Why Undertake Statutory Audits?

The need for statutory performance and efficiency audits of producer boards stems from the use of legislation to establish the boards. In essence, Parliament has delegated specific powers to the boards so that they can provide services for farmers in a way which could not be done otherwise.1 For example, the enabling legislation for 5 of the 11 producer boards grants them single seller status for exports from New Zealand.2 It would not be possible to exclude other commercial organisations from exporting without such legislation.

The statutory requirement to undertake performance and efficiency audits is recent and is an integral part of the Government’s producer board reform measures. These reform measures, which are still to be fully enacted for most boards, are designed to:

  • give producer boards more financial autonomy and make them more responsible for their actions;
  • improve the performance of producer boards; and
  • make producer boards more accountable to farmers for their commercial performance and to Parliament for the exercise of their statutory powers. [In this article, references to farmers also cover growers and fishers.]

There are difficulties in meeting these objectives, particularly for the boards with single exporter status, in respect of:

  • how to assess the performance of a board given the absence of some of the normal competitive disciplines and market performance indicators; and
  • how to make a board accountable to farmers for its commercial performance.

Statutory performance and efficiency audits are intended to address these difficulties. They are a means of providing farmers - and others -with an independent assessment of how a board is performing. As such, they are a substitute for normal commercial performance measures and accountability to shareholders.

Independent assessments are needed to help protect the interests of stakeholders, especially farmers who ultimately bear the financial and commercial risks of the boards’ decisions. Farmers, individually and collectively, are not well placed to protect their interests, mainly because they do not have ready access to adequate market information.

Furthermore, there is a wider community interest in the performance of producer boards stemming from their use of statutory powers. By making aspects of the statutory audit public, these wider interests (such as taxpayers and industry organisations) are provided with an independent assessment of a board’s performance. This assessment is additional to the requirement for each producer board to account to Parliament (mainly through its annual report) for the way it has used its statutory powers.

In the absence of a statutory requirement, it is unlikely that a worthwhile independent assessment of a board’s performance would be possible. A board could commission an audit of its own performance without a statutory requirement. However, the obligation on the board to account to farmers and others for its performance would be less. There could also be greater concern about the independence of the audit if the statutory requirement did not apply.

Objectives of the audits

Against this background, statutory audits of producer boards, especially those involved in commercial trading activities, could be viewed as having two overall objectives:

  • to provide farmers and wider interests within the community with an independent assessment of the performance and efficiency of the boards; and
  • to provide farmers with greater confidence that processes and strategies are in place within the boards to maximise profitability.

These objectives have been formulated within the context provided by the existing legislative framework. The focus of the audits is on the performance and efficiency of the producer boards themselves - the statutory position and powers of the boards are not subject to audit. Any effect which these powers may be having on the efficiency of the New Zealand economy overall is beyond the scope of the audits.

Specifying an Appropriate Reference Point

A major insight from the Dairy Board audit was the need for an appropriate reference point - a "peg-in-the-ground" against which to assess the performance and efficiency of the Board. The Dairy Board Act does not specify the overall aim of the Board, only its functions and powers. These were judged as being inappropriate for assessment purposes, and the reference point adopted for the audit was the Board’s own mission statement.

Two aspects need to be resolved in selecting the reference point:

  • responsibility for specifying the reference point, especially whether it should be specified in the enabling legislation of the board; and
  • ensuring that the nominated reference point is appropriate for assessing a board’s performance and efficiency.

There are several arguments in favour of specifying the reference point in legislation. A board has been established by statute and given powers to do specified tasks which, presumably, Parliament has judged to be in the best interests of New Zealand. These tasks reflect the reasons for establishing the board; that is, the board’s purpose in life. It is this purpose which should be expressed as a goal in legislation. A board’s performance and efficiency can then be assessed with respect to how well it is achieving, or is placed to achieve, its goal. This goal may need to be changed from time to time to take account of, for example, changing market conditions or requirements of stakeholders.

Specifying the goal of a board in legislation would increase the independence of the audit in that the board (or its auditor) would not be setting its own performance target. It would also facilitate the audit process by making clear the target against which performance and efficiency is to be assessed. The specification of such goals would require legislative change in respect of most, if not all, producer boards.

