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Further supplementary memorandum from the Audit Commission (LAI37B)
Background
The Audit Commission submitted a memorandum of evidence to the
Select Committee in January and
We have subsequently been asked to produce a short note on the work of appointed auditors in relation to finance, as part of the regular Corporate Assessment of local authorities, to provide some context for what the Committee says in its report in relation to treasury management. Summary 1 Public audit is an essential element in the process of accountability for public money. The Audit Commission's appointed auditors' provide independent assurance on whether public money has been properly safeguarded and accounted for, and how well it has been used in the delivery of services. They are an important safeguard where taxpayers' money is raised by compulsory levy and the normal commercial disciplines of the market do not apply. 2 The focus of auditors' work is a local authority's annual accounts and the financial management systems and processes that underpin them. Their work is therefore essentially retrospective. 3 It is a fundamental principle that public auditors should be independent of those who are responsible for the stewardship and use of public money. The Audit Commission's primary statutory function is to appoint auditors on behalf of the taxpayer and preserve their independence. This is essential if taxpayers, on whose behalf public auditors work, are to trust auditors' judgements and conclusions. 4 Auditors cannot comment or advise on an authority's treasury management strategy or policies, as they may subsequently have to review the effects of their implementation. Neither can they substitute their judgement on risk or second guess specific investment decisions by managers, as these are properly the responsibility of management. 5 Both appointed auditors, in planning the audit to meet their statutory and professional responsibilities, and the Commission, when mandating elements of the annual audit programme, are mindful of the need to adopt a proportionate approach and to target audit work on the areas where the risks that something might go wrong are highest. This risk based approach also serves to reduce the cost and burden of audit for audited bodies. 6 Following the development of the CIPFA Code of Practice on Treasury Management (the CIPFA Code) in light of the events surrounding the collapse of BCCI in the early 1990s, neither the Commission nor appointed auditors perceived treasury management to be a significant risk. Indeed the view was that this was generally a well managed function. 7 Few experts in investment were drawing attention to risks with
Icelandic investments until the spring of 2008, and many not until the autumn.
In carrying out their audits of the 2007/08 accounts, auditors would not have
had cause to draw attention to potential risks relating to investments in 8 In giving their annual value for money conclusions and use of resources assessments, auditors reviewed the treasury management arrangements put in place by an authority. This involved the auditor satisfying him or herself that an authority had put in place arrangements to comply with the CIPFA Code. The CIPFA Code was considered the appropriate standard, as it not only represents generally accepted best practice in this area but is defined in regulations as a 'proper practice' to which authorities should have regard. It is only the recent extraordinary events that have exposed its limitations. 9 They are, however, now in a strong position to assess, separately
for every individual local authority, whether things have gone wrong and, if
so, why. Combined with our national report on these issues, this will
ensure that the appropriate lessons are learned by all authorities, whether
they had investments in Introduction 10 Public audit is an essential element in the process of accountability for public money. The Audit Commission's appointed auditors' provide independent assurance on whether public money has been properly safeguarded and accounted for, and how well it has been used in the delivery of services. They are an important safeguard where taxpayers' money is raised by compulsory levy and the normal commercial disciplines of the market do not apply. 11 Auditors have two core responsibilities that touch on treasury management. a. Their primary responsibility is to give assurance (in the form of an opinion) that the financial statements of the authority present fairly (ie do not materially misstate) the financial performance and position of the authority. b. Reflecting the wider scope of audit in the public sector, auditors have a duty, as part of their audit of the accounts, to satisfy themselves that the audited body has put in place proper arrangements to secure economy, efficiency and effectiveness (ie value for money) in its use of resources. 12 In meeting these responsibilities, the focus of auditors' work is a local authority's annual accounts and the financial management systems and processes that underpin them. Their work is therefore essentially retrospective. 13 In the context of their value for money responsibilities, appointed auditors also consider the financial standing of local authorities as part of the annual use of resources assessment, which forms part of the Commission's Comprehensive Performance Assessment of local authorities (and from 2009 will form part of the new Comprehensive Area Assessment). Treasury management arrangements are considered in this context. 14 This supplementary note focuses on auditors' responsibilities in relation to value for money and their related use of resources assessments. However, for completeness, it briefly outlines the work auditors do in relation to local authority investments in giving their opinion on the financial statements. 15 First, however, it outlines considerations relating to auditors' independence and summarises the annual audit cycle, both of which impact on auditors' role in relation to local authority investments. The independence of auditors 16 It is a fundamental principle that public auditors should be independent of those who are responsible for the stewardship and use of public money. The Audit Commission's primary statutory function is to appoint auditors on behalf of the taxpayer and preserve their independence. This is essential if taxpayers, on whose behalf public auditors work, are to trust auditors' judgements and conclusions. 