Financial Statements of the Government of New Zealand for the Year Ended 30 June 2006

Ministerial Statement#

The Government’s fiscal strategy is an integral part of our overall approach to economic management. 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. Probably for the first time in our history, the Crown has moved into a positive net financial asset position. This positive position is the result of the Government’s commitment over the last two terms to reduce debt and more recently build up financial assets.

The financial statements for the year ended 30 June 2006 show an Operating Balance excluding Revaluations and Accounting Changes (OBERAC) surplus of $8.6 billion (or 5.5 percent of gross domestic product (GDP)). This compares with $8.9 billion (5.9 percent) for the previous year. After allowing for capital investment the government recorded a cash surplus of $3.0 billion, down from $3.1 billion in the year ended 30 June 2005. Most of the cash surplus has already been built into spending and tax plans, and the remainder will be considered as part of the 2007 Budget.

Gross sovereign-issued debt (GSID) increased by $0.4 billion in 2005/06 to $35.5 billion, but fell as a percentage of GDP. At 22.6 percent of GDP, GSID is within sight of the Government’s long term debt objective of GSID broadly stable at 20 percent of GDP over the next 10 years.

Net core Crown debt was $7.7 billion (4.9 percent of GDP). Including the assets of the NZS Fund, the Crown was in a net financial asset position of $2.1 billion (1.3 percent of GDP). At 30 June 2006 the NZS Fund assets stand at $9.9 billion following the statutory contribution of $2.3 billion and investment returns of $1 billion.

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. 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.

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 slower economic growth.

Hon Dr Michael Cullen
Minister of Finance

29 September 2006

Commentary on the Financial Statements#

Introduction#

The Government’s fiscal strategy (outlined in more detail in The 2006 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 it intends to run its cash position so that 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 2005/06 financial year and its financial position as at 30 June 2006. They provide a comparison with the fiscal forecasts in the Budget Economic and Fiscal Update and with 2004/05. They also provide the public with a snapshot of the progress the Government has made in implementing its fiscal strategy as set out in its Short Term Fiscal Intentions and Long Term Fiscal Objectives.

Figure 1 – Fiscal strategy at a glance

Summary#

In 2005/06, the New Zealand Government recorded an Operating Balance excluding Revaluations and Accounting Changes (OBERAC) surplus of $8.6 billion, or 5.5 percent of gross domestic product (GDP). This was $1.7 billion higher than forecast at the time of the 2006 Budget. The 2005/06 cash balance was a surplus of $3.0 billion (1.9 percent of GDP), $1.2 billion higher than forecast at 2006 Budget.

Core Crown revenue was $2.5 billion higher than the 2006 Budget forecast. This largely reflects the change in the accounting treatment for the recognition of provisional tax that has resulted in a one-off, non-cash adjustment to tax revenue of $1.8 billion (refer Changes to the Calculation of Provisional Tax Revenue). Tax revenue from individuals was also higher than expected reflecting continuing strong labour income growth.

Core Crown expenses were $0.5 billion lower than expected at the 2006 Budget, with a range of areas contributing.

Capital spending was also $0.4 billion lower than expected. This underspend related to investments and advances to District Health Boards and Housing New Zealand Corporation and to purchases of physical assets in a number of departments.

New Zealand Government gross sovereign-issued debt (GSID) increased by $0.4 billion in 2005/06 to $35.5 billion, but fell as a percentage of GDP. At 22.6 percent of GDP this is within sight of the Government’s long term debt objective of GSID being broadly stable at 20 percent of GDP over the next 10 years.

Net core Crown debt was $7.7 billion (4.9 percent of GDP). Including the assets of the NZS Fund, the Crown was in a net financial asset position of $2.1 billion (1.3 percent of GDP). At 30 June 2006 the NZS Fund assets stood at $9.9 billion following the statutory contribution of $2.3 billion and investment returns of $1 billion.

Comparison with Estimated Actual#

This section compares the actual 2005/06 financial results with the 2006 estimated actual forecast released in the 2006 Budget Update.

The following table provides an outline on the composition of the key fiscal indicators.

Revenue and Expenses#

Revenue#

Tax revenue was higher than forecast by $2.3 billion. The increase against forecast can be broken down as follows:

• The change in the revenue recognition of provisional tax (refer Changes to the Calculation of Provisional Tax Revenue) added $1.8 billion to tax revenue, split between company tax ($1.2 billion) and other persons tax ($0.6 billion).
• Apart from the provisional tax change, corporate tax was $0.1 billion higher than forecast owing to slightly higher-than-expected terminal tax assessments, i.e. revenue in respect to prior years, in the June quarter.
• GST was $0.2 billion higher than forecast owing to higher-than-forecast price pressures in the June quarter, when annual inflation was 4.0% against a Budget Update forecast of 3.4%.
• Source deductions (mainly PAYE) was $0.1 billion higher than forecast owing to higher-than-expected aggregated salaries and wages in the June quarter. Although wage rate movement was in line with Budget Update forecast, employment expanded by 1.0% in the June quarter whereas the forecast was for a contraction of 0.2%.

