Resource Accounting and Budgeting
Good morning—or good evening, as the case may be. I call formally to session the first meeting of the Finance Committee to begin at 8 am, or pretty close to 8 am. I offer apologies on behalf of Elaine Thomson, who is unwell, and David Davidson, who has business in the north of Scotland.
Professor June Pallot is at the University of Canterbury in Christchurch, New Zealand. Good evening.
Professor June Pallot (University of Canterbury, New Zealand):
Good evening. Thank you and good morning to you.
I am Mike Watson, convener of the Scottish Parliament's Finance Committee. I am a Labour member for a Glasgow constituency. I will introduce my colleagues on the committee, which is, of course, all-party. Moving round the table from left to right—not necessarily politically—I introduce Andrew Wilson, a Scottish National Party list member for central Scotland; Dr Richard Simpson, the Labour member for Ochil, in what might be called the midlands of Scotland; Adam Ingram, a Scottish National Party member for the south of Scotland; and Donald Gorrie, a Liberal Democrat member for central Scotland. We are joined by Professor Irvine Lapsley whom, I understand, you have met. We also have our usual array of clerks, staff from the Official Report and sound technicians, who have made the link-up possible. We are pleased that you have joined us.
Thank you very much.
Would you like to make an opening statement? The committee has received your submission and your full and interesting background paper.
Thank you. I am a professor of accountancy at the University of Canterbury in New Zealand. It was suggested that I might like to make a submission to the committee because New Zealand has 10 years' experience of what is, effectively, resource accounting and budgeting, although we have never called it that.
I speak from about 20 years' observation of New Zealand's public sector reforms; from involvement with setting public sector accounting standards; and from my work as an assistant Auditor-General for a couple of years. My submission is made in the light of such experience.
I will direct the committee to a few short statements in my submission. I emphasise that New Zealand did not undertake resource accounting and budgeting as a separate technical exercise—we did not even have a separate name for it. It was merely a part of overall public management reforms, although it was an integral and important part. It was never considered to be an accountants' programme or anything like that.
The public sector reforms were part of wider economic reforms, which means that it is difficult to say definitively which successes have arisen directly from resource accounting and budgeting and which have come from the reforms as a whole, because they are strongly linked.
I will give a brief background to the events in New Zealand. Two major pieces of legislation introduced the main Government reforms. They were the State Sector Act 1988 and the Public Finance Act 1989 which, in effect, introduced resource accounting and budgeting. By 1991, all New Zealand's central Government departments—and, under separate legislation, all local government and all other Crown entities—were using full accruals accounting. We also produced non-financial statements of service performance which, I believe, we are unusual in auditing. If the committee wishes to ask questions about that, I will be happy to answer them.
New Zealand was the first country—in 1992-93—to introduce whole-of-Government financial statements on a full accruals basis. The Fiscal Responsibility Act 1994 was passed to require the Government to produce its future plans and financial plans on a full accruals basis, for greater transparency to the public. We have complemented the whole-of-Government financial initiative with some strategic goals and result areas.
I sense that some countries' discussions about introducing accrual accounting make it sound a little difficult or they have concerns about problems. In New Zealand, the introduction in departments of the system was pretty straightforward and did not cause many problems. That was partly because the system had been discussed for a while, although only a few people had implemented it. Skills were readily available, particularly as the State Sector Act 1988 made it easy to move people between the public and private sectors. We have only one accountancy body in New Zealand and everybody in that body is trained in commercial and governmental accounting.
We made the change easy for departments by separating the department and the whole of Government, so that tricky issues—such as heritage assets, taxation revenues, infrastructure assets and liability for pensions—were dealt with at the whole-of-Government level. Individual departments had to deal only with simple items such as tables, chairs, cars and other vehicles, for which commercial accounting packages were reasonably readily available. We managed to deal with the tricky accounting issues. I am not sure whether we did that perfectly—that remains to be seen—but we made a start.
