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What is the state of public sector reporting, and what is it saying about public sector management?

July 2009: Auditor-General Kevin Brady's address to the managing and measuring performance seminar on 20 July 2009.

Some of you may know that tomorrow is my last day in office. So over the past few weeks while I have been counting down to tomorrow, I have obviously spent a bit of time reflecting on the seven years during which I have been honoured to be the Auditor-General. This seminar is a timely opportunity to share some of those thoughts with you.

The job as Auditor-General is one that can easily be seen as a negative one – you are the public watchdog; you are the independent guy who blows the whistle when things are not as they ought to be. So what I would like to start off by saying is that – despite it being my job to tell it how it is, warts and all – I have been continually reassured, through my interactions with the people who work in the public sector, of their commitment to good public service, and their high personal ethical standards. In short, in making my observations today, I know that they will be received by you all – high-calibre, committed professionals from across the public sector – in the constructive spirit that they are intended.

Any of you who have worked with me will know that I tend to be a practical, “let’s just sort it out”, kind of bloke. While I hope you know that I have not pulled my punches where I have thought them needed, I am not given to esoteric ruminating or philosophising. So in looking back, it struck me that in the last year or so I have reported twice in a way that is unusual for my Office. I am referring to the two reports that within the Office we refer to as my “think pieces”: the 2008 report on my observations on the quality of performance reporting; and my recently released views on setting financial reporting standards for the public sector.

These reports are unusual because they are not simply reporting results of annual audit work, or performance audit and inquiry work. They are, of course, based on the Office’s work, but they set out my own observations of issues garnered as my Office carries out its audit work. These two reports span much of the “formal reporting” – be it of financial or non-financial information – that is prepared in the interests of public sector performance and accountability.

There are some common themes in these two reports that I would like to draw out and dwell on today for the first part of my address – What is the state of public sector reporting?

Firstly (although hopefully it is not obvious to you here today), you could be forgiven for thinking that I am a bit grumpy. In respect of non-financial information, in my 2008 observations report I described the overall quality of non-financial performance reporting by public entities as poor and disappointing. In fact, many of you will have heard me be blunter in the past, calling it “crap”. It needs to improve significantly to allow Parliament and the public to hold public entities accountable for use of taxes and rates, and for the effectiveness of their service delivery.

I am also disappointed with the overall quality of financial reporting standards applying to most entities in the public sector. In my view, the approach to setting financial reporting standards needs to change to ensure that appropriate standards apply to public sector entities, so that those entities’ financial statements will meet the needs of people using the statements.

In making these remarks, I would not want to suggest that the public sector’s shift to generally accepted accounting practice and to outputs and outcome performance reporting (from cash- and input-based reporting), which took place about 20 years ago, has been misplaced. Rather, I think this shift has introduced considerable strength and rigour to both public management and accountability. In my view, despite the issues that I will discuss, many public sector entities report a range of useful information.

Also, despite the concerns I have raised about the quality of the standards for financial reporting by entities, and of performance reporting, the New Zealand public sector performance management and accountability arrangements are well regarded internationally. However, I am advocating improvement and change to ensure that the New Zealand public sector does not lose its reputation and – more importantly – the benefits of our public management system. There remains much that can be done to lift the quality and usefulness of reporting in the public sector.

Why does reporting matter? It is so basic and fundamental that it goes, at times, almost unstated – we are accountable because we use resources taken from people and impose restrictions on their actions by force of law. I don’t think there would be a single person in this room who would disagree that there is a moral duty on us all to use and account for our use of public resources and our exercise of powers as well as we can.

Our accountability documents are an essential component of our accountability arrangements. Their shape and presentation may change over time (for example, in response to changing user expectations and technology), but their overall purpose is to allow users to understand and assess whether public entities are delivering cost-effective and sustainable services. Accountability documents ensure that government departments and other state sector entities can be held accountable to Parliament and the public, and that local authorities and their controlled entities can be held accountable to local communities. Parliament and the public rely on accountability documents to assess the performance of public entities and the effectiveness of public entities' use of taxes and rates.