Expenses#

Core Crown expenses were $0.5 billion lower than forecast. Across the functional classifications the main variances were:

• Social security and welfare expenses were lower than forecast by $104 million, mainly due to changes in debt provisioning and lower uptake of Family Support.
• Education expenses were lower than forecast by $125 million, primarily in relation to student loans. Historical data on borrowings has been updated since the 2006 Budget forecast, resulting in an adjustment to the initial fair value write down on the student loans book since its initial calculation in November 2005.
• Economic and industrial expenses were lower than forecast by $133 million, made up of lower operating costs for the Whirinaki power station and also lower than expected spending on employment related programmes. Better than expected weather reduced the need for operating Whirinaki. The resultant under expenditure is partly offset by lower revenue.
• Transport and communication expenses were lower than forecast by $92 million, primarily due to lower than expected road user and petrol excise revenues being available for spending. This reduced revenue was caused by increases in fuel prices reducing demand.

Investment income, finance costs and foreign exchange gains/losses need to be considered together. In the aggregate they were $0.3 billion ahead of forecast, primarily due to movements in exchange rates since the time of finalising the 2006 Budget forecast.

The GSF unfunded liability valuation was lower than forecast by $130 million. The reduction in the valuation was largely due to changes in assumptions, in particular updating mortality assumptions.

Net Surpluses of State Owned Enterprises and Crown Entities#

The net operating balance of SOE/CEs was $2.2 billion, which was lower than forecast by $0.1 billion. There were a number of offsetting factors within the SOE/CE results, of particular note:

• the revaluation gain on Air New Zealand’s aircraft assets has increased the operating balance by $0.3 billion
• the valuation of the ACC unfunded liability has increased expenses by $0.1 billion

OBERAC#

The OBERAC was $8.6 billion, $1.7 billion higher than forecast in the 2006 Budget. This favourable outturn has largely been driven by the activity in the core Crown segment (namely higher tax revenue and lower expenses).

The reconciliation from the operating balance to the OBERAC is outlined in the below table. Also included is a brief explanation of variances in the OBERAC adjustments compared to the 2006 estimated actual forecast.

Residual cash#

Net core Crown cash flows from operations was $8.9 billion for the year ended 30 June 2006, which was higher than forecast by $0.8 billion. The variance was primarily due to the cash impact of the increase in tax revenue and lower department expenditure (as outlined in the revenue and expenses sections).

Cash flows from investing activities were $0.4 billion lower than forecast, primarily due to delays in capital spending spread over a number of departments.

These above variances have resulted in a $1.2 billion increase in the residual cash position compared to the 2006 Budget.

Figure 3 – Comparison of core Crown cash flows from operations and investing activities

Debt indicators#

Gross sovereign-issued debt (GSID) as at 30 June 2006 was $35.5 billion or 22.6 percent of GDP. Compared to forecast GSID was $0.5 billion lower than forecast. The reduction was primarily due to lower issuance of Treasury Bills as there has been less demand for these instruments since the recent Reserve Bank reforms around the settlement cash level.

The increase in the current year residual cash position against forecast has not led to a change in the level of GSID at 30 June 2006, as this is generally set at the time of the Budget Update. Any change against forecast in residual cash will flow onto net core Crown debt, through the cash being held as marketable securities and deposits.

Net core Crown debt was $7.7 billion or 4.9 percent of GDP. Compared to forecast, net core Crown debt was $1.3 billion lower primarily due to the increase in the residual cash position.

Net Worth#

Net worth was $71.4 billion as at 30 June 2006, which was higher than forecast by $12.9 billion.

The increase against forecast of $9.9 billion was primarily 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 for these increases in valuation are continuing appreciation of property prices, price increases and movement in foreign exchange rates.

The rest of the increase against forecast of $3.0 billion has resulted from the higher than expected operating balance. Within the individual components of the statement of financial position the variance from forecast can be seen in financial assets and accounts receivables.

Prior Year Comparison#

Prior Year Comparison (continued)#

The 2006 operating balance was higher than the 2005 operating balance by $5.2 billion. This was mainly due to:

• Tax revenue being higher than last year by $5.3 billion, with the main factors driving the increase being:
  • The change in the revenue recognition of provisional tax has increased tax revenue by $1.8 billion
  • Wage and employment growth led to an increase in source deductions of $1.6 billion, and
  • Corporate profit growth, particularly in the Finance and Insurance sector and the Electricity, Gas and Water Supply sector, was largely responsible for an increase of $1.2 billion in corporate tax revenue.
• Other revenue being higher than last year by $1.8 billion. This was primarily due to increases in investment income, in particular the returns on NZS Fund and GSF assets.