We have tried to evaluate the system as much as possible and, by and large, the reactions of managers, senior managers, ministers and other politicians have been positive. It is felt that there is a wider range of information for decision making, and there is improved accountability and a clear understanding of what departments are doing and how much services cost, because of the emphasis on outputs and output budgeting. Management of cash, debtors, creditors and physical assets has improved as a direct result of accrual accounting and the longer term implications of short-term decisions are more apparent.
I must caution the committee that much of the evidence came from people such as senior managers, Treasury officials and overseas commentators and that their evidence tended to be positive. No one has canvassed the opinions of people who were dismissed from the public service, for example, and the views of people at the lower end of organisations have also not been much considered.
Overall, the response has been positive and the exercise has been felt to be beneficial. However, it would be unfair if I did not say that there were concerns, some of which have lingered. I have mentioned some of the main concerns, including the costs to small departments of meeting accountability requirements. We must put protocols in place to control that. Accountability requirements for non-departmental entities are not as stringent as are those for departments, and it is felt that the requirements on Crown entities that are owned by the Government, but which are not departments, could be a little stronger.
Some people consider the capital charge a head office exercise, and it might be hard to show that it has the effect that it is claimed that it has. I am concerned that departments have not been able to retain surpluses. That position is particular to New Zealand. I ask whether that works against the positive motivational aspects—such as the flexibility to manage—that resource accounting and budgeting has otherwise provided. The suspicion is growing that, once the initial fat is removed from the system, some departments become undercapitalised in the pursuit of short-term efficiency. There is mounting concern about maintaining capability. A persistent concern has been that we should do more to measure outcomes—the system is based on outputs.
I have drawn the committee's attention to a fairly recent report by the Office of the Controller and Auditor-General in New Zealand, which makes several suggestions. It considers the information that Parliament should receive and suggests reclassifying appropriation as current and capability expenditure, instead of using the purchase and ownership ideas, because not everything can be thought of as a purchase. The report says that maintaining capability is important and it goes beyond balance sheets and financial capability to human resources and information capability. It also recommends that outcomes should be measured. It remains to be seen how many of those ideas will be implemented, but I think that there is a groundswell of opinion in favour of change.
The question is not whether resource accounting and budgeting is ideal, but whether it is an improvement on the previous system. No one to whom I have spoken anywhere wants to return to the old system of cash accounting and centralised control.
I am happy to answer any questions that the committee might have.
Thank you for that introduction, which complemented your written submission.
I will start the questioning. Your written submission says—you repeated it today—that resource accounting and budgeting was not undertaken in isolation, but was part of management reforms in New Zealand. How was that achieved? I am interested in the other management reforms that were taking place. In the UK, we are not setting RAB in that context. It is considered here to be a technical accounting exercise. As that is the case, what shortfalls could the system in the UK face?
The main problem with treating RAB as a technical accounting exercise is in obtaining commitment to it from non-accountants. The exercise could be seen as something that goes on elsewhere and which involves the boffins or the bean counters. It could be hard to obtain the commitment and involvement of everybody who works in the Government.
In New Zealand, we started the system in 1978, with a report from the Controller and Auditor-General, which mentioned accrual accounting as merely one way of dealing with some problems, such as understanding costs and making choices among suppliers. The system was seen primarily as an exercise not of external accounting and reporting, but of management. New Zealand then became involved in reforming its economy and its public sector. The reforms were so comprehensive that nothing was left untouched. The financial systems were reformed along with the human resource systems and all other aspects, which included the restructuring of all Government departments. Every aspect of the New Zealand Government was altered. The financial management and resource accounting and budgeting aspects were just a part of that—they never had separate labels. There were public sector reforms, but no separately identifiable accounting reforms. Those reforms were simply carried out.