The core purpose of performance reporting is to provide public accountability for the responsible use of public resources and regulatory powers, including demonstrating that public services are being delivered effectively and efficiently.

So, financial and non-financial performance information needs to be integrated. True accountability for cost-effectiveness requires transparency about financial, and non-financial, performance – and an appropriate relationship between the two. It is important that financial reporting standards result in financial information that can be readily integrated with non-financial performance information.

Therefore, financial reporting standards are important. They set the requirements for preparing financial statements and, as a result, play a crucial role in the accountability of entities in the public sector. The key challenge is to get the arrangements for financial reporting and non-financial reporting elements to integrate in a way that is complementary, and hopefully helps the governors and managers of public entities to drive improved services.

Comparing the seemingly disparate areas of financial reporting standard-setting, and non-financial performance-reporting, may seem like a long bow for drawing parallels – but, to me, they are closely related. In both cases the quality and usefulness of publicly reported information hinges on the strength of the reporting framework.

For financial reporting, that framework is determined by independent bodies. The structure, composition, measurement, and disclosure for financial reporting are heavily prescribed by financial reporting standards. For the past six-and-a-half years, most financial reporting standards issued in New Zealand have been based on the International Financial Reporting Standards (IFRS). IFRS have been put in place by the International Accounting Standards Board for application by large profit-oriented entities that access capital markets. The Financial Reporting Standards Board, a committee of the New Zealand Institute of Chartered Accountants, has established New Zealand equivalents to IFRS (NZ IFRS) for application by reporting entities, whether profit-oriented or not. The Accounting Standards Review Board, an independent Crown entity, has approved NZ IFRS for application by certain reporting entities, including most entities in the public sector.

However, taking standards created by the International Accounting Standards Board for one purpose and using them for another purpose relies on relevant and appropriate changes being made to IFRS. Unfortunately, in my view there have been few changes and little guidance included in NZ IFRS to assist public sector entities to apply the new standards.

I am concerned about the lack of changes and the lack of guidance for the public sector, particularly given that IFRS contain a lot of guidance and examples for circumstances and transactions common to profit-oriented entities. I am concerned because of the adverse effect that deficiencies in financial reporting standards can have both on the quality of financial reports prepared by public sector entities, and on the costs of doing so.

During the past few years, I have been calling (begging and shouting) for sensible changes to be made to IFRS when creating NZ IFRS. I am disappointed that my calls have, mostly, not resulted in the changes I think are needed. This lack of change has resulted in some instances where NZ IFRS are difficult to apply in the public sector, and where information in financial statements is of questionable relevance to the people using it.

In my view, NZ IFRS have introduced a new and unnecessary level of complexity to general purpose financial reporting. As a result, many public sector entities now need external assistance to prepare their financial reports. Also, anecdotally, members of governing bodies and other people who use financial statements are finding it increasingly difficult to understand the information.

Increasing complexity is now evident to varying degrees in all aspects of financial reporting (that is, recognition, measurement, presentation, and disclosure). In my opinion, based on proposals currently being worked on and those that are planned, complexity is only likely to increase.

In my view, the introduction of IFRS has resulted in a financial reporting framework that increasingly struggles to take account of the core purposes, needs, and differences that are the stuff of the public sector.

I think there needs to be a significant change to the way financial reporting standards are set for the public sector. This is likely to include taking more account of the work of the International Public Sector Accounting Standards Board. The focus for change needs to be on relevant and appropriate financial reporting standards that are designed to produce financial reports that are understandable and can be used by people to properly hold public sector entities to account.

In my view, the Accounting Standards Review Board needs to be given the power to create financial reporting standards (as opposed to only approving or not approving standards submitted to it). If the Board had that power, it could then decide the best way forward and implement it so that standard-setting for the public sector could be put “back on track”.