17 The independence of the Commission's appointed auditors - whether District Auditors from the Commission's own staff or private sector accountancy firms - is enshrined in statute. They are legal entities in their own right with separate statutory duties and powers. 18 While the Commission can give guidance and advice to auditors and can mandate elements of their annual work programme, it cannot: a. interfere with an appointed auditor's exercise of his or her professional skill and judgement in performing his or her statutory functions; b. substitute its own judgements for those of an appointed auditor in the exercise of those functions; or c. direct an appointed auditor to act or to review his or her decisions, as only the courts have the powers to do so. 19 The Commission's Code of Audit Practice, which is approved by Parliament and with which auditors have a statutory duty to comply, requires appointed auditors to exercise their professional judgement and act independently of both the Commission and the audited body. It also requires them to comply with the Ethical Standards issued by the independent Auditing Practices Board (APB). 20 Ethical Standards (ES) contain basic principles and mandatory procedures to be followed, together with related guidance, on the integrity, objectivity and independence of auditors. They identify a number of potential threats to auditors' independence and integrity, including the self review and management threats. 21 To avoid these specific threats the Code of Audit Practice states "it is not part of auditors' functions to question the merits of the policies of the audited body, but auditors may examine the arrangements by which policy decisions are reached and consider the effects of the implementation of policy. ... In making any recommendations, auditors should avoid any perception that they have any role in the decision-making arrangements of the audited body". 22 Therefore, appointed auditors cannot comment or advise on an authority's treasury management strategy or policies, as they may subsequently have to review the effects of their implementation. Neither can they substitute their judgement on risk or second guess specific investment decisions by managers, as these are properly the responsibility of management. 23 Auditors can only intervene in extreme circumstances, primarily if they believe unlawful acts are imminent. The audit cycle 24 Initial planning for the audit of the 2007/08 accounts took place in spring 2007 and these initial plans were firmed up in the autumn. Work on the opinion audit began in earnest at the beginning of 2008, with the bulk of the work taking place in summer 2008 when draft accounts had been prepared and approved by the authority. 25 Both appointed auditors, in planning the audit to meet their statutory and professional responsibilities, and the Commission, when mandating elements of the annual audit programme, are mindful of the need to adopt a proportionate approach and to target audit work on the areas where the risks that something might go wrong are highest. This risk based approach also serves to reduce the cost and burden of audit for audited bodies. 26 Following the development of the CIPFA Code in light of the events surrounding the collapse of BCCI in the early 1990s, neither the Commission nor appointed auditors perceived treasury management to be a significant risk. Indeed the view was that this was generally a well managed function. 27 When auditors were planning their audits in 2007, they had no reason to consider treasury management to be a significant risk. Only a few experts in investment were drawing attention to the potential weakness of the Icelandic banks before the spring of 2008, and many not until the autumn. 28 When carrying out and
reporting on their audits of the 2007/08 accounts, auditors would not have had
cause to draw attention to potential risks relating to investments in 29 The vast majority of local authority audits for 2007/08 were completed (and the reports to those charged with governance summarising the key findings of the audit had been prepared and issued) before the collapse of the Icelandic banks. Of the bodies with Icelandic deposits, only nine audits were outstanding at 7 October 2008. Value for money conclusion 30 It is one of the principles of public audit that the scope of the audit is wider than in the private sector and covers issues of probity and propriety and value for money. 31 The Commission's appointed auditors have a statutory responsibility, as part of their audit of the accounts, to satisfy themselves that an audited body has put in place proper arrangements to secure economy, efficiency and effectiveness (ie value for money) in its use of resources. Under the Code of Audit Practice they are required to give a positive conclusion as to the adequacy of those arrangements. In doing so, they must have regard to criteria specified by the Audit Commission. 32 These arrangements are defined by the Code of Audit Practice to include an audited body's arrangements for managing its financial and other resources, including arrangements to safeguard its financial standing. 33 The statutory focus of auditors' work in relation to the value for money conclusion is the arrangements put in place by an authority. In the case of treasury management, this involves the auditor satisfying him or herself that an authority had put in place arrangements to comply with the CIPFA Code. 34 The CIPFA Code was considered the appropriate standard, as it not only represents generally accepted best practice in this area but is defined in regulations as a 'proper practice' to which authorities should have regard. It is only the recent extraordinary events that have exposed its limitations. 35 As such, auditors would not: a. review individual investment decisions; b. review the portfolio of investments; c. provide assurance on the operation of the authority's treasury management arrangements. 36 These are properly matters for an authority's management. An authority's treasury management system is
part of its wider system of internal control.
