

Receivables and advances excluding student loans are recorded at the amounts expected to be ultimately collected in cash.

Student loans

Student loans are recognised initially at fair value plus transaction costs and subsequently measured at amortised cost using the effective interest rate method, less any impairment loss. The effective interest rate discounts estimated future cash receipts through the expected life of the loan to the net carrying amount of the loan but does not consider future credit losses. Interest is recognised on the loan evenly in proportion to the amount outstanding over the period to repayment.

Allowances for estimated irrecoverable amounts are recognised when there is objective evidence that the loan is impaired. Impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the loan and that a ‘loss’ event (or events) has an impact on the estimated future cash flows of the student loan book that can be reliably measured.

Interest and impairment losses are recognised in the Statement of Financial Performance.

Inventories

Inventories are recorded at the lower of cost and net realisable value. Where inventories acquired are recorded at cost, the weighted average cost method is used. Appropriate allowance has been made for obsolescence.

Investments

Marketable securities held for trading purposes

Marketable securities held for trading purposes are recorded at fair value.

Equity investments

Listed equity investments (other than those forming part of the reporting entity) are recorded at fair value.

Other equity investments (other than those forming part of the reporting entity) are recorded at lower of cost and fair value.

Other investments and marketable securities held for investment purposes

Other investments, including marketable securities held for investment purposes, are recorded at the lower of cost and fair value.

Investments held for hedging purposes are recorded on the same basis as the item being hedged.

Items of property, plant and equipment

Items of property, plant and equipment are initially recorded at cost.

For each property, plant and equipment asset project, borrowing costs incurred during the period required to complete and prepare the asset for its intended use are expensed.

Revaluations are carried out for the classes of property, plant and equipment noted below to reflect the service potential or economic benefit obtained through control of the asset. Revaluation is based on the fair value of the asset. Where an asset is recorded using depreciated replacement cost, depreciated replacement cost is based on the estimated present cost of construction, reduced by factors for age and deterioration of the asset.

Classes of property, plant and equipment assets that are revalued, are revalued at least every five years.

Classes of property, plant and equipment assets that are revalued are regularly reviewed to ensure the carrying value is not materially different from fair value.

Land and buildings

Land and buildings are recorded at fair value less accumulated depreciation on buildings. In cases where valuations conducted in accordance with the New Zealand Property Institute’s standards are not available, valuations conducted in accordance with the Rating Valuation Act 1998, which have been confirmed as appropriate by an independent valuer, have been used.

Specialist military equipment

Specialist military equipment is recorded at fair value based on depreciated replacement cost less accumulated depreciation. Valuations have been obtained through specialist assessment by New Zealand Defence Force advisers, and the basis of these valuations have been confirmed as appropriate by an independent valuer.

State highways

State highways are recorded at fair value based on depreciated replacement cost less accumulated depreciation. Replacement costs are based on the estimated present cost of constructing the existing asset by the most appropriate method of construction. Land associated with the state highways is valued using an opportunity cost based on adjacent use, as an approximation of fair value.

Rail network assets

Rail network assets are recorded at fair value based on depreciated replacement cost less accumulated depreciation. Replacement costs are based on the estimated present cost of constructing the existing asset by the most appropriate method of construction. Land associated with the rail network is valued using an opportunity cost based on adjacent use, as an approximation of fair value.

Aircraft (excluding specialist military equipment)

Aircraft (excluding SME) are recorded at fair value less accumulated depreciation.

Electricity distribution network

Electricity distribution network assets are recorded at cost less accumulated depreciation.

Electricity generation assets

Electricity generation assets are recorded at fair value less accumulated depreciation.

Other items of property, plant and equipment – at cost

Other property, plant and equipment, which include motor vehicles and office equipment, are recorded at cost less accumulated depreciation.

Other physical assets for which an objective estimate of market value is difficult to obtain

Such physical assets (national parks, for example) are recorded at fair value less accumulated depreciation.

Commercial forests

Commercial forests are recorded at fair value less estimated point-of-sale costs. This takes into account age, quality of timber and the forest management plan.

