Select Committee on Public Accounts Eleventh Report

Chapter 2: Support to Parliament—Financial Audit


  2.1  The primary objective of the National Audit Office's financial audit is to provide independent assurance, information and advice to Parliament on the proper accounting and use of public resources. In addition to reporting the results of this work to Parliament, the Office also aims to assist audited bodies to improve their financial management.

  2.2  The National Audit Office's financial audit contributes to these objectives in three ways:

    —  by providing Parliament with reasonable assurance that the financial statements are presented truly and fairly, have been prepared in accordance with relevant accounting and other requirements and are in accordance with the authorities which govern them;

    —  by identifying, assessing and examining risks to propriety and financial control in central Government bodies and reporting on significant weaknesses to Parliament; and

    —  by giving audited bodies constructive advice that will help them improve their corporate governance, financial management, control and reporting.

  2.3  The National Audit Office conducts its financial audit work in accordance with the Statements of Auditing Standards issued by the Auditing Practices Board. In the central Government sector these Auditing Standards are supplemented by a Practice Note, prepared in close consultation with the National Audit Office, designed to help ensure the consistent application of Auditing Standards across the central Government sector.


  2.4  The National Audit Office examines and certifies the accounts of Government departments and a wide range of public corporations, agencies and other public bodies. In 2001-02 the National Audit Office audited expenditure and revenue, which together totalled around £650 billion, and assets of much greater value. In addition the National Audit Office enjoys access rights to information held by a range of bodies helping to deliver public services on behalf of the bodies it audits. These include:

    —  Health Service bodies (almost 600);

    —  Further Education institutions (over 400 colleges);

    —  Higher Education institutions (over 130 universities and colleges of higher education); and

    —  Several thousand other miscellaneous bodies, including private contractors and grant recipients. For example the Office is able to inspect the accounts of EDS in relation to its contract with the Inland Revenue for the provision of IT services.

  The National Audit Office exercises these inspection rights to provide assurance to Parliament on propriety and regularity as well as providing advice to these bodies on accounting, corporate governance and audit matters.

  2.5  The current workload of accounts audited varies widely in type, size and complexity. The Office is responsible for the annual audit of some 550 financial accounts. These include departmental resource accounts, Executive Agency accounts, National Loans Fund accounts, as well as the accounts of funds and bodies established by statute or Royal Charter such as the National Insurance Fund and the Medical Research Council.

  2.6  The portfolio of accounts audited changes from year to year as new bodies are established by Parliament, or in response to machinery of government changes. Over the Plan period, the National Audit Office will be devoting more resources to the successful implementation of whole of government accounts, and will be taking over a number of audits of non-departmental public bodies following the Government's acceptance of Lord Sharman's Report "Holding to Account, The Review of Audit and Accountability for Central Government".


  2.7  The Comptroller and Auditor General contracts out some of his financial audit work to major accountancy firms. The aims are to help the National Audit Office manage the overall financial audit workload, which peaks after the 31 March year end adopted by central Government, and to help the Office benchmark costs and quality. Where work is subcontracted, it is still subject to quality assurance checks by the Office before the Comptroller and Auditor General provides his audit opinion on the financial statements.

  2.8  The proportion of subcontracted financial audit work was around 13 per cent in 2001-02. Over the Plan period , the Comptroller and Auditor General aims to extend the use of contractors to meet the target of 25 per cent recommended in Lord Sharman's report.


  2.9  Where the National Audit Office carries out the financial audit, it plans and organises the work so that the Comptroller and Auditor General can express an opinion on the accounts in the most cost-effective manner. The Office keeps its methodology under continual review and compares it with best practice through involvement with the standard setting bodies in the profession, contact with the leading accounting firms and, as noted above, by subcontracting audits to the private sector.

  2.10  The National Audit Office uses a number of techniques to support its certification audit, including assessments of the overall control environment, the review and testing of accounting and IT systems, and methodologies such as predictive analytical procedures and the direct testing of individual transactions. Although not all techniques are used on every audit, each audit requires some substantive procedures. Where individual transactions are checked, samples of transactions are normally selected statistically and weighted towards high value items.

  2.11  In 1999 the National Audit Office introduced changes to its audit approach to keep it at the forefront of financial audit methodology, drawing on the latest thinking and developments in risk based audit. The methodology starts from a top-down analysis of business risk in each of the Office's audit clients. It then considers these risks in the context of the body's financial statements, identifies the management controls which address those risks and tests their effectiveness. Detailed audit testing can then be focused on those areas where reliance on controls would not provide the necessary assurance.