The specified reference point also needs to be appropriate for assessing the performance and efficiency of a board - indeed, there would be little comfort in being judged as "good at doing the wrong things". Given the use of statutory powers, the goal of the board should not only be for the benefit of the industry it is to serve, but also for the overall benefit of New Zealand. For example, the goal of the Dairy Board should be consistent with the overall objective of maximising the net benefits of the dairy industry to New Zealand, in addition to any industry-specific objectives.

Control and Independence of the Audit Process

As already indicated, there are a number of people or stakeholders who have a legitimate interest in the performance of a producer board. In the case of the Dairy Board, for example, the stakeholders would include:

  • dairy farmers;
  • the Minister of Agriculture (on behalf of the Government, Parliament, and the wider community);
  • directors and staff of the Dairy Board;
  • dairy processing companies;
  • creditors;
  • the wider community (consumers, taxpayers, industry/community organisations); and
  • the auditors.

Any of these stakeholders could be given the responsibility for controlling the audit process. However, the choice has the potential to affect the success of the audit by influencing:

  • the independence and integrity of the audit;
  • the support for the audit;
  • the "ownership" of the audit findings and recommendations; and
  • the client relationships of the auditor.

The inherent conflicts between these factors are discussed below.

Responsibility for developing terms of reference

The terms of reference play a vital role in setting the scope of, and approach to, an audit. Who should be responsible for developing the terms of reference is therefore a major question. Responsibility could reside with, for example, farmers (or their representative organisations), the producer board itself, or the Minister of Agriculture.

For the audits of the Dairy Board, the Apple and Pear Marketing Board and, to a lesser extent, the Horticulture Export Authority, the boards have effectively been given overall responsibility for:

  • developing the terms of reference;
  • appointing the auditor;
  • controlling the audit process; and
  • paying for the audit.

However, each Board must consult with the Minister of Agriculture in the development of the terms of reference and with respect to prospective auditors. After this consultation, a board must obtain the approval of the industry for the proposed terms of reference and auditor, at which time the views of the Minister are to be made known to the industry. The adequacy of the procedures for gaining industry approval is discussed further below.

Giving the boards effective overall responsibility may cause concerns about the independence of the audit. From this perspective, it might be more appropriate for the Minister of Agriculture to have overall responsibility and for the government to bear the cost.

Auditor’s need for only one client

However, giving a Minister overall responsibility could lead to difficulties in defining the client of the auditor. In a normal commercial situation, the board subject to audit would be the auditor’s client - the relationship between the board and the auditor would be clear and unambiguous. Giving the board overall responsibility would be in line with commercial practice and is likely to be more acceptable to prospective auditors.

If the Minister of Agriculture had overall responsibility, an auditor could be subject to instruction from two sources of authority - the board being audited and the Minister. This could place the auditor in an untenable position and undermine the successful completion of an audit.

A further advantage arising from the board having overall responsibility is "ownership" of the audit process by those in a better position to take action to improve future performance. Relative to the situation of where an audit may be seen as being imposed by the Minister, this ownership is likely to result in:

  • greater support and cooperation from the board’s directors and staff for the audit during its conduct;
  • greater acceptance of the findings and recommendations of the audit; and
  • greater willingness to make changes based on the findings and recommendations in order to improve performance.

Role of the Minister of Agriculture

These advantages need to be balanced against the perceived greater independence and integrity of an audit if a Minister had overall responsibility. In this regard, however, some (perhaps most) of the benefits of greater independence and integrity can be captured by:

  • the involvement and influence of the Minister of Agriculture in the development of the terms of reference; and
  • the ability of the Minister of Agriculture to make the board being audited account publicly for the way in which it responds to the findings and recommendations of the audit.

Based on the experience of the Dairy Board audit, the Minister of Agriculture can be effective in influencing the terms of reference. For example, it was through the Minister’s involvement that the Board’s payment system was included in the terms of reference. The importance of ensuring that a board responds publicly to audit findings and recommendations, and the role of the Minister in this regard, is discussed below.

How the Boston Consulting Group went about its audit was a matter between it and its client, the Dairy Board. Having been involved in the development of the terms of reference, the Minister of Agriculture was not involved in the conduct of the audit. This allowed the Minister to respond independently to the audit findings and recommendations. Any involvement of the Minister in the conduct of an audit would run the risk of being seen by some parties as influencing the findings and recommendations.

