Part 5: Allegations about accounting and reporting

Inquiry into certain allegations about Housing New Zealand Corporation.

5.1
In this Part, we set out:

our expectations; and
our consideration of the allegations made by the contractor about accounting and reporting issues, which were:

5.2
The lack of detail provided by the contractor to support his allegations has made it difficult for us to be sure that we have adequately dealt with each of the allegations made.

Our expectations

5.3
We expected to find:

clear lines of responsibility for programme accounting;
proper controls within the accounting systems, and the timely completion of accounting functions;
accuracy of both financial reporting and monthly management reporting; and
appropriate documentation and formality surrounding accruals and other accounting practices.

Accounting for projects within the Community Group Housing programme

5.4
The CGH programme is a minor part of the Corporation's overall housing programme - comprising about 1500 houses in a total housing stock of about 66,000 properties. The CGH programme helps community groups and iwi provide access to community housing for people with special housing needs. The Corporation purchases and leases properties, with the aim of supplying 80 to 100 additional properties each year. The CGH programme had a capital budget of $21.166 million in 2004-05.

5.5
The contractor alleged that accounting for CGH capital spending was untimely. He alleged that there could be a 6- or 7-month delay in finalising the allocation of costs into Rentel, making it impossible to tell at any given time what amounts had been spent or committed.

5.6
The allegations were not specific enough for the Corporation to determine their substance. Therefore, when we interviewed the contractor, we sought to identify specifically which CGH accounts he was referring to. Beyond telling us that his concerns related to 4 or 5 general ledger accounts, the contractor was unable to provide us with details about the accounts.

5.7
We focused primarily on the 3 accounts that the contractor specifically referred to in correspondence before his departure from the Corporation (GL 80.1.510.7582, GL 10.1.850.5656, and GL 10.1.850.5657). One of these accounts relates to leasehold improvements on CGH properties, and the other 2 are clearing accounts used by several programmes. In addition, we identified 2 more clearing accounts of a similar type to those specifically referred to by the contractor.

5.8
The first of the 5 general ledger accounts (GL 80.1.510.7582) records improvements made to CGH leasehold properties. The Corporation leases rather than owns these properties, and improves them to make them suitable for a particular community group's purpose (for example, constructing a ramp so tenants in wheelchairs can access a building). Although the Corporation records the properties individually in Rentel, the leasehold improvement costs are not currently recorded in Rentel.

5.9
Improvement costs incurred on CGH leasehold properties are held in a separate ledger account, which is incorporated into the Corporation's Statement of Financial Position (commonly referred to as "balance sheet"). These costs are then amortised (amortisation is similar to depreciation) over the life of the property lease. The Corporation bases the amortisation on the average lease life, which is estimated to be 10 years. Therefore, the Corporation records one-tenth of the balance of the account as amortisation each year. The total balance in the account at 30 June 2005 was about $119,000.

5.10
The other 2 general ledger accounts identified by the contractor relate to infill development and acquisitions (GL 10.1.850.5656 and GL 10.1.850.5657). In considering these accounts, we assessed the CGH expenditure coded to them, as the contractor's concern was specifically about CGH capital spending. The total balance in these 2 accounts at 30 June 2005 was $1.832 million, of which only a very small proportion related to CGH properties.

5.11
In addition, there are a further 2 accounts (GL 10.1.850.5595 and GL 10.1.850.5659) relating to relocating, storing, and improving properties that have been moved off the Corporation's land and that will be used at other sites. These accounts operate in a similar manner to the accounts discussed in the previous paragraph.

5.12
Costs incurred (for example, valuation fees, and the cost of Land Information Memoranda) are coded to the 4 accounts until each property has been set up within Rentel. Although these accounts are expense accounts (as opposed to asset or capital accounts), the spending coded to them relates to capital projects and - in keeping with generally accepted accounting practice - should be capitalised. Therefore, each month the amount in these accounts is transferred through a reversing journal entry to a capital work in progress account, so that it is recorded within fixed assets on the balance sheet. In our view, this treatment is appropriate. It ensures that the costs are correctly reflected in the balance sheet at the end of each month.

5.13
Some of the projects with costs kept in the 4 general ledger clearing accounts run for a significant period, such as 12 months or more. This means that some costs in these accounts will be several months old, but this does not in itself indicate untimely accounting processes.

5.14
Land development costs are recorded in one of these accounts, because Rentel does not have analysis codes for land development costs (for example, drainage costs). Land development costs are held in the accounts until they are cleared annually as part of the accounting entries for the housing revaluations. This treatment is not inappropriate, although we note a process improvement project is currently under way to incorporate land development analysis codes within Rentel. This will enable direct processing of the costs into Rentel.

5.15
We were told that neither the balances coded to the clearing accounts nor the leasehold improvement costs on CGH properties are included as costs against programmes in monthly management reporting. This reflects the fact that they have not yet been recorded in Rentel.

Our view of the allegation

5.16
In our view, the financial accounting treatment of capital spending for CGH properties is appropriate. It results in the correct recognition of capital spending as fixed assets in the Corporation's balance sheet on a monthly basis.

5.17
Although some items do remain in these general ledger clearing accounts for several months (because of the nature of the projects), we consider that this does not reflect untimely accounting procedures. However, it can mean that monthly management reporting of costs against budgeted programmes is misstated.