  2.12  The approach, known as "Audit 21", has led to more efficient audits which add more value to clients. The Office, in conjunction with a private sector partner, has also developed a new financial audit support software package based on the Audit 21 approach. This package, known as "Team 21" was trialled on the audit of 2000-01 accounts and introduced office-wide for the audit of 2001-02 accounts.

  2.13  The financial audit work of the National Audit Office is not restricted solely to the certification of financial statements. A programme of periodic reviews of audited bodies' activities is undertaken to identify areas where there are potentially significant risks of irregularity, impropriety or failures in financial control. Using the techniques employed to support its certification audit, the Office obtains sufficient, appropriate evidence to draw conclusions on the existence and significance of the risks identified. The National Audit Office's work also encompasses a review of each body's Statement on Internal Control for compliance with requirements and investigation of any information which is misleading or inconsistent with that disclosed elsewhere in the financial statements.

  2.14  The Comptroller and Auditor General has a statutory responsibility to examine systems for the assessment, collection and allocation of revenue, in addition to his financial audit of the revenue accounts. This is a complex area of work involving the evaluation of systems—including major IT systems—designed by the revenue departments to manage the risks associated with revenue identification and collection, which are somewhat different from those associated with expenditure programmes.

  2.15  The National Audit Office support Parliamentary scrutiny of revenue by producing an annual report on the results of this financial audit work. The most recent report drew attention to the level of fraud from smuggling and evasion on Customs and Excise duties, which suggested that there was more work to be done to ensure that the department's controls are fully adequate to secure an effective check on this revenue. Tax revenue is expected to increase in value over the Plan period to match government expenditure and the National Audit Office will need to continue to devote significant resources to this important aspect of government activity in support of Parliament's scrutiny of this area.


  2.16  The National Audit Office actively contributes to the development of new professional guidance. The demands on the Office are increasing. Significant current projects include:

    —  assisting the Auditing Practices Board to develop guidance on corporate governance for public sector auditors;

    —  contributing to the development of British Standards for information systems management which will have a beneficial impact on the reliability of IT operations in both public and private sectors;

    —  participating in an Accounting Standards Board working group developing a public sector version of its Statement of Principles for Financial Reporting;

    —  membership of a Chartered Institute of Public Finance and Accountancy working group on the implementation of the new pensions accounting standard (FRS 17) in the public sector; and

    —  participating in an Institute of Chartered Accountants in England and Wales' working group on developing guidance for accountants reporting on grant claims in the public sector.

  2.17  The National Audit Office is also represented on the following bodies, some of which deal with value for money matters as well as financial audit:

    —  Financial Reporting Council. The Comptroller and Auditor General is an observer at the Council and a member of the Financial Reporting Review Panel.

    —  The Public Audit Forum. The Comptroller and Auditor General, together with the heads of the other national audit agencies, make up the Forum. Current projects include the relationship between auditors and inspectors and obtaining management value from accruals accounts.

    —  Institute of Chartered Accountants in England and Wales. A National Audit Office Director is on the Financial Reporting Committee, and a member of staff serves on its Council. A number of other members of staff contribute to various working groups or committees.

    —  Chartered Institute of Public Finance and Accountancy. An Assistant Auditor General is a member of the Council and is on the Technical Committee and another chairs its Central Government Panel. Other members of staff participate on its other professional panels and committees.

    —  Association of Chartered Certified Accountants. A member of staff is on the Public Sector Technical Issues Committee.

    —  Auditing Practices Board. An Assistant Auditor General is a member of the Public Sector Committee.

    —  Financial Reporting Advisory Board to the Treasury. An Assistant Auditor General is a member of the Board.

    —  Accounting Standards Board's Public Sector and "Not-for-Profit" Committee. A Director is a member of the Committee.


Ensuring that Departments' resource accounts provide proper Parliamentary accountability

  2.18  The first stage in the introduction of resource accounting has been achieved, with the completion of three years of parallel running with appropriation accounts (1998-99 dry run; 1999-2000 and 2000-01 fully published resource accounts). The 2001-02 financial year is the first year of resource-based Supply and the first year in which resource accounts will provide accountability to Parliament in place of appropriation accounts. Departments are now subject to resource-based, as well as cash based, limits. The Office needs to provide assurance to Parliament that results are being presented fully in accordance with accounting standards. It also needs to be able to provide assurance that the details of expenditure compared with the Estimates are being fairly represented. This and the additional features of resource accounts set out below make the audit work much more demanding.

