Part 5: The accountability system for local authorities

Summary: Inquiry into the Mangawhai community wastewater scheme.

No single agency oversees all of the work of local authorities. Local authorities are independent statutory bodies governed by directly elected members. As such, they are primarily accountable to the electorate through the democratic process.

Several agencies have some role in scrutinising the work of local authorities and holding them to account. However, each of these agencies does so within the limits of their role and statutory mandate. The main agencies are:

  • The Auditor-General: The primary role of the Auditor-General is to report on how public money has been used and what has been achieved with it. The focus is on providing audit assurance on public accountability reports and selected areas of public entity performance. The Auditor-General has associated powers to inquire when serious concerns are raised about how resources have been used. Audit New Zealand is the business unit that carries out annual audits. The Office of the Auditor-General (OAG) is the business unit that, among other things, deals with correspondence requesting inquiries.
  • The Ombudsman: An Ombudsman investigates the administrative decisions, recommendations, and acts or omissions of central and local government agencies as they affect individuals or bodies in their personal capacity. For local authorities, an Ombudsman can investigate decisions made by a committee of the Council or advice given by a Council employee to the Council. However, an Ombudsman cannot investigate decisions or actions of the Council itself. This restriction ensures that the focus is on "matters of administration" rather than the policy choices of the governing body.
  • The Minister of Local Government and the Department of Internal Affairs: Under the Local Government Act 2002, the Minister can, in certain circumstances, appoint ministerial reviews and commissioners to act in place of elected members if they cannot perform their functions or if they are not properly performing their functions. Part of the Department's concern, therefore, is to assess whether there is evidence that would support the Minister's intervention.
  • The Police and Serious Fraud Office: The New Zealand Police have general responsibility for investigating possible criminal offences. The Serious Fraud Office is a separate organisation with specific responsibility for investigating and prosecuting serious or complex fraud.
  • The courts: The courts provide a forum for deciding disputes and resolving questions of law involving public entities. In particular, judicial review is a form of legal action that has been specifically developed to enable the courts to rule on whether public sector entities are acting lawfully.

Independent review of the work of Audit New Zealand

The terms of reference for the inquiry set out that the Auditor-General would appoint an independent person to review the audit work carried out by Audit New Zealand relating to Kaipara District Council.

We commissioned Mr Neil Cherry for this work, who is chairman of the New Zealand Auditing and Assurance Standards Board.4 Mr Cherry worked for Audit New Zealand at an early stage in his career (as have most auditors with public sector audit experience). We therefore asked Mr Des Pearson, a former Auditor-General of Victoria, Australia, to act as a peer reviewer for Mr Cherry.

The terms of reference required the review to take a comprehensive approach, by looking at 10 years of annual audits of KDC and three audits of KDC's long-term plans (LTPs).

What the review found

The review emphasises the need to understand the role of an auditor compared with the responsibilities of the entity being audited. The entity is responsible for complying with legislative and accountability requirements. It must maintain financial and other records so that it can accurately meet its reporting obligations. The auditor's role is to provide an independent opinion on whether the information reported by the entity is reasonably reliable.

Overall, the review concluded that the audit methodologies and approaches developed by Audit New Zealand and/or the OAG provided a reasonable and appropriate basis for an auditor to plan and perform audit engagements. At all times, the audit methodology aligned with the requirements of the applicable auditing and assurance standards.

The review concluded that the audits carried out between 2003 and 2005 satisfied the audit objective: the auditor had obtained reasonable assurance that the audited information met the required standards. However, the review criticises the sufficiency of documentation in the audit files for these years. In particular, the review noted that there was not enough documentation to explain how or why the auditor assessed the management control environment as good or effective during these years. The review concluded that the auditor's consideration of the financial management environment had been too narrow and relied too much on discussions with management during these years.

The independent review found that, between 2006 and 2009:

  • problems continued with the adequacy of documentation in the audit files and the assessment of the management control environment within KDC;
  • the auditor did not update their understanding of the wastewater project in these years, did not adequately assess the project's potential effect on KDC or the audit engagement, and did not give any independent consideration to the accounting treatment for the project;
  • the auditor inappropriately relied on KDC's management as a primary source of audit evidence and did not independently corroborate the information management provided;
  • the planning and assessment of risk that was done did not provide a sound basis for planning and performing the audits during this period and some audit test procedures were performed incompletely or inadequately; and
  • there were significant deficiencies in the auditor's work on rates during these years and the auditor should have detected many of the irregularities covered by the Validation Bill through normal test procedures.

Overall, the review concludes that the audits during these years were substandard in some respects and questions whether they satisfied the audit objective. This conclusion affects four annual audits and two audits of LTPs. The review concluded that, for the 2009 Annual Report, the result was that the financial statements materially misstated information and that an incorrect audit opinion was issued.

The independent review found that the quality of audit work improved between 2010 and 2012. The sufficiency and quality of documentation in the audit files increased, showing the additional effort that was going into the KDC audit as problems came to light. The review found only minor deficiencies in audit quality during these years. These deficiencies were unlikely to affect the auditor's conclusions.