Goodwill and intangible assets

The excess of cost over the fair value of the net assets of entities acquired (subsidiaries) at the date of acquisition is recognised as goodwill. The balance of goodwill is assessed annually for evidence of impairment in excess of annual amortisation.

Identifiable intangible assets which have been purchased are initially recorded at cost and thereafter either at cost less accumulated amortisation and any accumulated impairment losses or, where in the rare case where an active market exists, at a revalued amount being fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses.

Liabilities

Borrowings

In the Statement of Financial Position, borrowings (including currency swaps) are recorded at nominal value adjusted for the unamortised portion of the premium or discount on issue.

Foreign monetary liabilities

Where short-term foreign monetary liabilities are subject to forward exchange contracts, they are translated into New Zealand dollars at the contract rate. Otherwise, foreign monetary liabilities are translated at the closing exchange rate.

Exchange gains and losses are recognised in the Statement of Financial Performance in the period in which they arise.

Pension liabilities

Pension liabilities in respect of the contributory service of superannuation scheme members are recorded at the latest actuarial value of the Crown's liability for pension payments. Movements of the liability are reflected in the Statement of Financial Performance.

ACC claims liabilities

The future cost of ACC claims liabilities is revalued annually based on the latest actuarial information. Movements of the liability are reflected in the Statement of Financial Performance.

Currency issued

Currency issued represents a liability in favour of the holder. Currency issued for circulation, including an amount to cover expected future redemption of demonetised currency, is recognised at face value.

Leases

Finance leases transfer to the Government as lessee substantially all the risks and rewards incident on the ownership of a leased asset. The obligations under such leases are capitalised at the present value of the minimum lease payments. The capitalised values are amortised over the period in which the Government expects to receive benefits from their use.

Operating leases, where the lessors substantially retain the risks and rewards of ownership, are recognised in a systematic manner over the term of the lease.

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

Employee entitlements

Employee entitlements to salaries and wages, annual leave, long service leave, retiring leave and other similar benefits are recognised when they accrue to employees. The liability for employee entitlements is carried as the present value of the estimated future cash outflows.

Other liabilities

All other liabilities are recorded at the estimated obligation to pay.

Commitments

Commitments are future expenses and liabilities to be incurred on contracts that have been entered into at balance date. Commitments include those operating and capital commitments arising from non-cancellable contractual or statutory obligations. Interest commitments on debts and commitments relating to employment contracts are not included in the Statement of Commitments.

Contingent liabilities and contingent assets

Contingent liabilities and contingent assets are recorded in the Statement of Contingent Liabilities and Contingent Assets at the point at which the contingency is evident.

Changes in Accounting Policies

The measurement basis for recording rail network assets has changed from historical cost to fair value using depreciated replacement cost. This basis provides a more current value of the rail network and is more consistent with the approach taken to other significant items of property, plant and equipment. The financial impact of this change increases property, plant and equipment by $10.3 billion and increases net worth by the same amount. The Statement of Financial Performance is consequently impacted by increases in depreciation of $155 million.

There has also been a change in the disclosure of bad debt write-offs of tax receivables. Tax write-offs are now shown as an expense rather than netted off against revenue. The impact of this change in presentation has no impact on the operating balance but does result in an increase in both revenue and expenses of $0.7 billion ($0.3 billion in 2005/06).

There have been no other changes in accounting policies. All other policies have been applied on a basis consistent with the previous year.

Comparatives

To ensure consistency with the current period, comparative figures have been restated where appropriate.

Notes to the Financial Statements

Note 1:  Tax and Levies Collected through the Crown’s Sovereign Power (Accrual)

Note 1:  Tax and Levies Collected through the Crown’s Sovereign Power (Cash)

Note 2:  Sale of Goods and Services

The Statement of Segments shows the sale of goods and services as a total for each area of the Crown (ie, total sales for core Crown, Crown entities and SOEs). The total for Crown entities includes such items as lottery sales, housing rental and Crown research institutes (CRI) sales. The total sales of SOEs (including Air NZ) represents the majority of their income from electricity generation and distribution services, postal services, advertising and air travel sales.

