The Public Finance Act passed in 1989 transformed the financial reporting of Central Government in New Zealand. Full accrual accounting by all individual government departments was followed from 1992 by the preparation of accrual-based financial statements for the government as a whole. This appears to be the first time in recent history that a sovereign government (referred to in this article as the "Crown" (The term "Crown" is defined by the Public Finance Act 1989 to mean all Ministers of the Crown and all departments. It neither includes local government nor extends to the nation as a whole. )) has produced combined financial statements on a full accrual basis. The government reporting entity has since been extended to include State-owned enterprises, which are commercial companies owned by the government, and Crown entities which are other public bodies over which the government exercises control.
The Public Finance Act requires the following to be produced by the crown:
The financial statements are accompanied by an extensive commentary and charts which indicate trends overtime. Individual departments of central government are also required to prepare statements of objectives and statements of service performance which incorporate non-financial information such as the quantity, quality and timeliness of their outputs of goods and services. All annual financial statements and statements of service performance must be audited by the Auditor-General.
From the above, it can be seen that the information contained in- the new financial statements of the Crown are much more than that produced by companies in the private sector. They help in meeting the objectives of public accountability and are also useful in decision making.
The Public Finance Act 1989 specifies that Crown reporting shall be in accordance with generally accepted accounting practice (GAAP). However, no comprehensive public sector GAAP, specific to national governments appear to have been codified. This has presented difficulties for both the preparers and the auditors of the financial statements.
In the absence of GAAP dealing specifically with accounting by national governments, the task of resolving accounting issues and determining accounting policies to be adopted in the preparation of Crown Accounts was undertaken by the policy group within the Financial Management Branch of the New Zealand Treasury, with assistance from the Office of the Controller and Auditor-general. The aim was to find equivalent circumstances in the private sector wherever possible. Issues for which new solutions had to be found included: definition of the reporting entity, the method of consolidation, infrastructure and heritage assets, taxation revenues, pension liabilities, and the present value of future tax revenues and welfare payments.
Definition of the Reporting Entity
Consolidation of Crown financial statements required identification of all entities over which the Crown exercises control. Although it was recognised that the Crown exercises control in various ways, including the purchase of goods and services and the use of coercive powers, the decision was made to focus on the consolidation of control through "ownership", for example,
The definition of "Crown" includes all property over which the Crown holds ownership rights. This is because a significant amount of property (for example, national parks and state highways) is owned by the Crown rather than by individual departments.
The exercise has illustrated that accounting is not just a technical matter. Consolidation of Crown accounts has raised all manner of legal and political questions about the boundaries of the Crown's estate, the relationship between various arms of government and the ownership of tangible and intangible assets. It has required an examination of these matters and subsequent clarification in legislation.
Method of Combination
Having decided to prepare combined accounts, the next issue to be addressed was the method of combination. Ministers of the Crown, government departments, Offices of Parliament and the Reserve Bank of New Zealand are fully consolidated with corresponding liabilities, revenues and expenses being added together line by line and transactions and balances between the sub-entities being eliminated. Crown entities and state-owned enterprises are combined using the equity method of combination. This records the Crown's share of these entities' net assets, including their surpluses and deficits on inter-entity transactions not carried out on an arms-length basis being eliminated. Other inter-entity transactions and balances are not eliminated. In the future, it is likely that the sub-entities which are currently equity accounted will be examined on a case by case basis to establish whether full consolidation is justified.
Assets
Assets posing particular problems include infrastructure assets, heritage assets and specialised military equipment.
Infrastructure assets are fixed assets of a network kind providing essential services such as roads, drains, or electricity transmission. Heritage assets are assets of cultural or environmental value which are intended to be reserved for future generations; for example, scenic parks and historical artifacts.
Highways have been valued by the engineers on a depreciated replacement cost basis. This valuation methodology required the use of the national road authority's infrastructure and maintenance database. The assumption has been that roads have a finite life, even with regular maintenance, and standard depreciation practices have therefore been adopted. The possibility of adopting a renewals accounting approach, which tracks actual maintenance or lack of maintenance, may be explored in the future.
Conservation and heritage assets have been reported separately from other land. The land was valued using "sales evidence of land in the same general location with comparable topography and vegetation cover". Values were then adjusted downwards to reflect restrictions on national parks and the invariably smaller land areas in private sales.
National archives were valued in categories using the best estimate of net current value at opening balance date. This was based on any recent sales or by comparison with the other categories of archives. 'Exceptional items were individually valued by independent valuers. The National Library valued its current collections on a depreciated replacement cost basis and its research collections on an estimated net current value basis.
Reporting assets on the Crown balance sheet is not meant to imply that those assets are intended for sale. Neither is it meant to indicate their value in non financial terms; for example, the conservation value of a scenic reserve. Descriptive information about infrastructure and heritage assets is provided in the appendices to the Crown financial statements.
Defence equipment has been recorded at depreciated replacement cost, valued by specialist advisors from the New Zealand Defence Force.
Right to Tax
The power to tax has not been treated as an asset even though this represents a flow of future cash inflows to the Crown. This exclusion has been justified by drawing an analogy with mutual or cooperative organisations in the private sector. It is not generally accepted accounting practice to treat such a levy as an asset. It has also been argued that while the value of the power to tax is relevant information, it is too difficult to determine with any reliability.