Could you comment on the situation in the UK, in as much as you are aware of it, and in as much as we are setting resource accounting and budgeting in a different context? I take on board your point about bean counters and about how RAB might be viewed as some kind of compartmentalised exercise for those who understand its technicalities. I can see the benefit that you in New Zealand spotted in wanting to spread the change as widely as possible throughout Government and the management of Government departments.
Given that that is not the way in which changes are being undertaken in the UK, do you still think that it is possible to introduce resource accounting and budgeting effectively?
I imagine that, once the changes were put through, there would not be a problem; RAB would simply become part of the way of doing things. I am not an expert on the United Kingdom, but it seems that there is less of a climate of overall change in the UK, whereas the whole climate was one of change at the time when resource accounting and budgeting was introduced in New Zealand.
If there is a significant group or body of people who are not particularly well disposed towards change, I can see that as more of a problem. That does not mean that the system is not more appropriate; it means simply that there is more resistance to it. One form that that resistance can take is comments such as, "This is an exercise by bean counters." Once the system is up and running, I expect that that view will disappear and that the attitude will be more that the system is boring and merely part of how things are done.
In your written submission, you make the point that New Zealand has one accountancy system, and that the public and private sectors are as one in that respect. You discuss the recognition of the need for Government agencies to recruit accountants from the market place at the going rate. How important is that with regard to cross-fertilisation between the public and private sectors? How does it impact with regard to your statement that
"The requisite skills were available"?
We have heard that—while resource accounting and budgeting is being introduced in the UK—ensuring everybody's technical competence to deal with it has been viewed as a problem, not least in terms of information technology. There is even a suggestion that there could be some resistance to moving to the new system on the part of those who have been used to cash accounting. How important has the experience in New Zealand of having a single system of accountancy been in overcoming such problems?
It has been helpful in the sense that existing accountants in the Government sector knew all about accrual accounting and commercial accounting. For example, the audit office—Audit New Zealand—tended to circulate auditors around various sorts of organisations, including the Government companies, so that they each got experience in commercial accounting as well as in appropriation and so on, which were distinct to Government.
At a professional standard-setting level, the single body of experience was quite helpful in getting a cross-fertilisation of ideas between the private and public sectors. My feeling was that I wanted as much to come from the public sector to influence the private sector as the other way round.
What was really important was the ability to move people quickly from the private sector into Government. Under the State Sector Act 1988, it became possible to pay the rates of remuneration that were required to attract people, and the traditional public sector rigidity of grades and so on has gone. It was easy to pick up a lot of people from the private sector. Many of them had the required IT, accounting and other skills. The 1988 act's freedom to recruit from the private sector was particularly important for changing the culture and acquiring the skills in a short period of time.
I want to ask about some of the problematic areas to which you have referred. First, there is the matter of assets that do not have revenue-generating capability, and the fact that that was not addressed until whole-of-Government accounts were introduced.
Secondly, you talked about the separation between whole-of-Government accounts and departmental accounts. Could you say a little more about that? You seem to be saying that long-term physical assets were held by central Government, whereas the departments dealt only with what one might consider to be depreciating assets. Did not that create considerable incentive problems for departments?
No, because the view on that revolved around the notion of departments providing particular services to the Government and the public. The task of the Department of Conservation, for example, is to manage the conservation estate. It manages, but does not own the conservation estate and it is judged on how well it does that job. The Inland Revenue Department is responsible for administering the tax revenue, but the tax revenue is not that department's revenue. We could go through the various departments, and we would see that their jobs are the administration or management of something. They do not actually own what they manage; ownership, and therefore the balance-sheet presentation, is at whole-of-Government level.
What is the incentive to departments with regard to their physical assets? Let us take health, which is the area in which I am particularly interested. If the department that is responsible for health does not own the hospitals, how is there an incentive to that department to manage that asset through resource accounting and budgeting?
The health situation is different in New Zealand. The management of health was essentially put out to Crown health enterprises—although they are not called that any more; they are now hospitals and are named as such. Central Government retained only a health policy unit and a health purchasing unit.