Note 3:  Investment Income

Note 4:  Other Revenue

Note 5:  Subsidies and Transfer Payments

 

Note 6:  Personnel Expenses

The Statement of Segments shows the personnel expenses as a total for each area of total Crown (ie, total personnel expenses for core Crown, Crown entities and SOEs).

Personnel expenses include salaries and allowances to Ministers of the Crown totalling $7.0 million (30 June 2006: $6.7 million). In addition, Ministers are provided with ministerial accommodation in Wellington and receive allowances when travelling in New Zealand.

Note 7:  Operating Expenses

Operating expenses relate to those expenses incurred in the course of undertaking the functions and activities of entities included in the Government financial statements, excluding those expenses separately identified in the Statement of Financial Performance and other notes.Items disclosed separately below are those required by Financial Reporting Standards.

Other operating costs is the large residual item. Most of these costs represent payments made for services provided by third parties (roading maintenance for example) or for raw materials (fuel, medicines or inventory for example). They also include other day-to-day operating costs.

 

Note 8:  Cash and Marketable Securities, Deposits and Equity Investments

The asset values above are net of any cross-holdings. For example, the asset portfolios of the NZS Fund, GSF, EQC and ACC currently all hold amounts of New Zealand Government stock. For financial reporting purposes these amounts are eliminated within the combined financial statements. The total portfolios, including cross-holdings of New Zealand Government stock, are shown below, along with commentary on the restricted nature of some of the assets (for example the GSF assets are only available for the payment of GSF benefits – because of the restricted nature of these assets they are excluded from the definition of net core Crown debt).

Nature of financial assets – some are restricted

Within the financial assets above, several portfolios are restricted in their nature in that they are only available to meet very specified purposes and are not available (by statute or other reasons) for general use by the Crown. It is for this reason that such assets are excluded from the definition of net core Crown debt – one of the Crown’s key fiscal policy indicators.

New Zealand Superannuation Fund

The assets of the NZS Fund is the Government’s means of building up assets to partially pre-fund future New Zealand superannuation expenses and may only be used for New Zealand Superannuation. The assets in this fund total $12.989 billion as at 30 June 2007. The Government’s contributions to the NZS Fund are calculated over a 40-year rolling horizon to ensure superannuation entitlements over the next 40 years can be met.

Government Superannuation Fund

The GSF Authority administers the asset portfolio of the GSF totalling $4.2 billion. These assets result from contributions by beneficiaries built up through time and can only be applied to the ongoing payment of GSF benefits (as provided by the GSF Act). Also refer Note 16.

ACC portfolio

ACC manages the ACC scheme. At present there is a substantial outstanding claims liability associated with past claims of around $13.7 billion. To manage the payment of these claims in the future, ACC is building up a matching portfolio of assets. The target is to have the residual claims fully funded by 2014. Also refer Note 17.

EQC – Natural Disaster Fund (NDF)

The EQC is New Zealand's primary provider of seismic disaster insurance to residential property owners. The EQC administers the NDF, comprising capital and reserves. The EQC draws on the NDF money to pay out claims for damage caused by natural disasters.

Individual Portfolio Information (including cross-holdings of New Zealand Government stock)

Note 9:  Advances

Student Loans Book Value

Student loans are recognised initially at fair value plus transaction costs, and subsequently measured at amortised cost using the effective interest rate method, less any impairment loss.

Fair value on initial recognition of student loans is determined by projecting forward contractually agreed (promised) repayments required under the scheme and discounting them back at an appropriate discount rate. The subsequent measurement at amortised cost is determined using the effective interest rate calculated at initial recognition. This rate is used to spread the Crown’s interest income across the life of the loan and determines the loan’s carrying value at each reporting date.

The valuation model has been adapted to reflect current student loans policy. As such, the carrying value is sensitive to changes on a number of underlying assumptions, including future income levels, repayment behaviour and macro economic factors such as inflation and the discount rates used to determine the effective interest rate on new borrowers. The significant assumptions are shown below.

Note 9:  Advances (continued)

The data for student loans has been integrated from files provided by Inland Revenue Department, Ministry of Social Development and the Ministry of Education. The current data is up to 31 March 2006, and contains information on borrowings, repayments, income, educational factors, socio-economic factors amongst others and has been analysed and incorporated into the valuation model.

