UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 763-v

HOUSE OF COMMONS

ORAL EVIDENCE

TAKEN BEFORE THE

Communities and Local Government Committee

Audit and Inspection of Local Authorities

Tuesday 29 March 2011

Nigel R Johnson, Gervase MacGregor and Rakesh Shaunak

GILLIAN FAWCETT, STEVE FREER and VERNON SOARE

PAUL GEORGE and DAME BARBARA MILLS

Evidence heard in Public Questions 376 - 460

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Communities and Local Government Committee

on Tuesday 29 March 2011

Members present:

Mr Clive Betts (Chair)

Heidi Alexander

Bob Blackman

Simon Danczuk

David Heyes

James Morris

Mark Pawsey

________________

Examination of Witnesses

Witnesses: Nigel R Johnson, Assurance and Advisory Partner, Deloitte, Gervase MacGregor, Head of Advisory Services, BDO LLP, and Rakesh Shaunak, Principal, MHA, gave evidence

Q376 Chair: Good morning. Welcome to you all to the fifth evidence session of the Committee for the Inquiry into the Audit and Inspection of Local Authorities. For the sake of our records could you just introduce yourselves and say which organisation you represent.

Nigel Johnson: Thank you. I am Nigel Johnson, I am from Deloitte.

Gervase MacGregor: I am Gervase MacGregor, from BDO LLP.

Rakesh Shaunak: I am Rakesh Shaunak from MacIntyre Hudson, MHA.

Q377 Chair: Thank you very much for joining us this morning. We have had quite a bit of differing evidence given to us about whether there really is a difference between the audit requirements of public and private sector organisations. Do you think there is a difference and do you think the basic principles of public audit, particularly the fact that a public body should not appoint its own auditors, is important and should be maintained, or should it be altered and adjusted somewhat in line with the practice in the private sector? Who would like to start?

Nigel Johnson: I will kick off, thank you. I think there is a difference in the audit requirements for public sector bodies, in terms of the need for a review of the accountability for the use of public funds, and I think that is the principal difference between public and private sector audit. In terms of the scope of work, I think the current requirements for auditors in the public sectors, certainly in the Audit Commission regime, ask you to deal with elector queries, report on value for money as well as report on the financial statements themselves. Some of those responsibilities are sensibly able to be reviewed. I think public reporting by the auditor can still play quite a strong part in how auditors engage and show visibility of their work to the public at large, but I think the audit scope currently is probably too broad, would be my view, in terms of having to deal with every single elector query, some of which can be quite vexatious and become a waste of auditor’s time and elector’s money.

Gervase MacGregor: The main difference we see is clearly between the audit of expenditure, which is traditional territory for accountants, and VFM reporting, both of which are within the current scope of the audit report. VFM reporting is not something that naturally falls within the territory of accountant auditors but obviously the audit of expenditure does. So there is a difference in scope certainly.

As far as appointment is concerned, companies appoint their auditors on behalf of their shareholders and essentially what happens is that audit committees appoint those auditors. That I think over the last 20 years-certainly since I have been in practice-has been a good thing, and whatever changes take place as far as in the public sector I think need to replicate that sense of independence.

Rakesh Shaunak: I think, Chairman, if one looks at it quite radically and tries to divorce what is now to what could be there is benefit in convergence between public sector audit and private sector audit. I think fundamentally it comes off the fact that the public sector stakeholders are your taxpayers and in the private sector the reporting is to the shareholders, so arguably the public are the stakeholders within the public sector. I think their needs could be easily fulfilled by introducing intermediaries, such as community interest groups for example, for very specific studies, part of the Big Society, how does one dovetail the private and the public sector? So I think currently, as the Code of Practice is drawn, yes, it is difficult to see how one could divorce all those functions, but I think if one looks at it radically there would be benefit in converging the two.

Q378 Chair: We will come on to the scope of the audit and the public interest issues in a little while, but one of the principles of public audit has been the independence of public auditors from the organisation being audited. That has been a principle for a long time. Therefore, are you all happy to tear it up and forget about the past 150 years?

Gervase MacGregor: I certainly did not say that. I said that the independence, so far as in the private sector, the way audit committees have taken that role on from the reforms that started taking place 20 years ago, is something that needs to be maintained within the public sector. That independence is clearly very important. So it is certainly not our position that that should be torn up. How it is replaced is another matter and, in terms of having educated committees of non-execs, for example, who do the appointment, it is clearly something like that that has to replace it, it is not our suggestion at all that you tear up that degree of independence.