5.18
In our view, all programme spending needs to be reported in the month the cost is incurred. This will:

provide timely information of costs against programme budgets; and
eliminate any suggestion that costs may be held in clearing accounts until there is a more opportune time for them to be reflected in the management accounts.

Recommendation 1
We recommend that Housing New Zealand Corporation report all programme spending in the monthly management reports when such costs are incurred, regardless of whether the costs have been entered into Rentel or are held in a clearing account.

Recommendation 2
We recommend that Housing New Zealand Corporation reconcile each month the financial information in the management reports and the expenditure recorded in its accounting records. This would, for example, ensure that the clearing accounts (which are in capital work in progress in the general ledger) are accurately reflected in management reporting in the month the costs are incurred.

5.19
The calculation of amortisation of leasehold improvements provides a reasonable estimate for accounting purposes in the context of the Corporation's overall financial statements.

5.20
In our view, the Corporation should have a means to track leasehold property improvements on a property-by-property basis, either within Rentel or in a separate sub-ledger. While the current treatment provides materially accurate financial accounting information, GL 80.1.510.7582 will become more difficult to reconcile (even if immaterial to the total financial position) as the number of entries continues to increase.

Recommendation 3
We recommend that Housing New Zealand Corporation track leasehold property improvements on a property-by-property basis.

Costs coded to accounts at the end of the month, and reversed the following month

5.21
The contractor raised concerns about costs coded to accounts and then cleared at the end of the month and transferred to the balance sheet, only to be reversed at the start of the following month. We understand that the contractor was initially concerned that the Corporation might have been manipulating accounting results by posting reversing journal entries to transfer costs to the balance sheet each month.

5.22
The use of reversing journal entries is normal accounting practice. It is consistent with the application of accrual accounting, which underpins generally accepted accounting practice. We understand from the contractor that he no longer has concerns about this practice.

Our view of the allegation

5.23
In our view, the reversing journal entries are used appropriately as part of the Corporation's accrual accounting system, that reflects capital work in progress as part of fixed assets in the balance sheet on a monthly basis.

Alleged manipulation of results between financial periods

5.24
Sound accounting practice requires that expenditure be recorded and reported within the financial year that it is incurred. If, at the end of the financial year, further claims for work undertaken during the financial year are anticipated, an accrual should be made for such expenditure to be recorded in that financial year.

5.25
The contractor alleged that costs were manipulated by being reported in incorrect financial years. The contractor specifically referred us to 2 incidents:

He alleged that, at the direct instruction of the Special Programmes Manager, a quantity surveyor (independent of the Corporation) was asked to provide an invoice for work as at 30 June 2005 that had not actually been completed, for an amount of about $720,000.
He alleged that a journal entry was initiated by the Corporation's Wellington office for about $2.1 million, transferring costs from earlier years into the 2004-05 Modernisation programme. He expressed concern that these costs had previously been "parked" in suspense accounts rather than posted to the relevant programmes.

Incident 1: Quantity surveyor asked to provide an invoice for incomplete work

5.26
The contractor was unable to provide us with specific details, but after inquiring into this issue we consider that the contractor's allegation relates to the Greenstone Gardens project.¹

5.27
We have discussed this allegation with the Greenstone Gardens project manager, the Special Programmes Manager, and the National Property Improvement Manager. We have also discussed some aspects of this matter with the project's quantity surveyor and the building contractor, both of whom are independent of the Corporation.

5.28
The quantity surveyor told us that he was asked by the Corporation's staff to provide an assessment of the total project construction costs - the costs to date and any costs to complete. In a letter dated 6 July 2005 (which was not an invoice), the quantity surveyor assessed the total Greenstone Gardens construction costs as:

$6,750,000 for the core Greenstone Gardens project; and
an additional $722,000 for associated works.

5.29
The quantity surveyor told us that the $722,000 for associated works related to both the Greenstone Gardens property and an adjacent property. During our interviews, the Special Programmes Manager expressed the same understanding, but later told us that all the additional associated works related only to the Greenstone Gardens project. The Greenstone Gardens project manager and other Corporation staff we interviewed told us that all of these costs related to the Greenstone Gardens project.

5.30
The quantity surveyor told us that he understood the information he was asked to provide was needed to complete 2005-06 budgets. He told us that, in his view, most of the work included in the $722,000 was not complete at 30 June 2005.

5.31
The Corporation's staff had a different view. The Greenstone Gardens project manager and the Special Programmes Manager both told us that the quantity surveyor had been asked by the project manager for an assessment of project costs (not an invoice) to ensure that all costs had been appropriately included at the end of the 2004-05 financial year. Their view was that the project was substantially complete by 30 June 2005, and they therefore wanted to ensure that the full cost was accrued for work they understood to be complete. They told us that, at the time of establishing whether any additional accrual was needed, they believed that the project would reach "practical completion" on 8 July 2005. In their view, there was only minor remedial work to be completed after 30 June. Therefore, Corporation staff thought it appropriate to accrue the total costs assessed in the quantity surveyor's letter dated 6 July 2005.

5.32
The assessment of project costs requested from the quantity surveyor was to verify the accrual. The Special Programmes Manager told us that the contractor was asked to prepare the journal entry for this accrual.

