Report 16: 2019-20

Audit Results Report – Annual 2018-19 Financial Audits of Local Government Entities

Specific financial reporting issues arising from 2018-19 audits

Financial reporting of non-current assets

Quality of valuation documentation

For the 66 entities that we audited for the first time in 2018-19, we reviewed opening balances, as required by Australian Auditing Standards. As part of our review, we considered the reliability of re-valuations of infrastructure and of property that occurred in 2017-18 (the comparative reported amounts). Several of these asset balances had experienced significant increases or decreases in 2017-18.

We experienced some difficulty in obtaining explanations for these large differences in value. We expected that valuers’ reports and internal records would have clearly documented the main reasons for such large changes in value. In several instances, management and our audit teams concluded that the large changes were because the previous valuations, generally performed between 2013 and 2015, were less robust. We were able to confirm that most of the assets revalued in 2018 and 2019 were now reported at amounts that materially represented fair value. However, some required adjustments which were made during the audit process, (refer to page 24).

Inconsistent valuation methods

As reported in our Report 15: March 2019, our 2017-18 financial audits noted that a variety of valuation methodologies were used for property and infrastructure in the WA local government sector. We continue to have concerns about the inconsistencies of valuation methods.

Different valuers are applying different interpretations of some principles of the Australian Accounting Standards, in particular those relating to restricted use assets, resulting in significant differences in values across entities. This impacts comparability of the assets of local governments. Both the Australian Accounting Standards Board (AASB) and the International Public Sector Accounting Standards Board (IPSASB) currently have projects under way relating to fair value of public sector assets.

Most entities revalued these assets in 2017 or 2018 and, in accordance with LG Financial Management Regulation 17A(4), their next valuations are not imminent. It is therefore anticipated that the accounting standards boards will by then provide guidance that could be consistently and efficiently applied when these assets next require a valuation.

Recommendations

  1. Entities should ensure that reports from their valuers clearly explain key aspects of the valuations, and that management has a comprehensive understanding of the reports.
  2. Entities and DLGSC should monitor the progress of the AASB and IPSASB public sector fair value projects relating to the valuation of assets.

Significant changes in estimated useful lives of assets, and associated depreciation rates

At some entities, we noted significant changes in the amount of depreciation expense recognised in 2019 compared to 2018. To confirm the validity of the mostly lower depreciation, we made further audit inquiries. We established that the entities’ valuers had, while performing the 5-yearly re-valuations, recommended revised remaining useful lives for the assets. After further consideration, we were able to confirm that the estimates were reasonable and that depreciation expense for 2019 was appropriate.

However, as depreciation expense is dependent on the estimated useful life of assets, it is of concern that:

  • in most instances, there was no evidence that management had assessed the remaining useful life of assets over the intervening period since the last valuation. AASB 116 – Property, Plant and Equipment states ‘the useful life of an asset shall be reviewed at least at each financial year-end’. If the useful lives of assets had been reviewed by management annually as required by AASB 116, the large one-off adjustments to depreciation expense that we observed in 2019, could have been avoided at those entities.
  • a depreciable asset has to be depreciated over its useful life. AASB 116 defines useful life as ‘the period over which an asset is expected to be available for use by an entity’. It is therefore essential that entity management considers whether the valuer’s estimate of useful life matches management’s expectation of how long the asset will be used by the entity. There was however no evidence that management had discussed the valuers’ useful life estimates or taken into account management’s expectation of how long the entity expected to continue using the assets.

Recommendation

Management should annually review the estimated useful lives of assets used for calculating depreciation, if necessary in consultation with their valuers or other experts.
In addition, for greater consistency across entities, DLGSC should review its guidance regarding potential ranges for useful lives of assets, and entities should consider the guidance when doing their annual reviews.

Expensing assets with a value at acquisition under $5,000

Regulation 17A(5) of the LG Financial Management Regulations required, with effect from 2018-19, assets with a value below $5,000 at the time of acquisition, to be excluded from the assets reported in the financial report. This is consistent with the State sector and also reduces financial administration costs. These assets will instead be reported as an expense in the Statement of Comprehensive Income in the year of acquisition.

The vast majority of entities successfully implemented this change.

Accounting for bond monies

During the 2017-18 annual financial audits and the planning phase of the 2018-19 audits, we noted significant variation in the accounting treatment for bond moneys, such as work bonds, building bonds and hire bonds. This included:

  • Some entities held bond moneys in the Municipal Fund and therefore retained any interest income on those moneys.
  • A small number of entities held bond moneys in the Trust Fund and, in accordance with section 6.9(3)(a) of the LG Act, repaid interest together with the principal amount to the developer/hirer.
  • Some entities held bond moneys in the Trust Fund but retained any interest earnings as revenue of the entity.
  • Some entities held bond moneys in the Trust Fund, and in a non-interest bearing bank account.

Section 6.9(1) of the LG Act states:

A local government is to hold in the trust fund all money or the value of assets — 

  • that are required by this Act or any other written law to be credited to that fund; and
  • held by the local government in trust.

Section 6.9(3)(a) states:

Where money or other property is held in the trust fund, the local government is to —

  • in the case of money, pay it to the person entitled to it together with, if the money has been invested, any interest earned from that investment.

