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Speech to the Hawkes Bay Accountants AGM.

18 October 2002
Speech Notes

Speech to the Hawkes Bay Accountants AGM.

Today I want to talk about the government’s policy on economic growth, and how the accountancy profession can contribute to it. You may think that accountants measure economic activity rather than drive it – unless of course the glass towers funded by consultancy fees are regarded as a driver of growth.

The government puts a lot of store, and a high priority, on lifting New Zealand’s sustainable growth rate. In number terms, we have talked about moving to a four percent per annum sustainable growth track, and through that of eventually moving back into the top half of the OECD in terms of per capita living standards.

If we look at the New Zealand of today, our standards of living are vastly higher than they were fifty years ago. It doesn’t matter what indicator you use: life expectancy; years spent in education; cars per head of population; proportion of income spent outside of the necessities of life, like on recreation; the purchasing power of the state pension; per capita spending on health or whatever.

The problem is that even though our absolute standard of living has been steadily rising, our relative standard of living has been slipping: other countries, and in our case especially Australia, have been improving their material living standards at a faster rate.

If this continues, the income structure that the better performing economies can sustain opens up a gap on our own. People, and especially the skilled and employable, move away seeking to improve their lot. As they locate in the higher income centres, business follows them: that is where best market and profit opportunity resides. We end up with a negative cycle: labour and capital relocating in the better performing economies, further driving that better performance and widening the relative income gap.

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Of course we need to avoid the doomsaying aspect of this. People will not only live here, but will seek to come here, because it is a great place to live. Not only is it still a developed high-income country in the broader global scheme of things, but New Zealand has many non-tangible quality of life aspects that both retain and attract its citizenry.

The problem is that society builds expectations around what other people have: in things like access to health services, and about what constitutes a decent level of consumption of goods and services. If growth does not enable those expectations to be met, the result is an internal squabble over bigger bits of the inadequate pie. So we must grow.

The government’s growth and economic framework explicitly works off a recognition that economic growth does not simply happen. It has to be nurtured. While the government does not deliver economic growth, it both makes a contribution to growth and fosters and facilitates growth by coordinating and supporting the actions of private sector players.

I am not going to describe the whole framework, but want to give some overview of it. We get to a higher growth plane by lifting the quantity and quality of our labour force, by increasing the capital stock, and by improving productivity.

Productivity will improve if we lift our game in four key areas: skills, new investment, improved infrastructure and broader export opportunities.

It will improve further if we do two things well: strengthen the foundations of a modern economy and work on our natural advantages and aptitudes. The framework identifies three areas where this competitive advantage needs to be developed: biotechnology, communications and information technologies and the creative industries. Those sectors have attracted a lot of attention. We should, however, also pay attention to strengthening the foundations.

The foundations of a strong economy lie in things like clearly defined property rights, fair laws, efficient legal processes that are free of corruption, solid public finances, sound money and the like. But the government alone does not construct or maintain those foundations.

In recent months we have become painfully aware that dubious accounting standards and practices can be used by corporations with weak ethics to rock the foundations of even the biggest and richest of economies. And here is where the accountancy profession contributes to the growth and innovation framework: by making sure that its contribution strengthens the foundations of our commercial sector.

It used to be that accounting was considered boring and I’m sure many of you wish it still was. But when you see a cartoon of Osama Bin Laden saying, “Forget terrorism – I’m taking up accounting” then you know something is wrong!

All this interest has been brought about not just by Enron and WorldCom but by a plethora of corporate reporting scandals accompanying massive write downs of share values on the United States Stock Exchange.

Those two events are not unrelated. It is easy with hindsight to see that many share prices on Wall Street were overvalued. A part of this was due to the motivation corporate leaders had to maintain high prices, not just because the continued success of their businesses depended on it, but also because of the obscene increases in personal wealth available to them through stock options.

A key tool in keeping share prices high was the manipulation of financial reporting, sometimes by keeping just inside the rule based accounting standards imposed in the United States, sometimes by flagrantly breaching those standards, aided by complicit and conflicted advisors.

It would be foolish to say that this could never happen in New Zealand. But I doubt very much that we are facing similar problems to the US. Share options are not a significant element of employees’ remuneration in New Zealand – and so the motivation to deceive is not so high as it has been in the United States. And there is little to suggest that there is an asset bubble in New Zealand’s stock exchange.

But I am less concerned with motivation than I am with the opportunity to present accounts that mislead and with whether we have adequate safeguards to ensure deceit and complicity cannot take root in New Zealand financial reporting.