Core Crown expenses were $3.7 billion higher than forecast. Significant movements within the core Crown functional expense classification were:

• Social security and welfare expenses increasing by $0.9 billion due to the annual indexation of welfare benefits and the first full year impact of the Working for Families Package
• Education expenses increasing by $2 billion, due to the initial write down of recording Student Loans at fair value ($1.4 billion) to better reflect the loan balance under the Government’s new interest free policy. The rest of the increase has resulted from roll growth and new policy initiatives
• Health expenses increasing by $0.7 billion, primarily due to increase funding to maintain and increase existing services levels and the impact of demographic changes

The net SOE/CE surpluses were $1.8 billion higher than last year. The key features of the increase were:

• The ACC unfunded liability expense was lower than last year by around $0.7 billion
• Investment returns in the Crown entity segment are up from last year by around $0.7 billion (namely ACC and EQC), due to stronger global equity markets
• Air New Zealand recording a gain of around $0.3 billion from its revaluation of aircraft assets compared to a loss of around $0.1 billion last year

Gross sovereign-issued debt was $0.4 billion higher than last year. The main impacts on debt during the year have been:

• An increase of around $2 billion due to the Reserve Bank raising the Settlement Cash Level, reflecting the Reserve Bank’s concern over liquidity pressures in the New Zealand money market; partially offset by
• A reduction in debt due to repayments made during the year, largely funded from the build-up of financial assets from recent outturns.

Net core Crown debt was $3 billion lower than last year due to the flow on impact of the residual cash available from the current year cash flows.

Net worth increased by $21.4 billion due to the revaluation of property, plant and equipment of $9.9 billion and the impact of the operating balance of $11.5 billion.

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#

This shows the day-to-day spending of the core Crown – i.e., 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#

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#

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#

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#

Total gross debt and Gross sovereign-issued debt (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#

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 help 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 risks.

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#

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#

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 2006#

I have audited the financial statements of the Government of New Zealand for the year ended 30 June 2006, using my staff, resources and appointed auditors and their staff.

Unqualified opinion#

In our opinion the following financial statements of the Government of New Zealand:

• comply with generally accepted accounting practice in New Zealand; and
• fairly reflect:
  • the Government of New Zealand’s financial position as at 30 June 2006; and
  • the results of its operations and cash flows for the year ended on that date.

The audit was completed on 29 September 2006, 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 conducted our audit in accordance with the Auditing Standards published by the Auditor-General, which incorporate the Auditing Standards issued by the Institute of Chartered Accountants of New Zealand.

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 the 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 2006. 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#

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

Financial Statements (continued)#

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.

Financial Statements (continued)#

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

Financial Statements (continued)#

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

Financial Statements (continued)#

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

Financial Statements (continued)#

Analysis of Key Components of the Statement of Financial Position (as at 30 June 2006)#

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 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. It is a measure of the core Crown.

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

Financial Statements (continued)#

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

Financial Statements (continued)#

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

Financial Statements (continued)#

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

Financial Statements (continued)#

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

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

Financial Statements (continued)#

Statement of Segments#

Statement of Segments (continued)#

Statement of Segments (continued)#

Statement of Segments (continued)#

Statement of Segments (continued)#

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 3 of the Public Finance Act 1989 comprises:

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

A more detailed listing of the components of the Government reporting entity is set out in the supplementary information at Supplementary Information.

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, state highways, 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 2006.

The Budget forecast is the original forecast for the financial year, as presented in the 2005 Budget on 19 May 2005. The estimated actual forecast, as presented in the 2006 Budget on 18 May 2006, has been prepared using actual data which was available at the time of the finalisation of the Budget forecasts (8 May 2006).

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. Offices of Parliament have previously been excluded from the financial statements, however due to legislative changes they now form part of the Government reporting entity.

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 Crown 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 Crown in exchange for the provision of outputs (products or services) to third parties, the Crown 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 the cost of borrowing. 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 (including state highways) are recognised as at balance date. To the extent that a gain reverses a loss previously charged to the Statement of Financial Performance, the gain is credited 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 as at balance date 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 specified criteria have been fulfilled and notice has been given to the Crown.

Discounts and premiums#

Discounts arising on the issue of a debt instrument are treated as an increase in the cost of borrowing. 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:

Freehold buildings

25 to 60 years

Specialist military equipment

5 to 25 years

Other plant and equipment

3 to 25 years

State highways:

Pavement (surfacing)

7 years

Pavement (other)

36 years

Bridges

90 to 100 years

Aircraft (ex specialist military equipment)

10 to 20 years

Electricity distribution network

2 to 80 years

Electricity generation assets

25 to 55 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 value 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.