    —  Departmental assets and liabilities are recognised on Resource Account balance sheets. Auditors need to ensure that all assets and liabilities have been identified and properly accounted for.

    —  Resource Accounts provide Parliament with much more information on operating costs and revenues. As well as including analyses by type of expenditure and income, transactions are analysed by objective and by programme. These analyses, in separate financial statements, are supported by additional detail in notes to the account.

    —  Supplementary financial statements are required for some departments: for example pension fund statements for public sector pensions schemes need to be prepared and audited.

    —  Agency accounts are consolidated into their parent departments' Resource Accounts.

  2.19  Departments continued to improve the quality and timeliness of their resource accounts for 2000-01, compared with those for 1999-2000. Nevertheless, nine out of the 52 accounts for 2000-01 received a qualified audit opinion, and 21 accounts were presented for audit after the statutory deadline of 30 November. Much, therefore, remains to be done by some departments to achieve unqualified accounts and timely rendition for audit. The consequences for the Office's financial audit are that additional assistance, examination and testing over and above what would be required to express an opinion on soundly based accounts, continue to be required to overcome the accounting—and in some cases, staffing—deficiencies.


  2.20  The Public Interest Disclosure Act 1998 came into force on 2 July 1999, and provides a right to redress in the event of unfair dismissal or other sanction for individuals ("whistleblowers") who make disclosures relating to malpractice in the workplace. The Act aims to encourage responsible disclosures and encourages internal disclosures in the first instance. However, where an individual reasonably believes they would be victimised or there would be a cover up, the Act provides for them to make protected disclosures externally to prescribed persons.

  2.21  The Comptroller and Auditor General is a prescribed person under the Public Interest Disclosure Act 1998 for receiving disclosures of matters in the public interest from employees of any organisation. He is prescribed only for disclosures that concern the proper conduct of public business, fraud and corruption in relation to the provision of centrally-funded public services. The Act does not require the Comptroller and Auditor General to investigate allegations, but in view of his audit and reporting duties, he follows up relevant allegations.

  2.22  The National Audit Office has set up a dedicated telephone line, publicised on its website, to receive disclosures, and may also receive allegations in the course of its work. As public awareness of the Act increases, so has the number of allegations received by the Office, which are now running in the order of 50 a year.

  2.23  The disclosures to date have included references to tendering procedures, the contractual status of consultants, performance-related pay, the misuse of funds, and overseas travel. In practice, the majority of allegations warrant further investigation, although to date no instances of fraud or mismanagement have been confirmed. This does not mean that effort is wasted, however, since National Audit Office investigations have led to a strengthening of controls at audited bodies.


  2.24  The adoption of the "Turnbull" report on Internal Control by the central Government sector for 2001-02 accounts, and the Cabinet Office's Modernising Government Agenda Action Plan have led to a greater awareness of the benefits of sound risk management and internal control systems within central Government bodies. The National Audit Office is contributing to this process through sector wide initiatives under the auspices of the Auditing Practices Board, the Public Audit Forum and a joint Treasury/Cabinet Office working group on risk management. It is also contributing through its audit work on internal controls and management systems and the examination of bodies' Statements on Internal Control. For example, many clients are strengthening Audit Committees, in which the National Audit Office is playing a major role.


  2.25  The National Audit Office's clients continue to make more use of IT to prepare their accounts and to support electronic service delivery. From a financial audit standpoint, the key requirements are that adequate controls are built into departments' systems and that there is evidence that the controls have operated effectively. The Office's commitment to work with clients was reflected in its contribution to the Public Audit Forum report on electronic service delivery, which has helped to highlight the importance of shared standards and certification schemes to ensure continuity of control. Over the Plan period, the Office will continue to contribute to the maintenance of existing standards and promote the development of new standards where gaps are found.

  2.26  The National Audit Office has made extensive use of computer assisted audit techniques for a number of years, and also uses the Internet and its own corporate intranet to harvest and manage information. The Office is currently piloting a mobile computing project, which enables staff to access this and other information when they are away from the Office, thereby improving efficiency. The Office aims to extend mobile computing to all financial audit staff over the Plan period.