But let me be clear. Significant change, rather than fine tuning, is required. Such change, at a minimum, would include requiring listed issuers to adopt pure IFRS and allowing any other profit-oriented entities that wish to state their compliance with IFRS to also adopt pure IFRS. In this way, these entities would be using standards designed for them.

The challenge for the Accounting Standards Review Board would then be to decide the most appropriate approach to setting standards for all other reporting entities. My “think piece” outlines four broad approaches that the Accounting Standards Review Board could consider.

All four approaches have advantages and disadvantages, and assessment of these approaches comes down to a trade-off between the quality of financial reporting standards (including the ability of entities to readily apply the standards) and the cost of setting standards to achieve that quality. I would strongly prefer an approach that emphasises the quality of financial reporting standards for the public sector.

By contrast, one of the key issues I raised in my observations on performance reporting is that there are no reporting standards in New Zealand for non-financial performance statements. Therefore, every entity needs to prepare and customise its own framework, and elements – primarily outcomes and outputs – within that framework, to reflect its own nature. Each entity must judge which elements (outcomes and outputs) are most relevant and significant, and how they are best aggregated for the purpose of external reporting. These judgements, from my observation, appear to lie behind many of the quality concerns I raised in my “think piece” on performance reporting.

Day after day, my auditors tell me that, when they are discussing performance management and the resulting reporting with entities, they are asked to tell entities what they think should be in reports. On one level I think this is okay – after all, your auditors are working with you to understand your business and should be expected to draw observations and make suggestions. But, just as you wouldn’t expect your auditor to prepare your general ledger and tell you what financial account codes to have, I think it is a bit rough to expect your auditor to tell you how your entity should be managing and monitoring its performance. So we seem to have a problem in that our devolved system expects everyone to be an expert, and there is no clear “go to” place for information, advice, and support.

My profession of accountancy provides leadership and oversight of preparation of financial information, and requires its members who prepare financial information to apply the profession's technical standards and meet standards of professional competence. There is no professional body that provides equivalent leadership for preparing performance information. Just as there are no technical standards governing the preparation of performance information, there is no purpose-built set of professional competency standards, or professional support, for preparers of such information.

Over the 20 years since the introduction of output and outcome performance reporting, central agencies, my own Office, and (at times) other sector agencies with leadership roles in the public sector, have worked on initiatives to try to help with the dearth of support. Unfortunately, these initiatives have often lacked co-ordination, sustained effort, and focus. In particular, they have not been based on a constant set of messages about the elements of performance reporting and their application; and have not focused on helping entities to apply general guidance to their own circumstances and on how to make incremental improvements and adjustments over time.

Part of the difficulty in ensuring co-ordinated and sustained effort, is that there are many parties with an interest in preparing and using performance reporting. In my view, there is a need to consider the question of leadership, co-ordination, and accountability within the public sector, for ensuring the application of standards and expectations for performance reporting, and for improving its quality.

I have suggested that, over time and as experience develops, the Treasury, in consultation with interested groups, should facilitate and ensure the preparation of such reporting standards. It should also consider how such standards are applied and maintained.

So the issues of public sector financial and non-financial reporting begin to look very much like any number of public sector paradoxes that you will be familiar with. On the one hand, a system that is highly regulated, and developed to create certainty and consistency, is producing information that is both insufficiently nuanced and inflexible – which undermines the usefulness of the information. On the other hand, a more devolved and flexible system is creating uncertainty and a lack of clarity for preparers and users, which undermines the usefulness of the information. As with so many public policy questions, there is unlikely to be a one true answer, and our challenge is to continue to adjust and refine to achieve our key underlying objectives.

Because there are so many users of, and uses for, accountability information, there is unlikely to be a single or complete solution to the range of complex and varying information needs – and many people are not in a position to demand information that is designed specifically for their needs.

However, although specific information needs cannot be met, there are, typically, common information needs that arise for many different people about the resources of an entity and how those resources have been used, and about the entity’s performance and impacts. Accountability information is therefore premised on providing accurate information relevant to the needs of users.