Revaluations are carried out for most classes of property, plant and equipment 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.

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.

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 depreciated replacement cost (fair value) 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 depreciated replacement cost 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.

Aircraft (excluding specialist military equipment)

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

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.

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 Crown 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 Crown 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#

In November 2005 the Government agreed (with effect from 1 April 2006) that interest will not be charged on student loans where certain criteria, largely related to being domiciled in New Zealand, are met. To better reflect the value of student loans under this no-interest policy, the accounting policy for reporting loans has also been updated. The accounting policy is to initially recognise student loans at their fair value and to subsequently report them at amortised cost. This accounting policy is to apply from 2005/06 and is consistent with the ‘loans and receivables’ designation under International Accounting Standard 39 (IAS 39) for financial instruments. The Crown will be adopting the New Zealand equivalent to IAS 39 for all financial instruments from 1 July 2007.

The key changes resulting from the no-interest student loan policy and adopting a new accounting policy are:

• There is a one-off write-down of $1,415 million in 2005/06 of the existing loan book value to fair value[1]
• The difference between the fair value of new loans and the amount lent is recognised as an expense in the year the loan is provided
• The initial fair value write-down will be unwound (ie, recognised as income) over the maturity of the loans. The value will be adjusted for any impairment (eg, non repayments caused, for example by death or bankruptcy of the borrowers).

For an analysis of the annual movement in student loans refer to Note 9 in the notes to the financial statements.

There has been a change in the method for estimating provisional tax revenue. Provisional tax revenue is now recognised in the period in which it is earned. Previously, the estimation was on the payment due date. The new method will better align tax revenue estimation with the accounting policy for tax revenue at the time the debt to the Crown arises. In doing so, the financial statements will have a more reliable estimate of tax receivables as at each balance date.

The transition to the new estimation method has resulted in a $1.8 billion increase in tax receivables in the Statement of Financial Position. This increase reflects tax revenue earned in April, May and June 2006 but which was not due for payment until after June 2006. In accordance with FRS-7, this change in estimate is also reflected as a one-off increase in tax revenue in the Statement of Financial Performance. In effect, tax revenue for this transition year captures more than just the normal 12 months of provisional tax revenue.

This change has no impact on taxpayers’ obligations or tax receipts; hence there are no cash flow impacts for the Crown.

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#

Notes to the Financial Statements (continued)#

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 $6.7 million (30 June 2005: $6 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 in their purpose#

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 $10.2 billion as at 30 June 2006. 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 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.

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.

ACC portfolio#

ACC manages the ACC scheme. At present there is a substantial outstanding claims liability associated with past claims of around $12.7 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.

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 is the amount for which the loans could be exchanged between knowledgeable, willing parties in an arms length transaction. Fair value on initial recognition of student loans, is determined by projecting forward the repayments required under the scheme, to a willing buyer and discounting them back at an appropriate discount rate.

As student loans are subsequently measured at amortised cost, the model projects all future cash flows to the Crown associated with the loan and the effective interest rate is 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 book value at each reporting date. If the timing of future receipts is revised, the book amount at reporting date is adjusted to reflect the revised estimated cash flows at the loans’ original effective interest rate. The adjustment is recognised as income or expense in the Statement of Financial Performance.

Note 9:  Advances (continued)#

With the support of the Ministry of Education (MOE), Inland Revenue Department (IRD) and Ministry of Social Development (MSD) have adapted the Ministry of Education’s valuation model to reflect the recently introduced student loans no interest, amnesty and voluntary repayments legislation. The substantive information has remained consistent with previous years, incorporating educational, demographic, income and loan data. As such, the fair 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 rate. The significant assumptions are as follows:

The data for student loans has been integrated from files provided by IRD, MSD and MoE. It consists of records of all borrowers from the start of student loans in 1992, the data from 1997 is limited with mainly IRD information available. The current data is up to 31 March 2003, and contains information on borrowings, repayments, income, educational factors, socio-economic factors amongst others and has been analysed and incorporated into the valuation model. Data to 31 March 2005 is now in the process of being analysed and will be available to be incorporated in the valuation model in 2006/07. Any revised future cash flows arsing from incorporating the updated data that impact the valuation will be recognised as they occur in 2006/07.

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 as at 30 June 2006. The estimated fair value of the student loan debt at 30 June 2006 has been determined to be approximately $5,538 million($5,994 million at 30 June 2005).

The fair value calculated is sensitive to underlying assumptions chosen. For example a 1% increase in the discount rate would decrease fair value by approximately $339 million, whereas a 1% decrease in the discount rate would increase fair value by approximately $391 million.

The 2006 Student Loan Annual Report contains more information on the student loan scheme.

Through the everyday operations of the student loan scheme the Crown 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#