CONTEMPORARY ISSUES IN ACCOUNTING AND AUDITING

Presentation to Australian Health Services Financial Management Association

By Wayne Cameron
Auditor-General of Victoria

26 May 2004

In preparing this presentation, I asked myself what changes had taken place since the last conference:

• The spectre of new accounting standards looms ever closer (despite the FRC hiccup).

• The financial viability of the health sector continues to remain an issue – in spite of a number of interventions by government.

• Audit performance appears to be on the improve – based on recent survey results.

• The Minister of Finance has issued new Directions which, among other things require

• audit committees to take a greater role

• compliance framework sign-offs.

• My recent release of a performance audit report titled Managing emergency demand in public hospitals (May 2004).

• Governance oversight of health authorities has become more centralised – following last year’s health review.

Today, I will outline:

• The results from the previous year’s round of public hospital financial audits (i.e. timeliness, financial statement quality and common audit issues identified). - all of which was reported in my November 2003 Report on Public Sector Agencies – Results of special reviews and 30 June 2003 financial statement audits.

• Current accounting and auditing issues being considered by my Office.

• Recent accounting developments as a result of international accounting standard harmonisation, whole-of-government and health sector initiatives.

• Revised audit arrangements (i.e. the Audit Act and audit service provider relationships).

• Key areas that my Office will focus on in the 2004 round of public hospital audits: both at the individual hospital and across the health sector levels.

• Recent reports and better practice guides from my Office that will be of interest to you all.

Results of 2003 financial audits – timeliness

The timeliness of public hospital financial statement completion has significantly improved on last year. Seventy per cent were finalised in 12 weeks, compared with 35 per cent in the prior year.

The key factors contributing to the improvement included:

• the Department of Human Services introducing a process to monitor progress by agencies

• a more stable accounting policy environment and earlier resolution of accounting and disclosure issues.

Major reasons for certain agencies not meeting the deadline included delays in:

• finalising the revaluation of non-current assets

• resolving issues associated with the ongoing financial viability of certain hospitals.

Hence, the value of our Office ensuring that:

• public hospital and ambulance annual reporting guidelines are appropriate prior to circulation to health sector finance managers

• across-the-board accounting issues for asset valuation and contributed capital transfers are resolved promptly

• any DHS undertaking of financial support (needs to be in writing) is provided to hospitals in a timely manner.

Early reporting could be achieved if hospital management re-engineer financial statement preparation by:

• working collaboratively with the financial audit team to a fixed timetable

• March 2004 quarter health check on key reconciliations and request internal audit to review prior to June 2004

• follow-up key account reconciliations in May with rollover to June 30

• ensure all accounting issues are resolved prior to June 30

• understand and note the potential IFRS impacts on public hospital financial statements

• involve audit and risk management committee in managing the competing demands on year-end activity, e.g. do you really need to prepare July accounts?

Quality of financial reporting improved

Reduced number of accounting standard and DTF requirement changes, assisted in generally improved financial statements provided to audit.

There is still a need to understand that there should be no differences between the audited financial statements and the published/printed annual report. There was a marked improvement from the 2002 year, however, there were still numerous typographic errors identified by DHS financial management staff.

This year, a smaller percentage of health sector annual reports contained errors such as:

• printing problems - duplicate notes or pages

• audit report alteration

• figures changed from certified accounts

• figures not adding up!

The information placed on hospital websites also needs improvement. The errors included:

• use of the normal audit opinion instead of the website opinion (in accordance with auditing standards)

• blurred/unreadable audit opinions

• director’s declarations omitted.

In 2004, audit will ask to check printer’s proofs and hospital website updates as part of the audit process. We will include the results of our work in this area in our reports back to the audit committee.

Audit qualifications - 30 June 2003

Clear audit opinions were issued on the financial statements of 103 agencies in the health sector for 30 June 2003.

The financial statements of 7 agencies were subject to audit qualifications for:

• failure to consolidate controlled entity financial statements

• non-compliance with AAS 15: Grant revenue received in advance

• Non-compliance with AASB 1041 requirement for the annual re-assessment of asset fair values.

IFRS changes indicate that the AAS 15 grants received in advance will be accounted for on the “matching” basis from 1 July 2005 onwards.

2003 common audit issues

A key responsibility of the management of each agency is to establish and maintain a sound control environment and an adequate system of internal controls to ensure that:

• the agency’s financial records and other information completely and accurately reflect its activities

• its assets are safeguarded

• irregularities are prevented, detected and corrected, should they occur.

The 2002-03 financial audit process affirmed that the overall control environments established in agencies in this sector, and associated systems of internal control examined by audit, were generally satisfactory.