Given the lead time required between analysing the raw data and its availability for use in the valuation model, it is expected that there will always be a 15 month lag between the available data set and the valuation reported in the annual financial statements.

Student Loans Fair Value

Fair value is the amount for which the loan book could be exchanged between knowledgeable, willing parties in an arms length transaction. It is determined by discounting the estimated cash flows at an appropriate discount rate. The estimated fair value of the student loan debt at 30 June 2007 has been determined to be approximately $5,443 million ($5,538 million at 30 June 2006).

Fair values will differ from carrying values due to changes in market interest rates, as the carrying value is not adjusted for such changes. They will also differ in the treatment of credit losses, as carrying values adjust for credit losses that have been incurred while fair values capture adjustments for expected future credit losses. The difference between fair value and carrying value does not represent an impairment of the asset.

The fair value calculated is sensitive to the underlying assumptions. For example a 1% increase in the discount rate would decrease fair value by approximately $232 million, whereas a 1% decrease in the discount rate would increase fair value by approximately $258 million

Despite the increase in the nominal value of student loans outstanding, the fair value of the student loan portfolio is lower than that calculated last year (and lower than the carrying value) because of an increase in the risk free discount rates used in the fair value calculation and an increase in expected future credit losses. The risk free rates are determined by calculating forward rates from the yields and coupons of NZ Government Stock. Forward rate yield projections move from 7.7% in 2007 to 6.2% from 2016 and thereafter (projections as at June 2006 were 6.9% in 2006 to 5.8% from 2016 and thereafter).

The Student Loan Annual Report contains more information on the student loan scheme.

Through the 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, causing the scheme to incur a loss.

The student loan scheme policy does not require borrowers to provide any collateral or security to support advances made. As the total sum advanced is widely dispersed over a large number of borrowers, the scheme does not have any material individual concentrations of credit risk.

The credit risk is reduced by collection of repayments through the tax system.

Note 10:  Receivables

Included in taxes receivable at gross value less provision for doubtful debts are general tax receivables administered by the Inland Revenue Department. The net book value was $6,089 million ($7,925 million in 2005/06). The estimated fair value of the portfolio as at 30 June 2007 has been calculated as $5,849 million. The fair value has been determined by forecasting the expected repayments based on analysis of historical debt data deducting an estimate of service costs and discounting at an appropriate rate (11%). If the discount rate was 2% higher the fair value would reduce by $21 million, if the discount rate was 2% lower the fair value would increase by $19 million

Included in accounts receivables at gross value less provision for doubtful debts are debtor portfolios held by the Ministries of Social Development and Justice. Due to the nature of these portfolios the collection of outstanding amounts takes place over a significant period of time.

The debtor portfolio held by the Ministry of Justice largely relates to court fines and the associated court costs and enforcement fees. The net book value as at 30 June 2007 was $312 million ($424 million in 2005/06). The estimated fair value of the portfolio as at 30 June 2007 has been calculated as $195 million. The fair value calculation has been determined on an actuarial basis by discounting the expected flow of cash repayments, net of servicing costs, at a discount rate of 12%. If the discount rate was 2% higher the fair value would reduce by $6 million; if the discount rate was 2% lower the fair value would increase by $7 million.

The debtor portfolio held by the Ministry of Social Development largely relates to benefit overpayments, advances on benefits and recoverable special needs grant. The gross book value was $832 million. Net book value was $409 million ($413 million in 2005/06) after allowing for doubtful debts reflecting the nature of the collectability of the debtors. The estimated fair value of the portfolio at 30 June 2007 was $358 million. The fair value is determined by discounting forecast expected repayments, (using Government's bond yield rates at 30 June 2007) and deducting the estimated collection costs.

The fair values of these debtor portfolios will differ to carrying values due to changes in market interest rates, as the carrying value is not adjusted for such changes, and in the treatment of credit losses. Carrying values adjust for credit losses that have been incurred while fair values capture adjustments for future credit losses as well. The difference between fair value and carrying value does not represent an impairment of the asset.