Regulation 4(2) of the Accounts and Audit Regulations 2003, as amended
by the Accounts and Audit (Amendment) ( Use of resources assessments 37 In the context of their value for money responsibilities, appointed auditors also consider the financial standing of local authorities as part of the annual use of resources assessment, which forms part of the Commission's Comprehensive Performance Assessment of local authorities (and from 2009 will form part of the new Comprehensive Area Assessment). Treasury management arrangements are considered in this context. 38 Auditors are required to review a wide range of corporate financial and performance management systems and processes, by applying a series of Key Lines of Enquiry (KLOE), and 'score' their effectiveness against criteria specified by the Commission on a four-point scale:
39 KLOE 3.1 for the 2008 use of resources assessment considers how well 'the council manages its spending within the available resources'. The criteria for level 2 performance in this area required auditors to consider the authority's arrangements for keeping its treasury management strategy under review and monitoring performance against it, and for ensuring that the strategy reflects the requirements of the CIPFA Code. 40 For 2009, KLOE 1.1 asks auditors to consider whether the authority plans its finances effectively to deliver its strategic priorities and secure sound financial health. 41 The Commission has provided guidance to auditors on level 2 performance in treasury management as follows: 'The council's treasury management ensures it has sufficient cash to meet its needs, balancing achieving VFM with the security of its investments (i.e. achieving a balance between liquidity, security, and yield). Performance is monitored against its treasury management strategy and outcomes match benchmarks set out in the strategy. The council meets any tax and prompt payment legislation (Late Payment of Commercial Debt (Interest) Act 1998). The council has "had regard to" the Code of Practice for Treasury Management and the CIPFA Prudential Code, as per regulations issued under the Local Government Act 2003.' Audit for financial statements 42 In carrying out their audit of the financial statements, auditors comply with the same professional auditing standards that apply in the private sector. 43 Auditors are concerned to satisfy themselves that: a. an authority does actually own the investments it is claiming to have in its balance sheet; and b. the assets have been appropriately valued in the accounts. 44 To get the assurance they need to be able to give an opinion on a set of financial statements, auditors will carry out third party verification tests - where the auditor writes to those listed as holders of an entity's investments asking that they confirm that they have these investments. 45 Normally, valuation of deposits with banks is not problematic. Clearly, however, in the light of the Icelandic banking crisis this will be an issue when auditors audit the 2008/09 financial statements. Where authorities have reliable evidence about any reduction in value, they will need to reduce (write down or impair) the value of the investment in the balance sheet and charge the amount of the write down to the income and expenditure account. Where they do not have reliable information, they will have to disclose in a note to the accounts that they may not recover the full amount when the investment falls due for redemption. Actions taken since7 October 2008 46 Once the news of the collapse of the Icelandic banks broke, the Commission immediately issued guidance to those auditors who had yet to complete their audits of the 2007/08 accounts on the implications for their opinion on the accounts. 47 We also asked all auditors to review their use of resources assessments in relation to financial standing and, in a number of cases, auditors chose to revise their assessments on the basis of the new evidence available to them. 48 We have also asked auditors to obtain more detailed information about authorities' treasury management arrangements to inform our study of treasury management in local government. 49 Auditors will also be monitoring the situation locally. Many of the authorities that have money at risk in the Icelandic banks have already commissioned independent reviews of their practice, which have made recommendations. Auditors will consider whether the authorities' responses are appropriate and whether they need to take any action themselves, for example in terms of public reporting. 50 We will also ask all auditors to follow up the findings from this
study at the local level over the coming year, whether an authority had
investments in Conclusions 51 The Audit Commission's appointed auditors' provide independent assurance on whether public money has been properly safeguarded and accounted for, and how well it has been used in the delivery of services. 52 In order to maintain the independence, which is critical to their role, auditors cannot comment or advise on an authority's treasury management strategy or policies, as they may subsequently have to review the effects of their implementation. Neither can they substitute their judgement on risk or second guess specific investment decisions by managers, as these are properly the responsibility of management. 53 Historically, neither the Commission nor its appointed auditors perceived treasury management to be a significant risk. Indeed the view was that this was generally a well managed function. In giving their annual value for money conclusions and use of resources assessments, auditors reviewed the arrangements that an authority had put in place to comply with the CIPFA Code, which was considered the appropriate standard of best professional practice in this area. 54 Few experts in investment were drawing attention to risks with
Icelandic investments until the spring of 2008, and many not until the autumn.
In planning and carrying out their audits of the 2007/08 accounts, auditors
would not have had cause to draw attention to potential risks relating to
investments in 55 They are, however, now in a strong position to assess, separately
for every individual local authority, whether things have gone wrong and, if
so, why. They will follow up our national report on these issues to ensure
that the appropriate lessons are learned by all authorities, whether they had
investments in
March 2009 |