Memorandum by KPMG (AC 23)
PRINCIPAL ISSUE
OF CONCERN
TO KPMG: SUSTAINABILITY
OF THE
PROVISION OF
SKILLED PUBLIC
SECTOR ACCOUNTANTS
AND ADVISORS
Government is being challenged to deliver against the new
modernising agenda and must use all available good advice and
best practice. For example, in coping with the implementation
of resource accounting central government entities are finding
advice from external experts essential. The next stages of development
(eg public services to be available 24 hours a day seven days
a week, all dealings with government being deliverable electronically
by 2008[7])
will increase the need for sound advice and expertise delivered
by advisors who understand the public sector. Local government
must deal with new Best Value legislation and will look to the
private sector for cost-effective advice and for innovative service
solutions. The public sector needs a source of external expertise,
available on demand and constantly being regenerated. Larger firms
of auditors and consultants with a public sector specialism can
provide such a source of talented and well informed financial
advisors, available to support local government over the long
term.
Since its inception in 1983, the Audit Commission has used
its selected private sector firms for only one purpose: to drive
up the standard of external audit in the public sector. This aim
has been achieved and is to be applauded. But the Audit Commission
should not leave matters there. In our view, if the market currently
being operated by the Audit Commission continues as at present
then we fear it will stagnate and the supply of future financial
support to local government will diminish.
We observe that as experienced public sector auditors retire
or move on it is becoming ever more difficult to replace them.
We observe that the numbers of new trainees taking up a public
sector specialism is steadily reducing, with knock-on effects
in the supply of qualified and experienced staff. So far as we
can tell, this is principally because the dominant supplier (District
Audit) has been able to maximise its income by reducing its proportion
of student trainees and increasing its use of short term contract
employees, many on temporary working visas from overseas. It may
also be caused by a perception among potential recruits that the
major firms may be withdrawing from the market, two large firms
having taken this step recently. Small firms are being encouraged
to take the place of larger firms, but smaller firms are less
likely to be able to invest in recruitment and training for the
long term.
A reduction in the supply of new UK public sector audit specialists
will have serious potential long term disadvantages to the UK
public sector.
We ask the Sub-committee to consider whether the Audit Commission's
current market regime is as conducive as it could be in the long
term to a healthy economy in public sector finance specialists.
THE ROLE
OF THE
COMMISSION AND
ITS AUDITORS
IN VFM STUDIES
AND BEST
VALUE INSPECTIONS
VFM studies
As the Audit Commission has itself recognised, the time
has come for the local application of national VFM studies to
be reconsidered. For example, the study-implement-audit concept,
introduced a year or two ago but not as yet fully developed, provides
a useful platform for increasing local authorities' own participation
in applying the study findings in a timely manner, an approach
likely to be particularly valuable to authorities under the new
Best Value regime.
Best Value inspections
We believe the new Inspectorate should look to audit
firms for support, principally by appropriate secondments of audit
staff to take part in inspection teams. We believe audit specialists
have much to offer, as has been demonstrated by the inspection
pilots run by the Audit Commission using, among others, auditors
on short term secondments. The experience of KPMG staff taking
part in these pilots has been that their skills were very valuable
to the pilot inspection teams: more so, in many cases, than those
of service specialists seconded in from local authorities. This,
in our view, is because an experienced public sector auditor has
been trained to give an independent view based on objective observation
and detailed analysis without any predetermined opinions, skills
which a local government service specialists (through no fault
of their own) will not necessarily have been able to acquire.
Best Value Performance Plan audits
We are principally concerned with the role of the Audit
Commission and its auditors in carrying out the new audits on
Best Value Performance Plans ("BVPPs") as required by
the Local Government Act 1999. This function is being explored
and defined by the Audit Commission in conjunction with its suppliers,
and we welcome the Commission's open consultative approach.
Our only comment is that BVPP auditing increases the need
for experienced public sector auditors and, as noted above, our
observations are that the market in such invaluable people is
in danger of drying up.