In the first instance, the Crown health enterprises—or the health bodies—managed the assets of hospitals and so on in the same way as any other organisation would. Those assets enter the whole-of-Government level only when there is a consolidation of all the organisations that are owned by the Government. In the case of health, the hospital buildings and so on were on the CHEs' balance sheets. They were then consolidated into the whole-of-Government financial statements.
The health example is a little different from that of the Department of Conservation, which manages the conservation estate, although the estate itself is a Crown asset.
Let us take the example of roads; a very important issue for us, as I imagine it is for New Zealand. Who owns the roads? Does the relevant department manage, maintain and develop them, with ownership of the asset coming under whole-of-Government accounting?
The majority of the roads are split up among the local and regional authorities, which have roads on their balance sheets and manage them. They have the infrastructure plans for them and so on. Transfund New Zealand is the central Government authority that mainly funds local authorities for roads. It administers the Crown's urban motorways and the main national highways and is subject to the same sort of infrastructure management plan that occurs at local government level.
Let me move on to another issue, of which I was not previously aware, which is the notion of capability expenditure. Could you tell us more about what that is and about how it fits in? What categories of expenditure fit into it, and how useful is the classification?
Although our current thinking involves capability expenditure, we have not really implemented it yet. We have been talking about it, however, particularly since Professor Allen Schick, from the United States, did a review of the New Zealand Government system. We have been talking a lot about the need to maintain capability.
The State Services Commission has a different perspective from that of the Treasury, which led most of the public sector reforms. The commission was concerned about maintaining human resources, skills, education, training and the ability of public sector managers to survive in a rapidly changing environment, and about the education, training, recruitment and on-going development of staff. People are also concerned about technologies, the knowledge base and so on.
Without having all the answers, various people are trying to do more research and are trying to find better ways to record what is happening in the areas that are concerned, not just things that traditionally appear on financial balance sheets. The problem with relying only on balance sheets is that there is a certain selective visibility; people might look merely at what is on a balance sheet without seeing some of the other things that are important for maintaining capability, which accountants do not usually record.
There are big challenges ahead to address that, but we in New Zealand believe that, if we do not start somewhere, we will never make any progress. We do not have all the answers, but want to make a start. What happened with whole-of-Government financial statements was that we did not have the answers and there was no precedent, but we felt that, by making a start, we would learn and would make some progress.
It seems that your main message to the committee is—first—that RAB as a separate exercise is simply bean counting and that secondly, although the management of physical assets is important, New Zealand recognises that, having put the equivalent of RAB into an overall package, the assessment of human resources, intellectual property rights and the whole knowledge-based economy within the scope of the balance sheet is the next big, crucial step. You are at that point now, whereas we are about 10 years behind you with regard to physical assets which, in the modern age, are slightly less important. Is that a reasonable comment?
Yes. However, there was still value in recording physical assets in the first place—it was better than nothing. That was reasonably straightforward, because the technology existed. However, that is not anywhere near enough in itself.
Could you elaborate a bit on outputs, outcomes and strategic results? In the United Kingdom, in my opinion, we tend to count what is easy to count. For example, we count the number of people who go through the doors of a school, a hospital, a sports centre or an old people's day centre, but we do not measure the quality of their experiences. Do you have any advice to give us and experience to share on how you in New Zealand count quality as well as crude numbers?
I have noticed that our notion of output is somewhat different to the definitions of output in the United States, which seem to be much more quantitative. I am not certain where the United Kingdom stands, but I suspect that it is somewhere between New Zealand and the United States.
In New Zealand, we see outputs as what departments actually do and the goods and services that they actually provide. Audit New Zealand and the Treasury said from the start that the performance of departments had to be measured in terms of quality as well as quantity and cost. The quality dimension always had to be there. That is not necessarily easy, but it is a requirement. It is in our accounting standards, such as they are; we have very limited accounting standards on non-financial performance measurements. We are trying to draw up more comprehensive standards but, right from the start, it has been a requirement to report on quality. That is not to say that all the attempts to report on quality were successful or were very good, but attempts were made, and not even all the attempts to measure quantity or cost were successful to start with. The important thing is to consider what departments are doing and the quantity, quality and cost of those activities. I believe that, over time, we have developed much more robust measures and approaches to looking at output.