Rakesh Shaunak: Chairman, if I might chip in here, I think this question of independence applies equally to the private sector as well, because at the end of the day that is a potential conflict we face all the time. I know there are our colleagues from the Institute appearing later but fundamentally independence is the foundation of the work we do. So I don’t think one necessarily need compromise its independence by being appointed by somebody else.

Nigel Johnson: Can I just add, I think it is right to look at the private sector and say what creates the ability for an auditor to remain independent and potentially to be reporting without fear or favour, and I think there are mechanisms within that regime. For example, if an auditor is asked to resign by the directors, or indeed the shareholders, there are rights to write formally and have that letter reported in Annual General Meeting and that goes on public record at the company’s registrar, in terms of the statement of reasons and the auditor’s position versus perhaps the auditor’s position as presented by the directors or shareholders.

There are protections and mechanisms by which there can be openness about reasons behind an auditor being asked to resign or fired, which obviously can be in the public domain and therefore can show whether there is right or wrong in that decision. Similarly, obviously the appointment of an auditor should indeed be supervised by an appropriately qualified audit committee and again taken into public meeting for that approval. So again, it is not necessarily just the officers appointing the auditors-who they have friends in-it is generally an open appointment process.

So, with protections, with strong audit committees, with open ability to report reasons why and perhaps disagree with a resignation request, I think there can be ways in which that independence can be maintained, as indeed it is within the private sector.

Q379 Simon Danczuk: Can I start by asking about the pros and cons of the scope of the audit? I just wanted you to talk a little bit more about that, what do you think are the advantages and disadvantages of restricting the audit, the scope of the audit?

Nigel Johnson: Sure. I commented, that at the moment I think there are I guess two key areas on which one reports positively currently: one is the true and fair view on the annual accounts; the other one is the value for money conclusion, and I think the value for money conclusion is one of the key differences with the private sector. What has been helpful in a way, because I think that could be quite a broad set of responsibilities and require a broad amount of work, is: what is the definition of the scope of work that is required to apply to reaching that conclusion, because to say, "Value for money has been achieved" at an organisation as complex as a large local authority would take quite a lot of work.

So what has been helpful is that the Audit Commission has specified the scope of work that underpins that conclusion. Therefore, there have been some boundaries set. I think in any new regime people would expect perhaps for auditors to still have a value for money responsibility, but I think again some boundaries that are set by a regulatory organisation would be useful so that there is an expectation, there is a clear brief under which the auditors should work.

The other responsibility is about public interest reporting and objections as a result of elector challenge. I have commented, as I say, that I think there have been useful powers historically. I have had ranges of experience from very well-targeted queries from electors to some very, very seriously vexatious ones and single issue ones, which should not be applied in terms of auditor’s time and also local authority cost. I think, with a more transparent agenda, access to greater amounts of information currently, all the expenditure perhaps being accessible, it is possible for those inquiries to perhaps be better directed towards the authority rather than go through the auditor, and then perhaps for the auditor to assess how well those arrangements for handling those queries are constructed and dealt with. That could well form part of a value for money scope of work, to look at the arrangements, how elector queries in respect of expenditure or other challenge are dealt with, rather than going through the auditor.

Gervase MacGregor: I think, Nigel, I would probably take a slightly different view as far as the VFM is concerned. I mentioned earlier the territory of auditing expenditure clearly within the usual expertise of an accountant auditor. Obviously, included within that is the audit of the system of internal controls, that any organisation, including public sector organisations, use to control expenditure, make sure it is properly authorised and things like that.

I think when it comes to VFM the expertise required there is different, is different from what accountants are used to providing. Where I do see VFM, within the scope of an accountant, is making sure that an organisation-like an authority, for example-has a control that it looks at VFM, rather than undertaking the VFM itself.

Q380 Simon Danczuk: Just on that, it is almost as though you are suggesting that the system should be shaped to suit the accountants that are going to do the work, as opposed to what Government might want in terms of auditing the local authority.

Gervase MacGregor: I don’t think I am saying that at all. What I am trying to make sure is that the auditing is seen as auditing, and to the extent that value for money is undertaken. There are experts in various areas who can do that, and who can do that better than an accountant. Quite frankly, if you go to a large accounting organisation and you ask the auditors there, when the auditors do VFM they will be calling on their specialists. In my firm, for example, we have many specialists in healthcare who can very much do those aspects of VFM. I do distinguish those from what I see as the traditional territory of auditors, which is looking primarily at the audit of expenditure and looking at the system of internal controls.