  2.27  The Treasury aim to produce an audited set of whole of government accounts for the whole of the public sector for 2005-06 with "dry-runs" for the two preceding years. There is a phased approach with dry run accounts for central government for 2001-02 and 2002-03 and fully audited and published central Government accounts for 2003-04. The National Audit Office has a key role to play in preparing for and eventually auditing the central government and whole of government accounts. Work is underway on the first dry run audit of the central Government account, through direct contact with Departments, their agencies and non-departmental public bodies, and through liaison with the auditors of other bodies to be included within the account.

  2.28  The National Audit Office is also continuing with its substantial input into the range of complex accounting issues that have to be addressed to enable a whole of government account to be put together. These include the disclosure of tax revenue on an accruals basis, for example to show amounts due from taxpayers, rather than on a cash basis, accounting for social security benefits, the accounting treatment of debt and reserves, and the definitions of the bodies which will be included in the account.

Efficiency improvements

  2.29  Efficiency improvements in the way the National Audit Office carries out financial audit will arise from the application of the new computerised financial audit documentation package (Team 21). The Office will need however, to continue to invest appropriate levels of resources both into the computer hardware necessary to support the IT and in the training of staff using Team 21.


  2.30  The table below shows the average cost of auditing accounts compared with the targets set. The Office has successfully controlled its costs over time, keeping them within or below targets and plans to continue to do so over the Plan period.

1.  Average costs of certifying accounts


Large, complex audits
Medium sized audits, of
average complexity
Small, non-complex audits

1.At 2002-03 prices in £000.
2.Examples of:Large, complex audits—National Insurance Fund, Highways Agency
Medium-sized, average complexity audits—Arts Council England, QEII Conference Centre
Small, non-complex audits—Parole Board, Police Complaints Authority

Quality and timeliness

  2.31  The time taken from the end of a financial year to the production of a certified account depends upon Government accounting conventions; statutory dates for the signing of accounts; and departments' ability to produce an accurate account for audit. Notwithstanding a slight improvement in the timing of the presentation of accounts in 1998-99, the overall trend since the mid-1990s has been a decline in the number of accounts being presented for audit on time. The standard of preparation of some accounts passed to the Office for audit has also been poor. Departments have attributed such difficulties to the need to concentrate on introducing resource accounts, together with a lack of sufficiently qualified staff. Inevitably this increases the amount of audit time that has to be spent on such accounts. The ending of the requirement for appropriation accounts from 2001-02 may help departments to submit their resource accounts on a more timely basis in future years.


  2.32  The National Audit Office's certification audit work is fundamental in securing high quality central Government financial reporting and to assure Parliament that public resources have been used in the way intended. Departments also benefit from the knowledge that reliance can be placed on their financial statements. The "deterrent effect" of audit should also not be underestimated: rigorous independent scrutiny by the National Audit Office, reinforced by the effect of the hearings of the Committee of Public Accounts, is a major incentive for management to abide by the principles of good corporate conduct, propriety and regularity.

  2.33  There are also financial and other benefits arising from certification work. The National Audit Office draws management's attention to any scope for improvement in accounting and financial control systems arising from the audit. If important issues arise, or if the audit uncovers irregularities or improprieties, matters can be reported to the Committee of Public Accounts in separate Reports or Memoranda.

  2.34  The National Audit Office analyses and measures the impact of its work and records results in terms of the number and type of significant changes it stimulates. In 2001 departments made over 1,000 significant changes to their systems. Departments also achieved savings in excess of £75 million in 2001 as a result of the Office's financial audit work. For example:

  The Maritime and Coastguard Agency undertook a review of the charges it makes for the provision of statutory services to ensure compliance with HM Treasury principles on full cost recovery, and invited the National Audit Office to review its fees model in respect of charges for ship surveys and seafarers' examinations and certificates. The Agency implemented a number of improvements recommended by the Office relating to long-term planning, the reliability of information on the use of staff time, and monitoring recovery rates.

  The Highways Agency is empowered to enter into contracts for road development where the primary beneficiary is a developer but where there is also a public benefit, such as a road to a new supermarket. The developer deposits the total cost of the project in advance and the Agency's managing agents draw down funds to pay contractors as the project proceeds. The National Audit Office found a number of cases where the Agency had paid out more money than developers had deposited. Some £10.5 million has so far been recovered.

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Prepared 7 November 2002