We are a little behind where I believe we should be in measuring outcomes. In a way, for some of the outputs, such as policy advice, the real test of the quality of the output is not just that ministers are satisfied with the policy advice. The ultimate test is whether the policy works. That is an outcome measure. When I was working with Audit New Zealand, we did some exercises to try to get at that quality and outcome thing a bit more.
Let me tell you a quick story. In New Zealand, we have animals called opossums, which eat all the native trees and cause a lot of damage. The Department of Conservation therefore has a major programme to eradicate the opossums. We asked officials from the department to participate in our performance measurement exercise and asked them, "What measurement are you using?" They said, "The amount of poison we drop—and, by the way, the field officers are very annoyed with the Public Finance Act, because they have to report every time they go out and drop poison." So I said, "Is that a good measure?" and they replied, "No, because the rain comes and washes the poison away and it's not very effective." I asked whether there might be a better measure. One official suggested the number of opossums killed, but others disagreed and suggested that it should be the number of opossums left to do the damage. We asked them, "Is that a good measure? What are you really trying to do." They said, "We're trying to get the forests to regenerate." We said, "Can you measure that?" and they said, "Yes, we can. We have photographic techniques for doing that, but we've been so busy reporting how often we drop poison that we haven't had time. However, that measurement can be seen only over a number of years."
I mention that story because it illustrates how, if you keep talking things through with a department, you can move towards better measures. Often, you find that the measures are outcomes based and will be more than annual. The output measures are variable, but outcome measures are also important. I believe that that can be developed, never perfectly, but in a way that can lead to meaningful discussion and debate.
You are in an illustrious train of teaching by parables, and I think that your parable was successful.
How important do you think it is that departments can keep the surpluses that they generate, rather than giving them back to the Treasury?
The more I look at it—and I have a PhD student looking at this quite hard at the moment—the more I think that it is very important. I am still trying to get to the bottom of why the New Zealand Treasury has been so resistant to that notion. There are countries where departments can retain at least part of any savings that they make. Having spoken to managers in the public service, I have to ask whether, if departments cannot keep some of their efficiency gains, there is a real incentive to make savings in the first place rather than just spending the money. In my view, it is important to provide some motivation in the form of allowing the retention of some of the efficiency gains.
The counter-argument is that all that money belongs to the Government as a whole and that departments should therefore not be hanging on to it. If departments have made savings, it is argued, that has happened because they had not been efficient enough previously and all the surpluses should go back to the public.
It would be beneficial to examine the practices in a range of countries. I believe, although I am not absolutely sure, that Denmark and Sweden have a mixed system, whereby the department that makes the saving or gets a surplus can keep a third, a third stays in the sector—so that an education saving stays in the education sector, for example—and a third goes back to the general fund.
It is quite possible to run such procedures under resource accounting and budgeting. It is not resource accounting and budgeting, or accrual accounting, that has been the problem in New Zealand. Somebody from the Treasury may have a different view, but my view is that the incentives regime has not been quite right.
My next question comes at the issue from another angle. Have some departments been squeezed too tightly and therefore do not have enough capital for what they should be trying to do?
That is quite possible. There seems to be some anecdotal evidence building up about that, although I would not like to put it on the table at this stage, as I am still gathering more information. However, my strong suspicion, based on my current research, is that that is definitely the case. There is also anecdotal evidence all over the place in the public service. Audit New Zealand is quite concerned that there are a number of examples of cases in which that has happened.