Some areas for further improvement were:

• governance framework (in particular the experience of audit committees, business risk and fraud risk management mechanisms)

• financial management and monitoring of financial recovery plans, performance outcomes and specific accounting procedures

• reconciliation and monitoring of financial accounting systems and activities &

• accounts payable and payroll master file information

These issues were outlined in my November 2003 Report on Public Sector Agencies – Results of special reviews and 30 June 2003 financial statement audits, and reports at agency level, however, they were not widespread across the sector.

Accounting and auditing issues

Revaluation of non-current assets

• Requirement for revaluation every 3 years – assessment for intervening period as to whether significant price movement or impairment.

• “Found” assets are gains, not revaluations – include in period result, not as change in equity.

• Fair value methodology – should be consistent with Valuer-General fair value basis and recommended indices – extent of revaluation should be reviewed for reasonableness (reports should be tested, not merely accepted).

In prior years, significant issues noted by my Office, in this area, were:

• failure by some to revalue regularly

• incorrect treatment of assets not previously recognised

• no condition assessments

• methodology used to revalue not reliable

• an annual valuation (desk to indicative) is required to check if any material change to the land and buildings carrying value - required by DTF Bulletin – effectively, this is an annual check for asset value impairment.

• land and buildings are distinctly separate classes of asset

• other areas: inadequate documentation of valuation policies, inadequate reconciliation of asset revaluation reserve by asset class, and independent valuation reports not reviewed by management.

Contributed capital

• Health sector agencies can only deem items as contributed capital where specifically designated by the Minister for Health through the appropriation process.

• Appropriations for “Additions to Net Assets” – generally applied to capital projects at public hospitals, but can be also be an equity injection.

Grant revenue

• Present criteria for recognition of revenue is based on “control” – AAS 15 requires consideration of reciprocity.

• Covered by DHS Accounting Circular (no deferral permitted for 2004 year).

• Will change with adoption of IFRSs – reference will then be made to application of funding terms and conditions.

Controlled entities

• Under the 2003 revisions to the Audit Act, the Victorian Auditor-General audits all controlled entities of the state rather than 100 per cent-owned entities of the state. This may be a contentious issue given that many of the foundations that are not consolidated in the Mercy, Cohuna and Queen Elizabeth health services do not consider that they are controlled entities of the hospital.

• Changes to the Audit Act 1994: The Auditor-General to audit “controlled” entities, but not necessarily be appointed Corporations Act 2001 auditor – may be 2 audits conducted.

• Implication may be a review of the application of AAS 24 “control” criteria – with foundations, main/sole determinant may be receipt of financial benefits.

Health Super

• Health Super was established under the Hospital Superannuation Act 1988. The fund’s liability (shortfall) at 30 June 2003 was $146 million, and was recognised in Department of Treasury and Finance financial statements.

• Standard note narrative included in DHS Financial Reporting Guidelines (Public Hospitals) for inclusion in financial statements.

Where payroll is outsourced

In the health sector, salary arrangements are quite complex and varied … and have led to many system and calculation issues in the past. Our Office will be reviewing the payroll area in more depth this year because it is a major health sector agency expense, and that it is largely outsourced.

It is important that agencies:

• project manage system upgrades and transition

• ensure that any service level agreement with the payroll service provider has “internal control” and “completeness and accuracy” audit clauses

• the service level agreement is to provide for letters of comfort to auditor in line with AGS 1042

• ensure that staff are trained to use the systems correctly.

Audit issues and recent report

Financial viability of public hospitals at 30 June 2003

Fifteen hospitals - mainly metro (9 in 2002) - facing financial difficulties across all 4 indicators:

• operating result prior to extraordinaries

• operating result prior to extraordinaries and capital funds

• net cash from operating

• positive working capital position

A further 22 hospitals (15 in 2002) with unfavourable results in at least 2 of these areas.

Key matters noted:

• Real reason for the deterioration is a mix of funding model deficiencies, depreciation funding allocation and hospital cost-efficiency across the public hospital sector. This needs to be explored further.

• One-off funding doesn’t always help. Despite DHS cash injections, our review found that the overall operating deficit (excluding capital income) increased from $161 million to $317 million, and the net cash flow position changed from a positive $10 million inflow to a $58 million outflow as at 30 June 2003.

• We acknowledge DHS’ initiatives last year to address public hospital financial sustainability concerns, however, these haven’t worked. My Office will review the effectiveness of the current suite of DHS initiatives and individual hospital financial recovery plan progress as part of this year’s review – to be tabled in early December 2004.

Financial position – financial audit implications

• Where DHS letters of financial support are required, the standard format will apply. It is essential for early analysis of likely operating result by hospital boards and management. Where this letter is required, please ensure appropriate note narrative to the financial statements.

• In cases where there have been cash advances, we need to consider whether they will be converted to equity by DHS – and ensure the appropriate accounting treatment in hospital financial statements.