5.33
During our inquiry, Corporation staff initially referred to the Greenstone Gardens project as having reached practical completion by 30 June 2005. They have since advised that their use of the term "practical completion" was interchangeable with "substantially complete", and they were not implying that the practical completion certificate had been obtained at 30 June 2005.

5.34
While both the project manager and the Special Programmes Manager were adamant that the job was substantially complete by 30 June 2005 (and they were expecting practical completion on 8 July 2005), the practical completion certificate was not signed until 25 August 2005. Managers within the Corporation contend that any work performed after 30 June was minor, and delays were caused by other factors (such as the extent of remedial work and the weather).

5.35
We reviewed the payments made under the quantity surveyor payment certificates issued after June 2005, to see how much and what sort of work was performed after 30 June 2005. The total payments (excluding payments of retentions, which relate to work previously completed) after June amounted to a little more than $1 million. While this may indicate that a significant amount of work was completed after 30 June, we understand that this figure includes:

a re-measure (adjustments to reflect where progress payments had underestimated actual costs); and
some payments to sub-contractors who were slow in submitting invoices.

5.36
We discussed the extent of work completed after 30 June 2005 with the main building contractor on the Greenstone Gardens project. He told us that the work consisted primarily of:

completing stairwells and applying fire-rated paint;
installing signage;
completing site works;
some remedial and minor finishing work in 2 housing blocks; and
installing curtains and blinds.

5.37
We discussed an estimate of the total cost of the work (excluding the remedial work, because the building contractor bears these costs) with the building contractor. He thought that the value of work performed after 30 June was between $200,000 and $400,000. This would suggest that, of the $1 million paid under the payment certificates after June 2005, at least $200,000 related to work completed after 30 June 2005. Therefore, although payments totalling about $1 million relating to this project were made after 30 June 2005, the majority of these payments were for work that had been completed before 30 June 2005 for the reasons given in paragraph 5.35.

5.38
On this basis, it is reasonable to conclude that at least $200,000, but probably not more than $400,000, of the $722,000 that was accrued at the end of the financial year was incorrectly accrued before the work was completed. This should be seen in the context of the total project cost at 30 June 2005 (see paragraph 5.84).

5.39
The building contractor told us that most of this work was completed early in July 2005, but that the stairwell painting was not completed until near the end of August (because the fire-rated paint arrived late). The building contractor told us that he offered to "hand over" one block of housing to the Corporation close to, or shortly after, 30 June.

5.40
We would not have expected programme management staff to have accrued the full cost of the project. We would have expected staff to have considered whether any work was to be completed after 30 June 2005, rather than assuming that, because the job was substantially complete, the full costs should be accrued.

5.41
We note that the Special Programmes Manager (who told us he had no responsibility for Greenstone Gardens) was asked by the Greenstone Gardens project manager to prepare the accrual. We were told that this situation arose because the costs ultimately fell within the Special Programmes cost centre, which was the responsibility of the Special Programmes Manager, even though he was not responsible for the project. No internal documentation supported this oral request. We consider the lack of clarity about responsibilities for programme accounting, and the lack of documentation surrounding this request, to be inappropriate.

5.42
We understand that the difficulties encountered in completing the Greenstone Gardens project resulted in the Corporation seeking an independent review of the project from PricewaterhouseCoopers. The report from PricewaterhouseCoopers highlighted some process issues for the Corporation to consider on projects of this nature, and was discussed by the Board's Property Committee in March 2006.

Incident 2: $2.1 million transfer

5.43
We found it difficult to identify the $2.1 million transfer referred to by the contractor. However, we consider that the contractor was probably referring to the situation described below.

5.44
When a job is created in Rentel, 3 inputs specifying the contract type and destination codes are included. The job costs are uploaded from Rentel into the capital expenditure sub-ledger. If the 3 input codes do not match in a way that is recognisable within system parameters, the balances get uploaded into a sub-ledger suspense account. Both the suspense account and the capital expenditure sub-ledger feed into the same general ledger account, and therefore there is no misstatement in the balance sheet.

5.45
In early 2005, the Wellington-based Finance team increased its efforts to reconcile the sub-ledger suspense account. The person who had been clearing the account left the employment of the Corporation in late 2003, and in his absence the account was not cleared. In May 2005, the Finance team began to clear a balance of $1.829 million held in the sub-ledger suspense account as at 30 April 2005, for the programmes in which the contractor was involved.

5.46
We understand that the Finance team asked the contractor to identify the costs by programme, so that all costs could be allocated and cleared from the suspense account. At the time, $793,000 was identified as relating to the 2003-04 financial year, and $1,036,000 related to the 2004-05 year. However, because of the way the suspense account is accounted for (see paragraph 5.44), items relating to a previous year do not affect the current year's financial accounting results.

5.47
Based on work completed by the contractor, the amount was split between 2 programmes: Modernisation ($1,703,000) and Reconfigurations ($126,000).

5.48
In May and June 2005, an additional $435,000 in transactions ($335,000 from May and most of June, and $100,000 from the last few days in June) was miscoded, and was therefore held in the suspense account at 30 June 2005. The contractor was also asked by the Finance team to itemise the $335,000. He advised that all of this related to the Reconfigurations programme. We consider that the $2.1 million held in the suspense account that was of concern to the contractor is the initial $1,829,000 million and the subsequent $335,000 described above. Together, these add up to about $2.1 million. The contractor was not asked to provide any information about the $100,000, and we therefore consider it to be outside the $2.1 million that he was referring to.