I would say one other thing about VFM, it seems to me that a lot of it is based on measuring inputs-cost per whatever-rather than some of the outputs, making a separation and putting the responsibility primarily for looking at whether there is value for money on the body that is spending the money and then getting specialists, as necessary, to come in and look at that. That is a much better way of achieving that. I am certainly not suggesting that you should stop that or that you stop looking at value for money altogether, far from it. What I am suggesting is that you look at it in a better way.

Rakesh Shaunak: My position is that value for money should be done by specialists as well. I think internal audit has a role to play in that, whether it is an externally appointed internal auditor or the local authority’s own internal audit function, provided the controls are in place and the requirements are clearly stated, such as for example in the Code of Practice.

I think the scope currently is too wide, and it ought to be focused towards expressing the opinion, both on the use of funds on the regulatory and probity side. There is a parallel in education, for example, where it is driven by a self-certification of the systems of control, back to the system of control, and assignment of the auditors, leveraging off the certification. So I would welcome a narrowing.

Q381 Simon Danczuk: Just very briefly, do you think that the local authority should be able to determine the scope of the audit? Would that be a good thing?

Nigel Johnson: I do not think that would be appropriate. I think somebody else should be setting the scope of the audit and that would be potentially around the annual accounts, although I think that is well-trodden territory and one draws on the normal accounting and reporting standards. For value for money, assuming that remains within the auditor’s remit, I think somebody else should set the scope of work for that piece of the audit.

Can I just say one other thing? In the value for money context I think auditors always prefer to report on something that is attested by the client, be it the directors or whatever. At the moment obviously the annual accounts are indeed certified by the finance officer and sometimes the leader of the council. There is no current attestation confirming, "We have spent money properly" or given a value for money attestation. So the auditor’s conclusion is the only thing that currently does that, and I wonder whether there ought to be an explicit attestation within this annual reporting framework, which requires the authority to confirm they have indeed spent money economically, efficiently and effectively.

Q382 Simon Danczuk: Do you think the local authority should set the scope?

Gervase MacGregor: I don’t think they should set the scope at all. Carrying on from what Nigel said about the VFM point-and he raises an interesting point there-if you did put that requirement for a test on the officers in a local authority, I think you would end up with a position where they were going out and getting specialists to carry out specific VFM studies on particular parts of their services and, you know what, if they did that that would all be part of what I said before, which is making sure there are adequate controls within the local authority to look specifically at VFM.

Rakesh Shaunak: I think on the attestation I stated my position, which is the same as these two gentlemen. No, certainly, the local authority should not be setting the scope. I do not mean to denigrate that, but I think fundamentally it is public money and so the scope should be set outside that regime.

Q383 Mark Pawsey: Chairman, I would like to go into the issue of public interest performance and, Mr MacGregor, you said earlier that the audit of expenditure is traditional territory for accountants and it is accepted that public audit needs to go further than that. Currently, if an auditor finds malpractice or improper expenditure by an authority they go into a public interest report. That is currently funded by the Audit Commission who provide advice and guidance in doing that. Is it your belief that those reports: firstly, should they continue; secondly, does the private sector have the expertise to be able to carry them on if they do, and who should pay for them?

Gervase MacGregor: I see the PIR as like an insurance policy or a failsafe. The local authorities know that it is there and it is one of those things that, at the end of the day, keeps them honest-if I can put it like that-knowing that that thing is out there. So, one looks at abandoning that with some trepidation, I think. I would be uncomfortable if an auditor found something, or was told about something, and was not able to investigate it because it was outside scope.

To investigate it, it is the age-old problem of somebody paying you to investigate their malpractice, or alleged malpractice. I think that I would feel quite uncomfortable with a situation where I would be going to somebody and saying, "I have been told about this, I want to investigate it. I need you to pay me to do that". So, I think if you continue PIR, and I think there are very good reasons to continue it, you need to maintain some sort of system of indemnification for whoever it is who is undertaking the investigation.

Q384 Mark Pawsey: So you would accept there is a conflict of interest, if the auditor has been appointed by the local authority and the auditor wishes to go further than the original specification?

Gervase MacGregor: I think that is consistent with the answers each of us has given in respect of the last question, which is: to what extent should a local authority set the scope? Here you are potentially talking about the local authority being asked to set the scope of a PIR and the best way to frustrate scope is to withhold funds to investigate.

Q385 Mark Pawsey: Who should pay for it?

Gervase MacGregor: Clearly public funds should pay for it, but how that is channelled to the auditor I think is a different question. It would need to be one of the public bodies.