For accountability to be properly served in the public sector, general purpose financial reports need to be understandable for a wide range of people. They might not be of equal relevance to all users – but they should provide a starting point for more specific purposes. Reports that are not understandable undermine public sector accountability.

I should hasten to add that although the information is intended to be general purpose, it does not follow that any person should be able to use and understand it. There is an assumption that users of the information are already moderately informed, and willing to make the effort to understand it.

One of the things that puzzles me about our current debate on performance information is that we appear to share the concerns and issues in accounting for performance as do our counterpart public sector entities from other jurisdictions of common ancestry, especially the UK. Yet, in the UK, performance expectations at central and – in particular – local government level, do not play out in a devolved structure such as ours. Rather, they are run in a pseudo-contractual system that has a high level of central control, and where purse-strings are centrally held. The calls for a focus on individuals, and for simple systems that are based on what matters at the service interface, make a great deal of sense in a system where entities are told what to do and what to measure.

So, what is our excuse? We have a system where there is a high degree of discretion about what to achieve and how to measure it and – for local government at least – a high level of locally raised funding. We also have a reasonably modest system of monitoring, inspection, and audit, compared with our UK relatives.

Yes, legislation asks entities to publicly set out and report on the outcomes sought, the services that are delivered to influence these, and provide measures for each. But, given that this ought to be the day-to-day stuff of our organisational management – and in the wider context, of accountability for the use of resources taken out of people’s pockets – it is scarcely an onerous request.

My uncomfortable suspicion is that we sometimes fall victim to an inferiority complex. We are a small country with very limited resources and so, very practically, we look to others to see what is happening internationally. However, in doing so we should be careful to understand our own unique circumstances and not make their solutions (born of their problems) our own – without careful questioning.

What my “think-piece” reports about financial and non-financial information are (at their bare bones) suggesting, is that the frameworks we are using for accountability reporting, whether imposed and rule-bound, or devolved and based on entities’ judgements, are not gelling well with internal management and they are certainly not serving users’ needs as well as they might.

I personally find this deeply worrying. If our external reporting is not telling us how well we are managing and what we are achieving, is it simply because we are not reporting well? Or is it that we do not know how well we are managing and what we are achieving? In turning to the second part of my address – What is the state of public sector reporting saying about public sector management? – I confess that I am not sure which is the correct answer.

What scares me more is that Derek Gill, who will later today share his research, shows us that for many public entities there is a high degree of alignment between external information and internal management. But while managers feel they have good information about inputs, processes, and outputs, they do not feel that they have good information about quality, impacts, and outcomes.  So what this research says to me is that external information does reflect internal management, but that neither focuses on what matters to external users – quality, impacts, cost-effectiveness, and outcomes.

I think Derek’s research supports my personal observation of the current weaknesses in our public sector performance reporting. In my report I said that overall, I considered that those preparing performance reports have little incentive to prepare quality reports. Instead, they often:

  • report what can be reported rather than what should be reported;
  • are reluctant to report information that may reflect poorly on the entity and its governors; and
  • do not adequately report the quality of output delivery and information to allow users to assess how outputs affect intended outcomes.

I have been surprised when entities tell me it is too hard for them to identify and assess their outcomes and the impact of their services on outcomes; or, recently, when a Minister told me that some entities had told him that they did not know why they existed.

This morning at this seminar, Professor Behn focused on managing performance within entities, and it seems to me that many of his observations will be transferable to our wider system of public management. In his 12 “better practices” that can help ratchet up performance, he starts with creating the performance framework, asking: “What would it mean to do a good job?”.

I suspect I will not find myself alone today in asking the following question: “If a public entity does not have systems for monitoring and aggregating the range of information used for internal day-to-day management and governance, how can its governors and managers be confident that they are fulfilling their responsibility to deliver cost-effective public services?”. So we can ask ourselves: “How should our accountability framework serve in helping us understand and explain whether we do a good job?”.