5.49
Costs uploaded into the suspense account because they have been incorrectly matched are not recorded in reported monthly programme spending. Therefore, although the financial accounting is accurate, management reporting on programme spending may not be. For example, the $793,000 that related to the 2003-04 financial year was reported as programme spending in the management accounts for the 2004-05 financial year.

5.50
The Finance team told us that, in May 2005, staff at the operational programme level would have been unlikely to know that incorrect coding would default to a sub-ledger suspense account rather than the capital expenditure sub-ledger.

5.51
When this issue was first raised with the contractor by the Finance team, the suspense account had not been cleared since part-way through the previous financial year. The build-up of the suspense account through 2003-04, until it was cleared in May 2005, resulted in some inaccuracies in management reporting of programme spending. The suspense account is now reconciled and monitored each month.

5.52
We reviewed reconciliations of the suspense account for each month of the 2005-06 financial year, up to 30 April 2006. The balance at 30 April 2006 was about $619,000. Operations staff have been reminded by the Finance team of the importance of getting the correct codes matching in jobs, and the incidence of jobs defaulting to the suspense account has reduced significantly since June 2005.

5.53
We understand that a system change is being prepared to prevent incorrect coding. It should stop jobs uploading into the sub-ledger suspense account.

Our view of the allegations

5.54
Given management's assertion that it understood the Greenstone Gardens project was substantially complete and would reach practical completion on 8 July 2005, it is difficult to conclude that any over-accrual was a deliberate attempt to manipulate reported results. Rather, it appears that any over-accrual may have arisen from a misunderstanding between those involved about what information the quantity surveyor was asked to provide.

5.55
Nevertheless, we consider that it is unacceptable for such a misunderstanding to occur. In our view, regardless of the availability of a suitable accounting resource, project managers should have a general understanding of accounting for construction contracts, and should understand the relationship between what is accrued and what work has been completed. Based on our discussions with the Corporation's staff, we have some doubts about whether this is the case. We have also found it difficult to obtain a common and consistent understanding of the accrual of $722,000.

Recommendation 4
We recommend that Housing New Zealand Corporation consider whether project managers need additional training on relevant accounting matters.

5.56
The financial accounting for the suspense account that we have reviewed was appropriate, and the balance sheet was correct, during the period that concerned the contractor. We consider it unlikely that there was any deliberate manipulation of results through suspense accounts (that is, by incorrectly coding jobs), as the balances in these accounts were appropriately reported for financial accounting purposes as though the miscoding had not occurred.

5.57
However, we note that the costs within the sub-ledger suspense account do not get reported against a programme for management reporting purposes until they are cleared from the suspense account. While this is not good practice, nothing has come to our attention to indicate that this was used as a deliberate means to hide programme cost overruns. As discussed previously, we consider that the Corporation should reconcile each month the financial information in the management reports and the expenditure recorded in its accounting records.

Alleged manipulation of results between programmes

5.58
The contractor worked in the Special Programmes team within the National Property Improvement team. The National Property Improvement team manages a number of programmes, including the Modernisation programme (modernisations, reconfigurations, and the Greenstone Gardens project) and Auckland Pensioner Housing.

5.59
The contractor alleged that the results of different programmes within the Special Programmes area were manipulated in 2004-05 by shifting costs between programmes. Further, he alleged that senior management at the Corporation were not only aware of, but actively encouraged, such manipulation.

5.60
When we interviewed the contractor, we sought to identify which journal entries he was referring to. The contractor gave the example of a journal entry for about $340,000, transferring costs between the Auckland Pensioner Housing and Modernisation programmes during 2005. He told us that he was instructed by his manager to process the transfer. The contractor's view was that this journal entry had no basis and that there was nothing to justify the transfer.

5.61
The lack of detail provided by the contractor made it difficult to identify the journal entry to which he was referring. We interviewed several Corporation staff, but none were able to recall such a journal transfer. However, we have identified the journal entry discussed in paragraph 5.62, which may relate to the allegation raised by the contractor.

5.62
It is possible that the contractor's concern arose from dealings with the Wellington-based Finance team when they were trying to resolve the suspense account balance discussed in paragraphs 5.43-5.53. The Finance team queried the contractor's assertion that a suspense account item of $335,000 should be allocated entirely to reconfigurations. After the contractor left the Corporation, it was established that most of the $335,000 related to modernisations rather than reconfigurations.

5.63
However, this matter did not relate to the Auckland Pensioner Housing programme, which was specifically mentioned by the contractor.

5.64
The Corporation's staff denied knowing of, or supporting, unsubstantiated journal entries between programmes. As discussed further in paragraph 5.71, we reviewed selected internal monthly reporting information against source information and found it to be accurate.

Our view of the allegation

5.65
Without more specific information about the journal entry mentioned by the contractor, we were unable to investigate this allegation any further. Based on the possibility we identified, and our review of other monthly reporting information, we found no evidence of a deliberate attempt by management to misrepresent reported programme results.