Overall, the review concluded that the audit work during these years satisfied the audit objective. The review notes that considerable resources were devoted to KDC's audit during these years, as problems came to light.

The Auditor-General's response

Some steps have already been taken, including:

  • Audit New Zealand was removed from the KDC audit in late 2012;
  • the OAG's quality assurance programme has been advanced to ensure that all appointed auditors working in the local government sector will have had their work on local authority audits assessed by June 2014; and
  • The OAG and Audit New Zealand have reviewed Audit New Zealand's methodology for considering rates during local authority audits. For annual reports prepared in 2013, the OAG required all appointed auditors of local authorities to complete a quality assurance questionnaire to enable the OAG to assess rating practice in the local government sector and to ensure that local authority auditors were applying a consistent standard to their work. The OAG is currently analysing the results of this work and will report on it separately.

The Auditor-General is also taking some additional steps to ensure that Parliament, the public, and public entities can rely on the quality of audit work from Audit New Zealand. She has asked Audit New Zealand to provide her with assurance that it has reached the objective of consistent audit quality throughout its portfolio. Audit New Zealand will develop and implement an improvement programme, which will be overseen by two independent advisers to the Auditor-General.

Until this regime is able to satisfy the Auditor-General that Audit New Zealand's work is consistently maintaining an appropriate standard, she will not allocate any new audit engagements to Audit New Zealand. However, the concerns raised by this independent review do not suggest widespread or systemic problems that would justify removing audits from Audit New Zealand.

Review of the work of the Office of the Auditor-General and other accountability agencies

The inquiry also considered the response of the five agencies that were asked to investigate concerns about KDC's performance in relation to the wastewater scheme. The five agencies were:

  • the OAG;
  • the Office of the Ombudsman;
  • the Department;
  • the New Zealand Police; and
  • the Serious Fraud Office.

This part of the inquiry was carried out by the Deputy Controller and Auditor-General, Phillippa Smith. Although she has been in the OAG since August 2005, Ms Smith had no significant involvement in matters relating to KDC before this inquiry started in March 2012.

The OAG received five complaints about KDC between 2002 and 2005. Ms Smith considered that the OAG's responses to them were adequate.

There were no further complaints to the OAG until early 2010, by which time the wastewater scheme was completed and operating. By May 2010, three correspondents had written either to the OAG, Ombudsman or the Department expressing concern about a targeted rate for the scheme. One of these correspondents also raised a range of wider concerns about the Council and the wastewater scheme.

Late in August 2010, the OAG decided not to carry out a formal inquiry because KDC appeared to be dealing with the issues about the rate. Given the information available to the OAG at the time, the inquiry concluded that the decision not to inquire was reasonable, although it is now clear that the correspondents were right about many issues.

The OAG's decision was appropriately based on an assessment of risk – the risk that there were issues with the wastewater targeted rate and the risk that KDC (as the entity responsible) would not address them. The information available to the OAG suggested that KDC was aware of the problem with the rate, was taking legal advice, and intended to correct defects. In this situation, it was also reasonable that the OAG did not review the legal questions about the rate in depth. However, the OAG's decision was based on inadequate information.

The inquiry found that the OAG did not acknowledge in its letters to the correspondents that it also thought that there were some problems with the wastewater targeted rate. Instead, it said that, although there were issues with "terminology", the Council's overall intention was clear and its approach not unreasonable. The advice that it was enough for the Council's intention to be clear, even if the rate did not meet the requirements of the legislation, was not correct. This is not advice that the OAG would now give.

The OAG began to suspect that there might be more issues about KDC and the scheme than the wastewater targeted rate only when KDC provided the OAG with evidence of wider problems. That evidence came in the form of the PJ & Associates report forwarded by a new councillor; the legal opinion from the second legal adviser, which suggested that the rating issues were broader than the wastewater targeted rate; and information from KDC's new management.

With the benefit of hindsight, the Auditor-General now considers that it would have been appropriate to reconsider the situation more fully in late 2011, given the renewed correspondence from ratepayers and the additional information emerging from KDC. If the OAG had done so, this inquiry might have begun a few months earlier.

The Office of the Ombudsman received complaints from the correspondents from 2009. It declined to investigate the rate issues when it learned that the OAG had also received complaints about the matter and was carrying out "preliminary inquiries". It wanted to avoid duplicating the OAG's work. The Office of the Ombudsman continued to decline the correspondents' repeated requests that it investigate for the same reason and then because KDC had commissioned a first-principles review of the rate.

Ms Smith found that the Office of the Ombudsman was acting reasonably when it declined to investigate the wider concerns raised with it. Like the OAG, the Ombudsman will usually decline to investigate complaints that the complainant has not first tried to resolve with the public entity concerned.

The inquiry identified shortcomings in the way that the three main accountability agencies communicated with each other and in the communication with the correspondents. There were no issues with the actions of the Police or the Serious Fraud Office.

4 Mr Cherry is the current chairman of the New Zealand Auditing and Assurance Standards Board, a board member at the External Reporting Board, and a board member at the Australian Auditing and Assurance Standards Board. He carried out this review in his personal capacity.

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