Pension Liabilities
For purposes of the Crown balance sheet, pension liabilities in respect of current and past government employees have been recorded at the latest actuarial valuation of the Crown's liability for pension payments, adjusted for any subsequent movements in value.
Future payments of retirement income and other social welfare benefits to citizens at large have not been included. The different accounting treatment has been based on differences in the nature of the payments. National welfare payments are non-contributory benefits financed from general taxation and paid at rates determined from time to time by the government whereas government employees contribute in return for defined benefits. The pension liability recorded on the Crown's balance sheets is seen as a liability of the Crown in return for employee services already provided.
Effect of Omitting the Present Value of Future Tax Revenues and Welfare Programmes
The present value of future tax revenues and welfare programmes are undoubtedly relevant in assessing the financial strength of government. However, they present huge conceptual and practical problems. While the information is clearly relevant, it is too unreliable to satisfy GAAP.
One problem is that, if such assets were included, they would swamp the balance sheet and render other items immaterial in comparison., Excluding them allows a closer look at the remainder. The balance sheet is therefore a statement of identifiable assets and liabilities under the control of the government rather than a complete picture of the fiscal sustainability of present government policies.
The present value of future tax revenues and the present value of contingent liabilities for welfare payments largely offset one another. The present value of future tax revenues can be viewed as the balancing figure in the statement of financial position.
There is probably a case for disclosing the present value of future retirement payments to citizens as a contingent liability outside the balance sheet.
Revenues and Expenses
The Operating Statement records the Crown's revenue and expenses for the period. Revenue is classified into:
Expenses are grouped by the functional classification i.e. administration, foreign relations, development of industry, education, social services, health and transport, together with finance costs. This classification is also used in the Statement of Cash Flows for cash disbursed through the Crown's operations. The notes to the financial statements further classify expenses by input type (personnel, operating, depreciation and so on) and provide a further breakdown of benefits, subsidies and transfers and of finance costs. The balance of the Operating Statement (termed the "operating balance" as it is not conceptually equivalent to the income of a commercial organisation) represents an accrual measure of the difference between total revenues and total expenses.
Where equivalent transactions can be found in the private sector, GAAP from the private sector have been applied. Aside from the depreciation of infrastructure assets, discussed earlier, the main area where private sector GAAP were lacking was the recognition point for taxation. Where possible, revenue is recognised at the time the debt to the Crown arises and is reported in the period to which it relates. For example, goods and services tax and provisional tax are recognised on the due date for payment, source deductions {Pay as You Earn (PAYE)} when an individual earns income subject to PAYE, and terminal tax on the date the assessment is filed.
The Statement of Cash Flows distinguishes operating activities, investment activities and financing activities. Taxation has been treated as an operating activity rather than as a financing activity as most of the taxation revenues are used for operating purposes; loan financing is used for investments in the assets of departments.
The Statement of Borrowings discloses three values for each item: nominal value, net current value and the value used in the statement of Financial Position (nominal value adjusted for the unamortised portion of the premium or discount on issue).
The Statement of Commitments covers capital commitments, leases and non-cancellable contracts for the supply of goods and services but excludes loan commitments and commitments to government employees. The Statement of Contingent Liabilities separately lists quantifiable and non-quantifiable contingent liabilities.
Financial statements in government need to be interpreted differently from those in the commercial private sector. The majority of revenue (in particular, taxation revenue) and such expenditure differs in nature from that of a private company. The private sector concept of profit and loss does not have a precise counterpart in the public sector. While the Operating Statement provides an important indication of the Crown's financial performance in a given period, it does not on its own show whether the government is achieving its broader goals.
Just as the Crown's Operating Statement is not entirely comparable to that of a company, neither is the Crown's Statement of Financial Position. Many assets recorded in the balance sheet are not held primarily to generate revenue but rather to provide services in the national interest e.g. heritage assets such as national parks and national archives. Interpretation of the balance sheet is different; for example, the power to tax means that a sovereign entity is not insolvent if it has a negative net worth.
Given the pioneering nature of these financial statements, the Auditor-General of New Zealand has notformed an opinion on the accounting practices adopted. The audit report on the Crown financial statements says that the statements fairly reflect the financial results and cash flows for the year and the financial position at the end of the year "in accordance with the accounting policies adopted".
While there is nothing in the present accounting policies that is inconsistent with current GAAP, it is expected that the accounting policies adopted for future sets of financial statements will change as GAAP evolves in both the public and private sectors. The second report of the Controller and Auditor-General for 1993 provides a commentary on the accounting policies adopted in the Crown financial statements and identifies some areas where further development is warranted. These include: the basis of combination; the measurement base for assets and liabilities; maintenance of infrastructure assets; heritage assets; employee-related expenses and liabilities; definitions of commitments and contingencies; and accounting for taxation revenue.
Some of these problems are also pervasive in the private sector. However, they are exacerbated in the public sector, either because they are particularly significant, or because there are additional sorts of assets and liabilities (such as infrastructure and heritage assets, taxation capacity). Continued cooperation between accountants in the private sector and officials in government will provide opportunities for broad based and innovative thinking on these perennial matters.
The new financial statements for the government of New Zealand provide a great deal of information which has improved accountability to Parliament, extended the range of information for assessing the Government's fiscal position and made managers conscious of the need to properly manage assets under their control.
In producing these financial statements, it has been necessary to tackle accounting issues on which there is no generally accepted accounting practice. New Zealand has directly confronted a number of practical problems and will continue to refine its policies in the light of practical experience.