VIEWS ON
THE AUDIT
COMMISSION'S
USE OF
THE MIXED
MARKET AND
MARKET TESTING
A mixed market?
In our view the Audit Commission does not operate a genuinely
mixed market. Too high a proportion of audits (75 per cent. by
number) is allocated to the Audit Commission's in-house agency
District Audit ("DA"). This leaves insufficient scope
for private suppliers to compete fairly against DA, to increase
the volume of audit work they derive from the Audit Commission
and thereby find economies of scale sufficient to justify continued
investment in maintaining quality by recruitment, career development
and training. Two large firms with a smaller share of the market
than ourselves (Ernst & Young and Arthur Andersen) have left
the market because the costs of investment were too high. A middle-sized
firm (Pannell Kerr Forster) has been brought in and others may
be interested. Our firm continues to keep the possibility of resignation
under annual review.
We understand that the main reasons for allocating a very
large proportion of the work to DA are:
— maximising Audit Commission income (a higher proportion
of the audit fee is retained by the Audit Commission on DA jobs);
— ensuring the most sensitive assignments (eg, Hackney,
Liverpool) are directly under Audit Commission control;
— a reluctance to disturb the status quo. Around
75 per cent of local authority audits were being handled by government
audit agencies at the time the Audit Commission was set up, in
1982. The Commission centralised this 75 per cent under DA and
rationalised the 25 per cent held by many private firms down to
a group of nine (now six) private suppliers.
In our opinion, DA's proportion should be reduced to 50 per
cent over time.
For the avoidance of doubt, we note below the reasons why
the Audit Commission must have an in-house agency supplier:
— to guarantee a willing supplier for the remote
assignments, in North Wales for example, or Cornwall;
— to enable the Audit Commission to maximise its
income.
Now that the scale of the Audit Commission's role and its
potential income have been increased, it can move to address the
monopolistic position of DA more easily than in the past.
Market testing?
The Audit Commission has put significant tranches of
work out to market test every year since 1994. We believe this
was done principally to show that the Commission subjects itself
(and its suppliers) to the same competitive tendering regime as
its audited bodies in local government. As has been shown by the
results, it has served no other useful purpose. Fees have not
decreased and other firms have not entered the market. The entry
of Pannell Kerr Forster last year was under special apprenticeship
arrangements, to compensate for the loss of E&Y and AA.
A market test costs any competing supplier who does not win
a great deal of time and money, funds which will not then be available
for investment in delivery and training. The effort of competing
is disproportionate to a supplier's share of the market. DA, with
75 per cent of the market, is able to spread the costs more effectively
than a firm with an average of six per cent.
There are no new assignments, and so work put out to market
test will have been taken from an existing supplier, who will
thereupon be compelled to bid for their own work. Audit Commission
work pays very low fees compared to private sector work but is
steady. A supplier willing to continue with this work on the grounds
that at least it does not demand high costs of competition will
be deterred by a market testing programme superimposed on the
regime.
The last round of market testing consisted of NHS Trusts
which were not willing participants. This resulted in all of them
voting for the status quo, which the Commission accepted. Auditors,
including DA, therefore incurred considerable cost to retain their
own audited bodies.
FEE LEVELS
We understand the restrictions on fee increases in the public
sector and welcome such adjustments to the regime as the Commission
is able to make.
Ultimately, if any firm can not make a return sufficient
to justify staying in this market it will exit from it. Smaller
firms may take the place of larger firms. Local government will
lose the benefit of audit and advice from larger firms which have
access to a wider and deeper range of intellectual resource and
experience.
We have made detailed representations to the Audit Commission
on fees, both on our own account and through the mechanism of
the Auditors Group, so we will not repeat them here. If the Sub-committee
would like to consider the matter in detail we can provide further
information.