I would like to focus on your continuing identification of the concerns, particularly with regard to accountability. You indicated that the reforms in New Zealand have improved accountability, not least because performance is now viewed in terms of results rather than cash spending, with enhanced information coming in for parliamentary committees to scrutinise and so on. However, you suggested that the accountability requirements for non-departmental entities could be stronger. Could you tell us a bit more about that and explain the difference between non-departmental entities and departments? Could you also tell us about the private finance initiative as it has been introduced and operated in New Zealand?
The accountability and reporting requirements for different public sector entities are different. There was an idea that the Crown entity sector was at arm's length from central Government and that it should be able to go into competition with private sector firms. In the first instance, the reporting requirements were a little less extensive, particularly with respect to such things as statements on service performance.
There is also a wider concern with respect to accountability that is not so much to do with the reporting and accounting. The arrangements for the remuneration of the board members and senior managers of some Crown entities are not particularly public. We had a few cases, particularly before the previous Government went out, in which it was discovered that excessive salaries had been paid for some of those jobs and that the arrangements had not been sufficiently transparent. In some cases, ministerial approval was not even required. It was therefore felt that much more could be done to strengthen accountability and transparency in those areas. I believe that the present Government is committed to redressing that situation.
Private finance initiative is not a term that is widely used in New Zealand. The Australians seem to be much more involved in that kind of exercise than we are, but I do not have a lot to say about PFI in New Zealand.
You identified as another matter of concern the capital charge and the incentive effect on managers who use many of the assets. You highlighted the question of how Government departments that provide services to low-income clients can recover the charge. Could you give us a specific example of that concern?
All sorts of departments are bringing in charges for services that they previously provided free, such as various forms of licences and passports. It was felt, particularly when the farmers were having a difficult time, that inspection fees for farmers were unfair. The farmers are doing all right at the moment but, for many years, New Zealand farmers had a great deal of debt and did not have much money to spare. The Ministry of Agriculture, as it was then, was faced with a capital charge and felt that it had no choice but to pass on some of that cost in the form of charges. That made people ask whether that was fair when the farmers were suffering financial difficulties.
The initial undertaking was that departments would get an appropriation for the capital charge, but there was also an assumption that they would act in a quasi-commercial fashion to incorporate that into their charges. We are conducting some deeper research into this matter and going back into how some of those decisions were made. Initially, departments were promised that they would be recompensed, but it seems that perhaps they were not. That may be what drove some of them to consider how else they could recover the charges. If, however, the Government lives up to its promises to cover the capital charge, that will be less of a problem.
Good evening, Professor Pallot. My question follows on from the previous one and I hope that it does not sound too daft. It is a question that has bemused me since the beginning of the RAB process here. You mentioned that the Ministry of Agriculture in New Zealand had to meet a capital charge and that that was why it passed on some of those charges. Broadly speaking, as far as we understand it, the Scottish budget has been increased by about £1.3 billion to meet capital charges, which have then been applied across the range of services that are provided. As a result, the introduction of RAB is neutral to begin with, in terms of the budget. Beyond that, we wait to see how the dynamics will work. Is that what happened in New Zealand? Was the introduction of RAB neutral? Were charges applied to the Ministry of Agriculture, for example, and was a budget allowed to meet those charges; or were charges applied without extra budget resources being provided?
It was supposed to be an internal exercise, to encourage departments to rationalise their assets and reduce the capital charge. If they made savings, they were supposed to be able to retain some of those savings. Another argument was that it would make costing comparable with private sector providers.
I—and a number of other people—have had real difficulty in pinning down the people who instigated capital charges as to which argument they favoured more. If you started picking holes in one side of the argument, they would slide over to the other side. The exercise seemed woolly. As I said, it was supposed to be an internal exercise. Everything was supposed to knit together and, as far as the general public were concerned, it would not be seen in Government financial statements. It would be seen in departmental financial statements, but appropriations were supposed to compensate for it.
It is fair to say that most people outside the head offices of departments do not have much idea at all about the capital charge, but surely the people who are making decisions on whether to get rid of assets are the ones who should know about it? That question has been raised. The people who make decisions on which assets are needed, and which are not, are not in the head office.