5.66
We note that there is a degree of judgement required about what work fits into reconfiguration and what fits into general modernisation.

Recommendation 5
We recommend that Housing New Zealand Corporation complete as soon as possible the guidelines and procedures for the Modernisation programme, to provide clarity for staff about allocating costs.

Alleged manipulation of monthly management reports

5.67
The contractor alleged that monthly management reporting was manipulated for both financial and non-financial information, and that results were amended to conceal poor performance in the Auckland Modernisation programme.

5.68
The contractor also alleged that, because of "audit queries" he raised, he organised a meeting to discuss and resolve the issues, but that the meeting was stopped. The contractor alleged that this may have been to ensure that the issues were not investigated.

Financial information

5.69
The contractor did not provide any further details about the financial manipulation of results.

5.70
We considered whether the Greenstone Gardens project was appropriately reflected in the monthly management reports, as we were aware that the project had been delayed and had incurred cost overruns. Although part of the overall Modernisation programme, the Greenstone Gardens project was reported separately in monthly management reports.

5.71
We reviewed the June 2005 monthly management reports for the National Property Improvement team and the Asset Services Group (which encompasses the National Property Improvement team reporting). We have also reviewed the Corporation's quarterly report.

5.72
Further to our consideration in paragraphs 5.26-5.42, where we reviewed the allegation of accruals being recognised before work was completed, we questioned the reporting by the National Property Improvement team and Asset Services Group. According to the management reports, the Greenstone Gardens project was on budget, when we understood that the project had incurred significant cost overruns. We considered:

the reported actual cost for the Greenstone Gardens project for 2004-05; and
the reporting of the budgeted cost for 2004-05 for the Greenstone Gardens project.

5.73
We expected the Greenstone Gardens project's costs for 2004-05 to have been reported as at least $7.505 million. This figure takes into account, consistent with the quantity surveyor's letter (referred to in paragraph 5.28) and our interviews with the Corporation's staff, the costs of $6.75 million, the additional associated works of $722,000, and professional costs of $33,000 (that is, for the quantity surveyor and the architect). Our expectation is based on what we understand was actually accrued, irrespective of our views on the appropriateness of the accrued amount (discussed in paragraphs 5.54-5.55).

5.74
However, in the management reports we reviewed, the costs were reported as $6.75 million. This was at least $755,000 less than we expected to see ($722,000 plus $33,000). The Corporation told us that the entire $722,000 accrual was recognised as part of the general Modernisation programme (rather than for the specific Greenstone Gardens project). We were told that, at the end of the financial year, the breakdown of the work associated with the $722,000 was not known. On this basis, the National Property Improvement team did not want to report it as part of the Greenstone Gardens project.

5.75
In our view, the disclosure (or non-disclosure) of the costs in this project described above was inappropriate. The $722,000 related directly to the Greenstone Gardens project (according to management's assertions). As such it, along with the professional fees, should have been included as part of the reported capital cost of the project. We consider that the disclosure adopted by the Corporation understated the full cost of the Greenstone Gardens project. The Corporation was satisfied that it had appropritely accrued the $722,000 cost of the associated work, and, therefore, in our view it should have reported this as a cost of the Greenstone Gardens project rather than in the general Modernisation programme.

5.76
The staff we spoke to noted that the Greenstone Gardens project was part of the overall Modernisation budget (rather than a separate programme), therefore implying that the disclosure adopted may not have been inappropriate, as the $722,000 was still included in the total Modernisation cost figures. A decision had obviously been made to show the Greenstone Gardens project separately in the Corporation's management reporting, and this treatment should have been consistently applied in all reporting on that project. In our view, the understatement of about 11% of the total costs of the Greenstone Gardens project for the year was inappropriate.

5.77
We also queried why both the National Property Improvement team and Asset Services Group reports show the Greenstone Gardens project's budget as $6.75 million, when the Corporation's quarterly report shows a budget figure of $6.15 million.

5.78
We have been advised of 3 different budget figures for the Greenstone Gardens project:

$6,150,000;
$6,750,000; and
$7,498,000.

5.79
We were told that the original budget figure for the Greenstone Gardens project was $6,150,000 and that this was before the final budget had been approved. We were also told that the number had simply not been updated in the Corporation's quarterly report.

5.80
We received conflicting explanations about the composition of the $6,750,000, although we understand that it is the revised internal forecast.

5.81
The final approved budget for the project was $7,498,000. This included $530,000 "opportunity cost" for the land. We note that this was an internally assessed budget. It was not a separately appropriated amount, but formed part of a larger Crown funding pool.

5.82
We consider it important for management reports to distinguish between approved budget figures and revised forecasts. Both are important, but they serve different purposes and should not be presented as the same within management reports. Presenting actual costs against revised forecasts may hide overruns in management reporting, as has been the effect here.

5.83
Further, including the opportunity cost of the land as part of the consideration of the total economic cost of the project would seem to cloud the actual accounting cost, as the recognised accounting cost does not include any opportunity cost. While the opportunity cost did not appear to be included in the reported budget figures, there is some risk of confusion about the allowable level of expenditure against a project.

5.84
It appears as though the project was significantly over budget at 30 June 2005. Actual costs for the year were about $7.5 million, compared with an original budget of $6.15 million and a revised forecast of $6.75 million. The costs should have been consistently reported as such.