Creating and using performance information within an organisation is commonsense management practice. I am concerned when public entities tell my auditors that external service performance information is not useful for those public entities' internal management – not because I think external information should drive internal management and services, but because external information should be a reflection of the management and performance of the organisation.

It should articulate strategy, how operations link to strategy, and how an entity monitors the delivery of its services and other objectives to (in turn) evaluate strategy effects and results.

But accountability information is highly aggregated information about an entity's wider environment, strategy, service delivery, and financial operations. Like other highly aggregated information, it will be of greatest interest to senior managers and the governors of public entities, allowing them to discharge their decision-making governance and accountability responsibilities. Like other highly aggregated information, it should be the tip of an iceberg compared with the sources of information used internally to manage business.

I think we should all expect to see, within a public entity, a broad set of input, process, output, and outcome information being collected, and monitored – at periods appropriate to the nature of the information. We should understand different sets of information will be relevant to different parts of an entity but expect that all relevant information is continuously used to help answer the key question: “Are we doing a good job?”.

I do not think we should expect external information to be the only source of information for internal management. A range of information is needed for internal management, and this information might be equally – and, sometimes, more – important for governance and management decision-making than (for example) output and outcome information. However finances and assets are expended and applied to deliver services, so the key must be to get the various arrangements for these elements to operate in a way that is complementary and – hopefully – helps to drive improvement.

I think, as I leave, that I’ve concluded it’s easy to bag our current external reporting systems – from a range of perspectives and for all sorts of reasons – and I have done my share of it. But we know – whether governments went through financial and performance reforms with zeal (such as we and Australia did) or through hesitant and incremental change over periods of time – that, increasingly, governments use accrual accounting, and are focusing on output and outcome performance management and transparency. Being at the head of the pack does not make us right, but we can take some comfort that our system is continuously rated well and its fundamental elements are increasingly employed by others.

Another thing we know is that the course of transparency does not run smooth. By this I mean that when Ministers or Select Committees sometimes do not notice or understand our concerns, when the media sometimes report issues in quirky, unexpected ways, or jump on things that seem erroneous to us, or when ratepayers and taxpayers make uninformed complaints to my Office or to the Ombudsmen, we conclude that accountability information has failed. Yet a body of literature exists suggesting otherwise, and our own experiences are varied – both supporting and countering concerns of apathy or general disinterest. It suggests that in some organic or osmotic way (that we do not fully understand) that the broad concept of transparency and accountability does work – but maybe not perfectly. The challenge lies in better understanding how to integrate information, how to present to and engage our stakeholders, and how to evaluate our achievements.

The fact that we are here today discussing what does not work, what does, and how to make things better, tells us that something about our system does work – but that it needs continuous review and refinement so the wheels stay oiled.

In my view, information in accountability reports of public sector entities should have at least the following important attributes:

  • the performance of the entity can be clearly understood in the context of what the entity is trying to achieve;
  • the financial performance of the entity makes sense when related to its non-financial performance;
  • the entity’s performance can be readily compared with the plans of the entity at the start of the reporting period;
  • the stewardship of the entity can be readily assessed by reference to the entity’s balance sheet and supporting notes; and
  • the entity’s long-term sustainability can be assessed.

Implicit in ensuring that information in public sector entities’ accountability reports is useful to people is an acknowledgement that those reports do have limitations. In other words, accountability reports cannot be expected to meet all the information needs of everyone. Rather, a sensible balance needs to be struck between not overloading people with information, but at the same time providing important information with which entities can meet their accountability requirements to the public.

So, one thing we need to keep building is our understanding of how public sector accountability works, and the information needed to help it work best. I do not think there is a widely accepted understanding of how we expect accountability to work and of the place of our formal reporting documents within this – in New Zealand or perhaps anywhere else.

However, we are all guardians of the moral duty to use public resources responsibly, ethically, and for the best results. As I look forward to my last day as Auditor-General, I thank you all for the opportunity to be discussing and sharing how we perform that duty and wish you every success as you all continue your work.

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