In essence, you said that the appropriation or the budget was passed to the Ministry of Agriculture and that the capital charge was an internal mechanism. What was the incentive to pass on the charge to farmers, as you outlined earlier?
There is a balance between a department's assets and the capital charge. If we consider the departments' details—the levels of their assets, the charges that were being levied, their different ways of managing their total assets and expenses—we must do so on a case-by-case basis. However, a political argument on the question that you raise was put forward.
I now have a very specific question, but your answer would be helpful to our debate. Is the rate of charge that is applied to capital assets in New Zealand constant for each department? How is it applied and what is the rate? In the UK, the rate is 6 per cent at present. Is it similar in New Zealand?
Our Treasury used the capital asset pricing model that was used in the private sector. It then added a bit more, to make up for certain factors—for example, the fact that departments do not pay tax. The rate therefore tended to be 2 or 3 per cent over the standard market rate in the private sector weighted average cost of capital.
There was supposed to be scope for departments to negotiate individually if they had reason to feel that their capital charge should be different. If they could show that there was a comparable business in the private sector with a different capital charge, and if they could argue that the Treasury had set a level that was too high when judged against the private sector comparator, they could negotiate a lower rate. Suitable comparisons with the private sector were pretty rare but, in form at least, there was a capacity to negotiate. Departments had different capital charges, depending on what could be described as the equivalent of the risk profile in the private sector. In practice, the department rates tended to be 2 per cent higher than the going market rate.
Roughly what is the going market rate in New Zealand? Does it vary from year to year?
Yes, it varies. We started off at about 13 or 14 per cent for the capital charge, but we are down at about 7 per cent now.
It is interesting and useful to learn that your experience is quite different to what is happening in the UK.
You mentioned a capital asset pricing model. Is that how you valued capital assets to begin with? You also mentioned that, in New Zealand, health services are provided by private enterprises and that the health department purchases services from those private enterprises. Was that the case before the introduction of RAB, or did it come afterwards?
I apologise—the Crown health enterprises that I mentioned were still Government owned, not private, although the Government could purchase from private providers as well. The main providers continued to be Government owned, but they were called enterprises, had boards of directors and were constructed in a rather commercial fashion. We have stopped calling those organisations enterprises—they are Crown health authorities.
The capital asset pricing model that I mentioned is a finance model that is used in the private sector. It takes into account risks, expected returns, loans, shares and so on. It is a kind of mathematical model that the maths gurus get involved in. The mathematical people in the Treasury have great fun with it, but I do not know that the departments relate to it especially well.
In your background paper, you say that
"Financial statements at all levels in the New Zealand government … are close to being on a current cost basis."
You go on to say that
"all fixed assets (including infrastructure and heritage assets) are revalued at least every three years."
That seems more regular than might have been expected. It must be quite costly; how are the costs apportioned department by department? Are costs written into the funding that departments and Government bodies receive? Is the extra information that the exercise produces worth the cost of producing it?
Standard practice is that the private sector revalues normal assets such as land and ordinary, rather than heritage, buildings every three years. That is accepted good practice and it yields relevant information.
One of the things that got the Treasury economists on side with the accountants in the production of whole-of-Government financial statements was the fact that the accountants were prepared to move away from historical cost accounting—accounting that the economists considered as nonsense and as yielding totally irrelevant information—and towards a way of providing more relevant information. The practice that you asked about is pretty much accepted for departments' simple assets—it is no big deal. The initial valuation exercise was quite time-consuming—especially for local authorities dealing with roads and infrastructure—but once the systems were in place and the assets were identified, the revaluations were much less time-consuming. In the case of infrastructure, it was part of good management to know what additions had been made, what maintenance there had been and how the value of assets had changed.