To help achieve an appropriate, consistent accounting approach, we carefully considered the matter and sought independent legal advice. We concluded that:

  • there are no provisions in the Act or any other written law that specify that work bonds, building bonds and hire bonds are to be credited to, or held in, the Trust Fund, and
  • unless agreements between developers/hirers and the local government entity require bond moneys to be held in the Trust Fund, they should not be held in the Trust Fund.

On 1 July 2019, we issued our local government position paper number 1 ‘Accounting for work bonds, building bonds and hire bonds’. While some entities were already appropriately accounting for these monies, the vast majority of other entities have now also followed this guidance. Apart from achieving consistent reporting, other outcomes included:

  • the monies are now held in the Municipal Fund and are therefore included in the Statement of Financial Position
  • entities that previously held the monies in non-interest bearing bank accounts, can now earn and retain interest on these monies for the benefit of the community
  • although our position paper mainly addressed bond monies, entities have also applied the principles of the position paper to more consistently identify whether other monies should continue to be held in the Trust Fund or in the Municipal Fund. Importantly, monies that are required to be held in the Trust Fund will continue to be subject to the additional provisions of relevant sections of the LG Act.

Recommendation

Entities who have not yet done so, should implement the recommendations of our local government position paper number 1 ‘Accounting for work bonds, building bonds and hire bonds’. This is available on our website.

 

Related party disclosures

Australian Accounting Standard AASB 124 – Related Party Disclosures requires not-for-profit public sector entities to disclose material transactions with related parties in the notes to the annual financial report. This is important to help identify known or unknown extraction of value from an entity, as well as potential bias in procurement, recruitment or other operational activities. The objective of the standard is to draw attention to the possibility that the financial position and profit or loss may have been affected by related party transactions, or by outstanding balances with related parties. Open disclosure of any related parties and related party transactions by councillors and other key management personnel (KMP) helps financial statement preparers and CEOs to report transparently.

Under AASB 124, related parties in a public sector context include councillors and other KMP of the reporting entity, their close family members, and entities controlled or jointly controlled by any of them.

Citizen transactions, where KMP or their close family members or their related entities are interacting with a public sector entity under the same terms and conditions as a public citizen, are not required to be disclosed. Examples include motor vehicle registration, rates, electricity or water charges.

To assist accounting staff and the CEO when preparing the annual financial report, entities generally require councillors and KMP to complete a declaration regarding their related parties and any related party transactions they may have had with the entity.

There is some overlap between the conflict of interest declarations made by councillors under the LG Act and the disclosures required for purposes of AASB 124. However, it was of significant concern that at 13 entities, related party declarations to address the requirements of AASB 124 were not made by some councillors and/or KMP. Three entities currently do not have a related party declarations policy in place and at some entities there were several councillors or KMP failing to complete declarations. Our annual financial audit process cannot identify all undeclared related parties or instances of payments to those parties. Therefore, it is important entities have strong frameworks in place with rigorous safeguards for disclosure of private interests and related parties in order to support and demonstrate probity in decision-making.

Recommendation

DLGSC should consider extending existing declaration processes to include annual related party declarations for councillors and key management personnel that assist compliance with AASB 124 and that are fit-for-purpose to the local government environment.

 

Quality of financial reports submitted for audit

The quality of financial reports submitted for audit varied significantly across entities, from good to very poor, including some that did not balance. Our audits also noted that various entities were often accounting differently for the same accounting transactions, balances or disclosures.

We identified numerous errors that were corrected by the entities during the audit process. In addition, 29 of the 106 entities had errors made in prior reporting periods that required correction in 2018-19. Some of these were identified by entity management while others were identified by our audit teams. These prior period errors included:

  • property assets not previously recognised
  • property assets incorrectly recognised as being controlled by the entity
  • asset valuations not correctly taken up in the financial report
  • asset valuations not comprehensive
  • entities’ share in Local Government House, which they had not previously recognised in their financial reports
  • entities’ investment in regional councils not consistently accounted for
  • share of joint ventures overstated.

In most entities a more robust quality review process needs to implemented to ensure that their financial reports are complete and accurate and the working papers adequately support the figures in their financial reports.

To ensure timely and accurate financial reports it is important that management in each reporting entity keeps proper accounts and records. Management should undertake various best practice initiatives throughout the financial year and after year end to improve the quality of their financial reporting.

At the beginning of the financial year, entities should confirm the accounting policies to be applied for the ensuing year.

Before year end, entities need to:

  • prepare a project plan of human and financial resources, assign responsibilities for tasks and set time frames for financial reporting
  • avoid receiving asset valuations late in the financial year or after year end and ensure that management reviews the valuations before they are included in the financial reports
  • identify and review changes to accounting standards and reporting requirements and confirm the approach to any changes with the auditors.

After year end:

  • analyse variations between actual and budget as well as previous year results to identify and correct omissions and/or errors
  • ensure the draft financial report has received an internal quality assurance review, preferably by internal audit or other suitably qualified professionals.

There is also an opportunity to improve the quality of financial reports and achieve greater reporting consistency across entities, through a helpdesk provided by DLGSC. This would be similar to the service provided by Department of Treasury to the State government sector.

Recommendations

  1. Local government entities should, where necessary, seek advice in advance of year end if uncertain about appropriate accounting treatments.
  2. To improve the quality of financial reports and achieve greater consistency across entities, DLGSC should consider providing an accounting advice helpdesk to the local government sector.

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