In answering that question, the accounting profession immediately comes under the spotlight. Standard setters, auditors, practitioners. Currently all of these groups face significant challenges. Let me mention some of them.

On the standard setting side New Zealand has an enviable international reputation for such a small country. It was one of the five countries, along with the United States, United Kingdom, Canada and Australia that made up the membership of the G4+1, a pre-eminent accounting international standards setting group. And New Zealand is now one of only nine countries that are recognised as partner accounting standard setters to the IASB.

Much of that recognition is due to New Zealand being a leader in setting sector neutral standards, standards that apply both to the public sector and the private sector, and our willingness to be a world leader in tackling issues such as valuation of infrastructure assets and accounting for social policy obligations.

The government complies with these sector neutral standards. It is sometimes uncomfortable to submit to independently approved GAAP – for example I am forced to recognise in the Crown’s accounts the effect of interest rate changes on the Crown’s obligations for the future costs of the Government Superannuation Fund and Accident Corporation.

While it is fair to recognise the Crown’s financial position changes as the time value of money changes, this is unhelpful in setting fiscal policy in the short term and so we have devised the OBERAC (Operating Balance before Revaluations and Accounting Changes) to ensure sensible fiscal policy targets,.

As an aside, it is interesting to note the IASB is currently addressing this issue in a private sector setting, and may come up with a similar solution to our own by breaking down comprehensive income into its constituent parts.

But, despite my occasional discomfort, the government’s financial statements continue to be prepared according to a sector-neutral set of accounting standards.

The challenge for standard setters is to continue to develop relevant accounting standards applicable to both sectors in a time when the demand of major corporates is simply to follow international accounting standards. This demand has been given greater urgency by the decisions recently announced in Australia to move to international accounting standards by 2005.

For our financial markets to operate well. New Zealand cannot stand alone. Our financial reporting standards must be the same quality as Australia and the rest of the world.

Standard setters therefore have a critical challenge in seeking to reconcile the interests of global markets with the good work achieved on sector-neutral standards and I am keenly interested in their success in achieving such a reconciliation. I am after all, not an unaffected party.

The other key challenge for standard setters is to produce useful reporting standards for entities that are small to medium enterprises that will help them grow into medium and large enterprises.

Must a firm change accountants from a provincial firm to a big four firm if it wants to move from the minor leagues to the major leagues? Must the accounting go straight from a kitchen-table basic set of tax accounts to a multi-page, almost incomprehensibly detailed set of internationally ordained disclosures?

This government is actively interested in seeing higher New Zealand growth paths and I would like to see the accounting profession actively consider how the transition from a small to a large business can be facilitated.

That brings me to auditors and the challenges they face. It seems to me that auditing in the future may be quite different to auditing in the past. It will no longer be a loss leader for consultancy business; it may no longer be the training ground for accountants generally as it becomes more of a specialist area in itself, and it will need to develop better processes to provide assurance of auditor independence. This means independent minds auditing as much as independent institutional structures operating.

The government will be very interested in the response your Institute’s “Corporate Transparency” discussion document generates in its suggestions regarding auditing. The Minister of Commerce is consulting with interested parties, including the Securities Commission, the Accounting Standards Review Board, the Stock Exchange and the Institute of Chartered Accountants. The Ministry is also considering a proposal from the Securities Commission to expand their oversight of financial reporting practice activity.

And finally that brings me to practitioners. The motto of the chartered accountants institute is “expertise and integrity”. To live up to that promise, practising accountants must understand and be able to apply high quality standards in the preparation of financial reports. This is likely to be a significant challenge as you go through the transition to international harmonisation, while staying relevant to the challenges of accounting for small and medium enterprises and the public sector in New Zealand.

I want to put on record what I see as the expectation of the New Zealand community, to whom I am ultimately accountable – its expectations of New Zealand’s accountants.

They expect you to work unceasingly to ensure that high quality financial reporting practices are met at all times, that accountants must meet the highest levels of ethical behaviour, and that accountants should continually review their practices to ensure they are effectively responding to the challenges of the day.

The government has the responsibility to ensure adequate safeguards are in place for the investor community. And if you are to ward off and render unnecessary an excessive level of Government intervention and response, you will see to it that your practices of self-regulation and self-discipline are effective and appropriate to the concerns of the times.

This is a very important issue and if we get the balance right, then the changes will be made that are necessary without going overboard, and without introducing undue compliance costs.

So at a time where we have every reason to be very confident about New Zealand’s economic future, we all have a responsibility to respond to current issues facing our financial reporting regimes.

Thank you.

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