Financial standing review

• DHS provision of additional funding to public hospitals may alleviate/eliminate concern with ongoing operating deficits (recent state Budget refers to $335 million additional funding commitments to hospital sustainability and demand management strategy). This is an area that we will be reviewing as part of our assessment of financial standing of hospitals in our December 2004 report to parliament.

• My Office will also be reviewing progress by each hospital against any financial recovery plan and consider the effectiveness of initiatives undertaken by DHS to enable a sustainable healthcare service.

Recent accounting developments

IFRS harmonisation process

• The Financial Reporting Council (FRC) has reinforced the requirement that all reporting entities are to prepare financial reports (in periods on or after 1 January 2005).

• The AASB has committed to the progressive release of harmonised accounting standards – which are due for completion and release on the AASB website by 30 June 2004.

• The Department of Treasury and Finance (Victoria) working party is looking at application to public sector agencies, including health, education, water, insurance etc. All our auditors and clients have been receiving IFRS updates from my Office through newsletters.

IFRS impacts

• Impact for 30 June 2004: Note narrative as to how agency is managing transition and explanation of likely key differences in accounting policies that are expected to arise.

• Future - 30 June 2005: Financial impacts in note – then – 20 June 2006: IFRS financial statements include comparatives.

Likely key implications for public sector agencies:

• income recognition (regarding grants with/without conditions)

• financial instruments (fair value measurement)

• intangibles (recognition and de-recognition)

• asset impairment (more rigorous and prescriptive)

• employee benefits (recognition of defined benefit scheme excess/deficit)

• asset revaluation (class vs. individual asset, revolves on whether “for-profit” or “not-for profit”)

• residual values (need to review each year).

Complexities – accounting for income tax, employee benefits, cash flows etc.

Public sector “trilogy” being reviewed - dealing with matters relating to application of AAS 27, AAS 29 and AAS 31 including grant (revenue) recognition (also, multi-year grants), found (physical) assets.

Implementation strategies - review harmonised AASBs to understand the key changes in accounting policies required. Undertake a “gap” analysis, make necessary changes to systems and procedures, conduct training programs, board and committees to take ownership of process.

Public sector developments

My Office will be monitoring the progress of the following developments that impact on the sector.

Financial Management Compliance Framework

• Minister for Finance Directions for better public sector management practices have been enhanced.

• Framework (annual compliance certification) permits monitoring of progress by departments and agencies.

• 2004 is a transition year, but we encourage instances of less than full compliance to be kept at a minimum going forward

Health sector

Common charts of accounts

• Overall purpose is to ensure financial information is comparable for monitoring and benchmarking.

• All metropolitan and 5 major rural hospitals are required to report under new chart of accounts from 1 July 2004.

Pricing review

• Detailed analysis of cost drivers at public hospitals conducted by DHS.

• Will result in changes to current and future funding arrangements for the public hospitals.

• My Office will review the outcomes.

Governance reform

• The recommendations by the minister’s governance review group are being implemented, including enhancing board accountability mechanisms, reducing the level of compliance costs and enhancing DHS’ micro-management of the public hospitals.

Revised audit arrangements

Improved audit relationship with audit service providers and health sector agencies

Over the past year, my Office has changed its method of working with audit service providers (ASPs), so as to treat them as an extension of the Office audit team and also sector-based audit teams.

Key changes include:

• Auditor-General representative sign-off on high-risk financial audit strategies, management letter finalisation, involved in up-front accounting and audit issue resolution, early review of draft financial statements and attendance at health sector entity audit committee meetings

• greater discussion of issues at the planning stage and during the audit process

• health sector audit forums with ASPs to enable a cohesive approach to audits

• Audit Focus on Health newsletter for CFOs and auditors to be provided in June 2004.

My Office’s new approach to the audit of 2003 financial statements resulted in quicker turnaround time on accounts – from 1 to 2 weeks to 1 to 2 days, in most cases.

Changes to the Audit Act (effective July 2003)

Key relevant points in the revised Audit Act:

• Increased signing delegations - the Audit Act was changed in July 2003 to allow delegated signing to ASPs where the total expenditure was less than $5 million. Previously, the criteria was net assets of less than $1 million. Changes to the Audit Act have allowed the delegation of signing of financial statements to ASPs in more cases, thereby speeding up the signing process.

• Controlled entities now subject to my audit - whereas in the past if they didn’t meet the definition of an “authority” they did not fall within my purview. Please notify my Office if you have entities caught by this change.

• Power to audit grants - in kind as well as in cash.

• Public/client request for audits extended to other non-financial audit matters that are of public interest.

Key areas of audit focus in 2004

Financial viability monitoring

As highlighted earlier, hospital viability will be monitored to ascertain the effectiveness of the initiatives currently in place at the DHS and hospital level.

Land and building valuations

Land and building valuations will be closely monitored to ensure an appropriate valuation basis and compliance with AASB 1041.