5.85
Further, we note the total costs of the project ended up being about $8.5 million against the budget of $7.5 million. Both totals included the opportunity cost, but excluded $356,000 for costs allocated to the adjacent property. As noted earlier, the cost overruns of about $1 million and the nature of the contract led the Corporation to seek an independent review of the Greenstone Gardens project. We understand that the Corporation's concern was not so much that the cost overruns occurred nor necessarily the extent of the overruns (given the heated Auckland construction market at the time), but that the cost overruns were not reported in a timely way.

5.86
We have viewed correspondence from both the quantity surveyor and the project architects to the Corporation dating back to October 2003. The correspondence raised concerns about the inadequacy of the budget and warned that cost overruns were likely. The Corporation's response to some of these concerns was to undertake a value engineering exercise that aimed to take enough costs out of the project for it to be on or close to budget. Although the quantity surveyor's November 2004 report indicated there may still be a significant cost overrun, the Corporation's management considered that the value engineering process was starting to take effect. This view was effectively supported by subsequent reports from the quantity surveyor, which showed a significantly improved position, although still with a level of cost overrun. It was thought that this would be eliminated by the time the project was complete.

5.87
The independent review referred to in paragraph 5.42 noted areas where the Corporation could have performed better, particularly around identifying the cost overruns earlier and the way the project was reported on, both by its external advisors and internally.

Non-financial information

5.88
We reviewed monthly management reports produced by the Special Programmes and National Property Improvement teams for June 2005 against source data. We did not find any discrepancies between Special Programmes team, National Property Improvement team, Asset Services Group, and Corporation reporting of non-financial information to the Board and Ministers.

Under-performance of the Auckland Modernisation programme

5.89
The contractor specifically referred to attempts to cover up the under-performance of the Auckland Modernisation programme. The contractor alleged that the targets were reallocated to hide the under-performance in Auckland , as internal reporting on the Modernisation programme is not detailed by area.

5.90
The Corporation sets national targets annually, with regional targets sitting underneath these. National targets are contained in the Corporation's accountability documents, and performance is reported to Parliament in the Corporation's Annual Reports, while regional targets are internal to the Corporation. The Corporation is therefore able to shift targets between regions if it becomes apparent that targets will not be met in a region.

5.91
We were told that difficulties in the Auckland region during 2005 stemmed primarily from skills shortages in the building industry, and that the Corporation's Modernisation work is not work that would be considered "glamorous" within the building industry. Consequently, in the context of a tight labour market, it was very difficult at the time to obtain skilled tradespeople for the work.

5.92
However, we wanted to know whether the Board was aware of any under-performance of the Auckland Modernisation programme. We therefore discussed the allegation with the Corporation's Internal Audit Project Manager. He told us that the regional issue had been raised with the Board's Assurance Committee as part of the Group Internal Audit Report in April 2005. We have seen a copy of this report.

5.93
The Internal Audit Project Manager also told us that it was made clear to the Assurance Committee that the Auckland Modernisation programme was behind target, that this was primarily because of resource availability in the region, and that a contingency plan was in place to shift some of the programme to areas with spare capacity. Our external auditor, who attends Assurance Committee meetings, confirmed this account of the discussion.

5.94
No one other than the contractor recalled that the contractor had arranged a meeting to address his specific "audit queries". Corporation staff also denied cancelling any such meeting to avoid addressing the issues. Without evidence to support either position, it is not possible for us to form a view on this allegation.

Our view of the allegations

5.95
We do not consider that either the appropriate budget or actual expenditure figures were consistently disclosed in management reporting of the Greenstone Gardens project. On completion, the project costs were compared to the revised forecast for management reporting purposes. In our view, the revised forecast figure was not the only appropriate budget figure to include in management reporting, and was almost certain to show a nil or minimal variance from the actual figure.

5.96
Further, because they specifically related to that project, it was not appropriate to exclude certain costs from the disclosed actual cost when it was known that such costs had been accrued. We accept that the Greenstone Gardens project fell within the wider Modernisation programme and was not a separately funded programme. However, the decision was made internally to separately disclose information in respect of it, and that information should have been as accurate as possible.

5.97
We consider that a suitably qualified accounting resource may have helped address the issues raised in the independent review of the Greenstone Gardens project by identifying cost overruns and by providing an improved project cost reporting framework.

5.98
Other than the comments noted above for the Greenstone Gardens project, based on our discussions and review of the financial and non-financial information contained within the monthly management reports, we did not find any evidence of deliberate manipulation of the information reported to management.

5.99
We also did not find any evidence to support the allegation that there were attempts to cover up the under-performance of the Auckland Modernisation programme. The decision to shift modernisation work to areas where there was spare capacity was transparent. In addition, the Board was aware of the situation, because it was mentioned as part of the April 2005 Internal Audit report to the Assurance Committee.

5.100
When it became apparent that the Modernisation programme for Auckland would not meet its targets for the 2004-05 financial year, the Corporation decided to make up the shortfall in other areas. In other regions, the Corporation brought forward modernisations that were planned to be completed in early 2006, and completed them in 2005. These actions were entirely reasonable in the context of the Corporation's current approach to regional targets and regional reporting.