APPOINTMENT ARRANGEMENTS
The Sub-committee will wish to consider whether the time
has come to allow certain authorities to select their own auditors,
from a shortlist approved by the Audit Commission. Beacon authorities,
for example, which are to be given many other degrees of freedom,
would be likely to welcome this opportunity.
In 2001, and in response to mandatory EC requirements, the
Audit Commission intends to require all private sector suppliers
to take part in a re-bidding of their entire portfolios of audit
appointments, in order to set up a wholly new "framework"
contract with private sector suppliers. DA appointments, being
in-house, are not affected. From the private sector firms' perspective
this is unfair and represents another major competitive disadvantage.
It will incur costs which will be wasted, in that they will not
provide any direct benefit to local authorities, and it is bound
to give rise to upheaval in the market despite the Commission's
declared intention to minimise any such disruption. We ask the
Sub-committee to direct the Commission to consider whether this
framework bid can be avoided, or the impact of it further reduced.
If the framework bid is to take place it should be extended
to DA with a view to reducing its share of the market.
GUIDANCE ON
THE CONDUCT
OF AUDITS
The Audit Commission has recently reconsidered the level
and nature of guidance it issues, and has announced an intention
to concentrate on the principles and issues, and on timeliness.
We welcome this intention.
BENEFITS TO
LOCAL AUTHORITIES
Local authorities receive the benefits of:
— an independent audit service;
— meeting or exceeding current standards of best
practice;
— a very low fee compared to the private sector;
— comparable fees across England and Wales irrespective
of the remoteness of location of the audited body;
— audit activities, scoped by the Code, which can
not be cut back or avoided.
But there are some disadvantages for the audited bodies:
— any non-audit work that might be seen as a potential
conflict of interest is banned;
— the local application of some national VFM studies
may not be useful.
An audited body may have good reason to wish to use its audit
firm to carry out non-audit work. Typically, it will be because
that firm already knows the authority well or happens to be able
to provide the best current expertise in the matter under review.
No firm may take on any such work if it is a potential conflict
of interest—this is banned by professional and ethical standards.
But work which the Commission considers may look like a conflict
of interest will be banned and the authority must find a supplier
elsewhere. This arrangement reduces the firms' abilities to add
value at lowest cost.
Frequently, a useful national study will have only limited
current relevance locally at any given authority. Until recently,
the Audit Commission's regime tended to compel auditors to apply
each national study at every authority but, recently, more flexibility
has been introduced. We are now able to substitute a more useful
local study, and we welcome this change. As noted above, we invite
the Sub-committee to consider whether further flexibilities could
be introduced to the local application of national VFM studies.
THE CODE
OF AUDIT
PRACTICE
The Code of Audit Practice is a statutory document setting
out how the Audit Commission requires an audit to be conducted.
As suppliers we are always consulted fully on any amendment to
the Code. We are happy with the way the Audit Commission approaches
the task of maintenance of the Code. There are some matters in
the current draft Code we would like to see changed, and we have
made representations to the Commission on these points through
the existing mechanisms of the Auditors Group.
ACCOUNTABILITY OF
THE AUDIT
COMMISSION
We consider the Audit Commission maintains a skilful balance
between compulsory and voluntary accountability, and we think
the existing compulsory accountability is sufficient. In our view
the Audit Commission's current appointment regime will tend to
drive out the larger firms. Smaller firms may be willing to take
their place but may not be able to sustain the necessary investment.
In the long run, we believe the quality of audit service can only
be maintained at its current high level if the Commission recognises
and supports the real cost of delivery and investment by operating
a more mixed market, and substantially reduces DA's proportion.
In our view a substantial increase in the extent and scope
of the Audit Commission's responsibilities, could endanger the
integrity of the existing audit regime. But we expect the Commission
to continue to do all it can to minimise this risk, and we do
not see a tightening up of accountability as adding protection
for the audit regime.
7 Cabinet Office white paper Modernising Government
published March 1999. Back
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