DHS annual reporting guidelines for the public hospital and ambulance sectors

Minimal change in annual reporting format (except for IFRS implication note) but the whole-of-government reporting deadline is tighter this year.

Whole-of-government reporting for 2003-04

• Deadline for Annual Financial Statements (Report) for the state brought forward from late October to late September (reduced by 4 weeks).

• Impact on material entities - reporting brought in by a week to 20 August 2004, for agencies to provide information feeding into the AFR and financial statements contained in the AFR.

• Material entities – Austin, Bayside, Eastern, Melbourne, Southern, Women’s and Children’s, Western, and Department of Human Services.

• Necessary to bring forward as much auditing pre year-end – key account reconciliations, analytical review, issue resolution, form and content of accounts etc.

• Post year-end, only left with check of reported figures for consistency with conclusions already reached.

Certain across-the-board reviews are also being considered across the health sector.

Audit committee effectiveness

Key matters to be considered: Is the audit committee:

• membership appropriate, do they have appropriate experience?

• reporting directly to the board /departmental secretary?

• role adequate in internal financial reporting, and risk assessment and management?

• relationship with internal audit and external auditors effective?

• run in accord with an approved and published charter?

• regularly meeting?

Fraud prevention and reporting 

Employee fraud is on the rise! We are seeing more evidence of this in the public sector in recent years.

There is a need to develop fraud prevention and detection strategies, and management and reporting framework, including appropriate treatments plans to minimise the risk of fraudulent activity.

Fraud prevention includes:

• development of a code of conduct

• whistleblower procedures

• staff training in the above processes.

Recent experience and anecdotal evidence from CEOs indicates the above processes are more fruitful where senior management “walk the talk”.

Risk management framework

• Section 44 of the Financial Management Act - requirement to have a risk management framework in place.

• We will assess whether there is an effective organisation-wide risk management framework implementation during the course of our review. A 2002 performance audit report prepared by our Office provided a good practice guide, which could be used in the health sector – which may be worthwhile taking a look at. We will be issuing a good practice guide within the next week or 2, in any case.

Recent reports

My Office has undertaken several recent performance audits in the public health sector:

A major performance audit report on Managing emergency demand in public hospitals was tabled today in parliament. We found that Victorian public hospitals have adopted effective approaches to respond to continuing high demand for emergency care and inpatient beds. These strategies address the underlying issues of system capacity constraints, and the need to divert and contain demand through better management of patients with chronic conditions. Improvements are still needed, however, in the clinical supervision of waiting room patients after triage, and in responding to the clinical risks of the large numbers of patients who leave before being seen by a doctor.

The control procedures over emergency department management systems need improvement in a number of areas:

• weaknesses in the security access over emergency department systems

• the lack of IT disaster recovery planning for 3 of the hospitals reviewed

• more formalised approach to managing changes to emergency department management software, errors or bugs is required

• improvements to both system validation procedures and patient management system integration would allow better capture of data upon entry. These would increase the quality of the data.

My Office’s review of the Austin/Mercy hospital redevelopment progress found:

• it was generally well-managed (in terms of time, budget, governance and risk management)

• however, there is a risk of shortfalls for the refurbishment of existing facilities and deferred refurbishment works for ambulatory care, clinical support services and clinical facilities.

My Office’s website contains all my reports tabled in parliament, including topics dealing with:

• mental health

• dental health

• medical equipment management

• IT security

• performance indicators

• risk management.

Good practice guides

The website also contains all good practice guides that we have issued, such as:

• Chief Finance Officer – Role and responsibilities

• Managing risk across the public sector

• Managing IT security

• Internal reporting practices

The CFO good practice guide, issued November 2003, contains a good practices check list that highlights:

Requisite skills and qualifications

• CFO is tertiary qualified and a member of an appropriate professional body.

• The required skills, qualifications and experience, roles and responsibilities are clearly defined and documented.

Annual and periodic reporting/monitoring

• Approve and endorse all financial reports (and are based on a sound system of internal control and risk management) provided to senior management, board and external to the organisation.

• Have direct access to the audit committee.

• Regularly review cash forecasts against actuals and interim financial reports prior to release.

• Ratify internal control procedures.

Compliance responsibilities

• Review all financial reports for completeness, accuracy and reliability in line with the FMA and accounting standard.

• Maintain and manage the chart of accounts.

Strategic and developmental

• Ensure that the finance management team and structure has clearly defined roles and responsibilities to support sound financial management.

• Regularly review and address financial management system developments.

• Review training and education needs for the financial management team..

• Be involved in the KPI development.

Looking forward

• Assist program managers to develop an effective financial approach in delivering expected outcomes.

• Provide a comprehensive service to program managers.

• Create and support performance management systems that link qualitative and quantitative KPIs to the organisation’s outcomes.