Verification of invoices under the Property Maintenance Assessment System contract

5.101
The contractor alleged that invoices for property inspections were being paid without appropriate checking of the validity of the invoice. Further, he alleged that amounts paid for property inspections exceeded the contracted amount (and gave the example of invoice payments of $5 million when the contracted amount was $3 million).

5.102
All of the Corporation's tenanted properties are inspected each year to ascertain their condition. The property inspections are outsourced to a private sector provider under the Property Maintenance Assessment System (PMAS) contract. This service provider completes a report for each property inspection and provides it to the Corporation. The report is then entered into Rentel.

5.103
Invoices under the PMAS contract are subject to the same authorisation process as any other invoice for payment at the Corporation, with invoices checked for accuracy and signed off only by managers with delegated authority.

5.104
The monthly PMAS invoices received by the Corporation between January and May 2005 showed the number of inspections and futile visits (a visit where the inspector was unable to access the property) for each region or suburb. We reviewed these invoices.

5.105
We were told that the Contract Manager checks each invoice for accuracy, then prepares a payment voucher and forwards it to the Special Programmes Manager (or other manager) for authorisation. Each invoice was accompanied by a payment voucher that was signed as being authorised.

5.106
The Corporation mentioned additional controls, including that the service provider is required to submit an annual plan that forecasts their monthly inspection schedule, and that the service provider reports on progress against the monthly forecast. The National Property Inspection team performs a twice-yearly quality assurance that involves a random selection of PMAS invoices. The quality assurance staff visit the properties to check that the inspections had been carried out and their quality. We consider these controls to be sufficient.

5.107
The new PMAS contract, effective from 1 November 2005 to 31 October 2008, has an additional control. It requires invoices to include:

unit reference;
street address;
suburb;
types of work completed;
quantity;
rate; and
total.

5.108
The PMAS contract does not contain an overall maximum cost that may be charged under it each year. However, charges under this contract are based on a set cost for each inspection or futile visit depending on the location of the property, and this provides a control. There is, in effect, a natural upper limit for inspections (and therefore costs) each year. PMAS expenditure was about $1.5 million in the 2004-05 financial year, which is broadly in line with cost expectations.²

5.109
We obtained details of all payments made to the service provider during the 2003-04 and 2004-05 financial years from the Corporation's accounting records. The service provider supplies other services to the Corporation as well as the PMAS inspections. It is possible that the contractor was not aware of the extent of other services provided, and that this caused confusion about the amounts payable for the PMAS inspections.

Our view of the allegation

5.110
Based on the work we have undertaken, it seems unlikely that overall payments for inspections could significantly exceed contracted amounts. Further, as noted in paragraph 5.108, actual PMAS expenditure was in line with forecast expenditure in 2004-05.

5.111
We note that the Corporation has improved its system for checking payments for inspections. We do not have a view on the efficacy of the new system.

Robustness of accruals within National Property Improvement team programmes

5.112
The contractor raised concerns about the robustness of the accruals process for the CGH and Modernisation programmes. In particular, he told us that he was instructed by the Special Programmes Manager not to record any accruals for the CGH programme. The contractor believed that this manipulated the results for this programme, as not all expenditure would be recorded in the correct period.

CGH programme accruals

5.113
The team the contractor was part of, the Special Programmes team (see Figure 1), provides specialist assistance for certain aspects of the CGH programme, such as the initial modification of properties. However, the overall CGH programme is part of the Housing Innovations group.

5.114
While the Rentel system automatically calculates the accruals needed at month and year end, there are times when a manual accrual may also be needed (see paragraph 5.118). We understand that a Contract Manager within the Special Programmes team was responsible for preparing month-end accruals relating specifically to the specialist services that the team provided. The Contract Manager told us that the contractor was given the job of ensuring that these accruals were completed. The contractor told us that, although CGH accruals were "part of his brief", he was instructed by the Special Programmes Manager not to record any accruals for the CGH programme. The Special Programmes Manager did not recall this instruction, but confirmed that all other CGH accruals were the responsibility of the CGH programme team.

5.115
For the 2004-05 financial year, the Corporation told us that accruals of about $750,000 were made for the CGH programme. These included accruals of about $220,000 for minor capital work (relating to the initial modification of properties) derived from Rentel that were the responsibility of the Special Programmes team. The remainder of the CGH accruals were made by staff outside the Special Programmes team. We did not see any need to review the accuracy of these accruals.

Modernisation programme accruals

5.116
The contractor did not provide us with any specific examples of his concerns about accruals for the Modernisation programme. However, we understand that his concern relates to the allegations about the manipulation of results through the transfer of costs between periods and programmes (see paragraphs 5.24-5.66).

5.117
We discussed accruals for the Modernisation programme in some detail with the Wellington-based Finance team. At the end of the 2004-05 financial year, the Finance team queried 3 accrual journal entries (in addition to those specified in other sections of this report) prepared by the contractor for the Modernisation programme. These 3 accrual journal entries might have given rise to the contractor's concerns about the Modernisation programme.

5.118
The first of the journal entries related to an adjustment to the automatic accruals calculated by Rentel. The system allows each job to be set up with start and completion dates and the contracted cost, and then automatically generates an accrual at the end of each month based on how complete - by percentage - the job is. These accruals will not be accurate if either the start or the completion dates of the job are incorrect. When this happens, a manual journal entry should be raised to correct the accrual.