Selection and approach of auditor

The independence and integrity of the audit will also be influenced by the auditor’s approach. The choice of auditor is therefore of the utmost importance. The board, the Minister of Agriculture, and the auditors all have an interest in ensuring that the audit is, and is perceived as being, independent and of the highest integrity. In particular, the auditor’s professional and commercial reputation depends on this being the case and constitutes a major check and balance within the audit process.

As already noted, the Minister of Agriculture must be consulted by a producer board on prospective auditors. However, despite the importance of selecting the best available auditor, the ability of the Minister to comment on the relative merits of different auditors is limited. The main benefit of consulting the Minister arises from the board having to justify its choice of auditor.

In summary, therefore, there is merit in the board being audited having overall responsibility for the terms of reference, selection of the auditor, and control of the audit process, subject to the above involvement of the Minister of Agriculture and the need to obtain industry approval. This appears to provide a reasonable balance between:

  • the need for the audit process to be independent and credible; and
  • the advantages of the auditor having a direct client relationship with only the board and greater ownership of the audit process and outcomes by that board.
Developing the Terms of Reference

Development of the terms of reference is, perhaps, the most critical phase in influencing the potential success of a performance and efficiency audit. It is during this phase that the "tone" of the audit is established. This arises because of the role of the terms of reference in:

  • specifying which activities of a board are to be evaluated; and
  • setting the context in which the board’s performance in carrying out those activities is to be assessed.

The process used to establish the terms of reference will also influence the attitude of people towards the audit.

Support must come from the top

A critical factor influencing the success of the Dairy Board audit was the positive approach of the Board. This was particularly marked during the development of the terms of reference. Rather than view the audit as a threat or nuisance, the Board repeatedly said it was taking the audit seriously and viewing it as an opportunity to identify ways to improve performance.

This positive approach reflected a strong commitment by the Board of Directors and senior executives to make the audit succeed. Had the support of either been lacking, it is likely that the support and cooperation of Board staff and dairy companies would have also been lacking. In this situation, the likelihood of a successful audit would have been greatly reduced.

The Minister of Agriculture also expressed strong support for the audit. This was conveyed directly to the Board and, through the Board, to dairy companies during the development of the terms of reference. Once again, had the Minister not demonstrated strong interest and support, it is very likely that the Dairy Board and others would have taken the audit less seriously.

Direct consultation with major stakeholders necessary

The board being audited needs to involve directly all major stakeholders. This will help ensure general support for an audit, and avoid potentially alienating some stakeholders. It is important that the stakeholders are involved early in the development of the terms of reference when attitudes are being formed. Such early involvement gives them the opportunity to influence the direction of the audit and helps ensure that their interests will be accommodated.

The Dairy Board and Apple and Pear Marketing Board each have a legislative requirement to gain the approval of their respective industries on the proposed terms of reference. This requirement does not apply to the Horticulture Export Authority. However, such a requirement does not necessarily ensure that farmers are provided with effective opportunities to influence the terms of reference. Indeed, in the case of the Dairy Board, the Dairy Board Act specifies that the Board is to obtain industry agreement from the dairy companies. Although most of these are farmer-owned cooperatives, the companies’ interests may not necessarily coincide with those of dairy farmers.

The consultative procedure specified or used could have the effect of alienating individual farmers, or their representative organisations, from having an input into the development of audit terms of reference. Given this potential, there may be a need to ensure that the legislative requirements provide the opportunity for farmers to be directly involved in developing the terms of reference.

Audits should be forward looking

The legislative requirements for the audits of the Dairy Board, the Apple and Pear Marketing Board, and the Horticulture Export Authority specify that the audits shall relate to the performance and efficiency of the Boards as at a nominated date, and their future prospective performance. However, the auditor may have regard to information related to the performance of a Board over the previous five years. This raises questions about the emphasis to place on past compared with future performance.

Since it is not possible to improve past performance, a strong argument can be made for a forward looking approach to be adopted and reflected by the terms of reference. This should help ensure that the audits do not become "witch hunt" exercises. The past should be used only as a means of identifying ways for improving future performance.

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Rural Affairs Coordinator
Sector Performance Policy
MAF Policy
Ministry of Agriculture and Forestry
PO Box 2526
Wellington
NEW ZEALAND

Phone: +64 4 894 0675
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