I do not think that we have to be terribly exact with things such as heritage assets. It does not make sense to try to be exact. The idea was to have something in place so that such things were included, but I am not sure that a great deal of effort actually goes into the revaluations.
Perhaps a more interesting accounting issue is what happens after the revaluations. If there is an increase in the value of the assets, is that revenue? If it is an addition, does the Treasury take that away? We have some issues to deal with in that respect.
The initial costs are reasonably high—they have to be if all assets are to be identified and reported. Much of the value of having assets on balance sheets is not for reporting purposes but so that everyone knows that the assets exist. When people know that assets exist, and know their value, they think about managing them better. Before we had accrual accounting, we used to ask departments to keep registers of assets; many of them did not, no reports were produced and the system did not work. However, once having such a register became a required part of the accounting system, organisations kept registers of their assets and their assets' values. People became aware of assets that they did not know they had before. I remember the National Library of New Zealand saying, "Gosh, look what we've got. There's a huge amount here and we're not sorting it properly. It's worth a lot." When the information was available, people were prompted to consider better ways of managing their assets. Although initial costs were high, there were many benefits in terms of better management. The information was not sought simply as part of a reporting exercise. The revaluations are accepted practice and they are not difficult.
That last point could perhaps be summed up by saying that a three-year revaluation of assets is good for Government accounting but bad for opossums.
Could you share with us your experience of the purchaser-provider split? Our experience is limited but, a few years ago, the then Government introduced it into the health service. Most people regard that as having been a failure—to put it mildly. What is your experience of such systems?
The purchaser-provider split was probably a UK initiative. I understand that we borrowed it from you and, especially in the health sector, encountered similar problems to your own.
My personal experience is with Audit New Zealand. The internal structure of the office was split in two. The office of the Auditor-General was, in effect, the purchaser and Audit New Zealand was a provider in competition with private sector audit firms. That seemed to sharpen up the quality of audit from our audit department, and improved the knowledge that private sector firms have of the public sector, but there are many concerns about the cost of such contracting. For example, all unsuccessful contractors waste a lot of time and effort and a lot of monitoring goes on. There are arguments for and against making such splits. It boils down to the costs of running the system.
I have a quite separate question. You referred to the fact that most of the research and evaluation had been done by those who were senior in the system, who were therefore most likely to feel that as they had introduced the system, it was a good idea. Have you any advice for us on how we should conduct research and evaluation of the process as it is introduced here?
There are many different approaches. What often happens is that even if outside experts are used, they end up talking only to senior managers, because they cannot talk to everybody. In New Zealand, senior managers and politicians have been fairly positive. That may mean that in effect everybody is positive, to be fair. You should start getting into the details, such as the operation of the capital charge. It would be helpful to find out more about how far down the organisation the system really bites. Are people really taking any notice? You should get involved with people at different levels in the organisation. Also, get outside perspectives as much as possible. Basically, you should take as many approaches as possible.
That concludes the questions that we want to put to you. Thank you for the extremely valuable assistance that you have given to the Scottish Parliament's Finance Committee in our inquiry. We will send you our report in due course. It has been valuable to have the benefit of your wide experience in this field. Thank you for making yourself available. It is getting quite late in New Zealand, and we are very appreciative of you being with us.
We have long known that New Zealand was a world leader in giving votes to women. I think that it is 100 years since that occurred. New Zealand has been a leader in world rugby for almost as long. As a Scot, I will say no more about that. It is particularly interesting to find that New Zealand is also a world leader in accrual accounting and good government practice. We have gained a great deal from our exchange with you this morning—or this evening.
Thank you. Of course, we inherited so much from Scotland, and continue to do so. It has been a great pleasure to meet you all. Good night, or good morning, as may be appropriate.
Thank you. I thank the technical staff for a flawless performance at both ends of the link. I understand that you may be coming to Scotland later this year, Professor Pallot. If you do, we would like to arrange a meeting with you as part of your visit. Thank you again for your assistance.
Meeting adjourned.
On resuming—