5.119
At the end of the 2004-05 financial year, the contractor completed an analysis of the Modernisation programme accrual, and asked that the system-generated accrual be reduced by about $2.6 million. Later, the Finance team reviewed these calculations, and identified errors in the spreadsheet prepared by the contractor. The Finance team has since established that the correct adjustment to the Rentel-generated accruals should have been $1.4 million rather than $2.6 million (an error of $1.2 million). The errors in the contractor's spreadsheet involved him using incorrect incomplete portions of jobs and using incorrect initial Rentel accrual figures. The result was that the reduction calculated by the contractor was for more than the original amount of the accruals.

5.120
The $1.2 million error (an under-accrual) was raised with the external auditor before the 2004-05 audit report was signed. The external auditor assessed the error, and determined that no adjustment to the Corporation's financial statements was needed. There was no effect on the Corporation's net surplus, and the error was not material in terms of the affected balance sheet items (property, plant, and equipment, and accruals). However, the external auditor asked for an adjustment to be made to the Statement of Service Performance.

5.121
Because of the under-accrual in the 2004-05 financial year, the Modernisation programme started off the 2005-06 financial year with a $1.2 million charge against its budget. The issue had been brought to the contractor's attention before his engagement with the Corporation ended, but had not been fully resolved at the time of his departure.

5.122
The second and third journal entries referred to in paragraph 5.117 were transfers of costs of $321,000 and $533,000 from the Modernisation programme into the Reconfigurations programme. These journal entries related to a group of properties that were incorrectly attached to the Modernisation programme instead of the Reconfigurations programme when they were set up in Rentel. The journal entries were posted by the Finance team at the request of the contractor, on the understanding that appropriate details would follow. The contractor did not provide to the Finance team any further details about the second transfer ($533,000).

5.123
This issue was not resolved until long after the contractor left the Corporation, taking some 9 months. The outcome was that the reclassification of costs was overstated by $491,000 because:

the 2 journal entries contained transfers relating to the same properties, and there was some duplication; and
the journal entries incorporated costs that did not relate only to the 2004-05 financial year.

Our view of the allegation

5.124
Regardless of whether the contractor was told not to process CGH accruals and the context of any such comment (if it was made), there was an accrual for the CGH programme automatically generated through Rentel that was the responsibility of the Special Programmes team. However, it is important that:

a review of the accruals calculated through the Rentel system is undertaken at each reporting date, to determine whether any manual adjustments are needed to reflect the true position; and
jobs that have not yet been entered into Rentel are reviewed to determine whether any manual accruals are needed to reflect expenditure incurred. This is especially important given that there is a delay before some of these CGH-related expenses are entered into Rentel.

5.125
Based on the later actions of the Wellington-based Finance team, there were some inaccuracies in the accrual calculations for the Modernisation programme. The inaccuracies appear to have resulted, at least in part, from errors in the contractor's own calculations. The Special Programmes Manager told us that he did not have regular formal supervision meetings with the contractor, although they worked closely together on a daily basis. The Special Programmes Manager told us that he believed that the Wellington-based Finance team oversaw the contractor's accounting work.

5.126
We have 3 concerns:

We are aware that the Finance team is usually provided with the appropriate documentation for all journal entries. However, in some instances, such as with the pressure of getting entries through for the end of the financial year, journal entries have been processed without appropriate supporting documentation.
The National Property Improvement team has an annual budget of about $224 million, but has no dedicated qualified accountant to ensure that accounting within that team is appropriate. A suitably qualified accountant would also provide a more seamless information and communication flow through to the Wellington-based Finance team.
It was unclear who was responsible for the accuracy of the contractor's accounting work.

Recommendation 6
We recommend that the Wellington-based Finance team remind all business groups within Housing New Zealand Corporation what the requirements are for manual accrual journal entries, and that exceptions will not be made.

Recommendation 7
We recommend that Housing New Zealand Corporation employ suitably qualified accounting resources within the National Property Improvement team.

Recommendation 8
We recommend that Housing New Zealand Corporation clarify the ownership of, and management responsibility for, the programme accounting function within the National Property Improvement team.

Transfer of budget from the Modernisation programme

5.127
The contractor alleged that there was an unauthorised transfer out of the approved 2005-06 budget for the Modernisation programme of about $1 million, and that the transfer was not discussed with the Modernisation project manager.

5.128
From the work we undertook, we consider that this allegation refers to the under-accrual of $1.2 million discussed in paragraphs 5.119-5.121. The under-accrual meant that the Modernisation programme effectively started the financial year with $1.2 million costs already recorded against its total budget. We discussed this with the Modernisation project manager, who agreed that this is a plausible explanation for this issue.

Our view of the allegation

5.129
In our view, the alleged unauthorised transfer was the natural accounting consequence of the error in the accrual at the end of the 2004-05 financial year. Again, in our view, the matter might have been avoided if a suitably qualified accountant had been more directly involved.

1: Greenstone Gardens , at 45 Albert Street , Otahuhu, is a modernisation project. It is managed separately to the rest of the Modernisation programme because of the size of the project.

2: Based on about 66,000 properties that should be inspected each year.

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