Nigel Johnson: I think public reporting by the auditor should continue and again, in our submission, I think we did make the comment that we think that our audit plans and our end of year reports should be publicly available. I think our suggestion is that matters of particular concern, which are perhaps currently looked at through the special public interest reporting regime because they are tricky issues, unlawful expenditure, or just very serious matters that auditors believe should be investigated and brought out in public, I think those then could be done through that public reporting regime and perhaps flagged quite specifically. I think that maybe that becomes a natural part of public reporting by auditors, rather than something that is currently very special and different and requiring quite a different response. So I think there is a refinement and perhaps an enlargement of public reporting by auditors, which could encompass bringing these sorts of special matters to attention.

In terms of expertise, most of the public interest reports that I have both read and been involved with I think the auditor has had the expertise to examine. There are some exceptions, and I would make a distinction between public interest reporting and objections. I think objections are much more difficult for the auditor currently, simply because that gets you into quasi judicial and legal areas with potential for challenge, and so on, through the courts. That sort of aspect of the current audit regime is potentially better served, and better value for money would be achieved, through excluding the auditors from that and letting lawyers handle that, or the matter be pursued through the local authority directly. So I think the auditor has the expertise to deal with most matters raised. If they need to take advice they will have to obtain that.

Then who should pay and how that mechanism should pay? At the moment, on public interest reports, the audited body pays. The Audit Commission doesn’t pay. So there is a way already whereby it is acknowledged that, if an auditor has to undertake a public interest report, the audited body will pay and they do indeed pay. Now, if you take the Audit Commission away and say, "Well, there isn’t that protection" where would the auditor be? I come back to if there is a very robust audit committee, who is independent and objective around the political colour of the organisation-

Q386 Mark Pawsey: So this is the audit committee of the body being audited?

Nigel Johnson: Yes, I think if there is a robust audit committee then I think they can serve as the channel through which not only can an auditor say, "I need to investigate this matter. This will cost money" and alert in advance, but also be the conduit through which the auditor does indeed get paid and proceed to do that reporting, without feeling put upon about, "Will I get paid for this and, therefore, I should be uncertain about proceeding to investigate the matter".

Q387 Mark Pawsey: Do you think there is a danger of conflict of interest?

Nigel Johnson: For the auditor?

Mark Pawsey: Yes, for the auditor being paid for by the body that is being audited. Is it in their interest to be too critical?

Nigel Johnson: That is where I think you need those protections about the independence of voice within the council itself, and I think you need a regime of quality control and oversight. If you ask me to duck a particular issue, then I would have to think very hard, because regulators already scrutinise our audit work very thoroughly. I think any new regime would indeed want to be looking at these sorts of issues that have arisen, and whether they have or haven’t been pursued. So I think again, with the regulatory oversight of the profession at the moment, I would be surprised if any professional person would feel put upon not to pursue something if they felt that was genuinely professionally the right thing to do.

Rakesh Shaunak: I agree absolutely and completely. I think independence is something that exists all the time and we overcome it quite successfully. Not simply because the regulators are looking over our shoulders, but through being professional and just the way we operate the Code of Conduct.

Yes, I think public interest reporting should continue and continue to be funded, whether it is top sliced, or a war fund, I think it is something that can easily be reformed.

Q388 Mark Pawsey: Do you think that the public interest reporting should be funded by an independent, separate body or are you comfortable that it should be paid for by the body that is being audited?

Rakesh Shaunak: I have no issue with the body that is being audited paying for it, provided the scope and the expectation is clearly defined.

Q389 Chair: Can I ask: do you really believe that Westminster Council would have paid for the public interest report into its various activities and Lady Shirley Porter?

Nigel Johnson: I would declare an interest in having been in the firm that investigated that.

Chair: With the backing and payment of the Audit Commission, of course, right the way through.

Nigel Johnson: Yes, but that is why I did make the distinction between a public interest report and an objection. The Westminster case was an objection, a legal objection, and I think I am suggesting that those powers to investigate objections do not sit any longer with an auditor.

Q390 Chair: We will come on to the objections in just a second, but an objection can lead on to a public interest report, can’t it? If a problem is drawn to the auditor’s attention, which he then deems is worthy of that degree of investigation then that can be the outcome?

Nigel Johnson: Yes. I guess the dealing with the objection and the response to it is typically taken in public anyway.

Q391 Chair: Okay, but in the end if the only degree of independence is that you have an independent audit committee, which I understand you are basically all suggesting might be one of the ways of achieving some degree of independence, should that audit committee have the right to specify expenditure on audit where required, separate from any further approval by the council?

Rakesh Shaunak: I think that would be a good safeguard to build in with the audit committee to commission additional work.

Nigel Johnson: I think they can make a recommendation; it is whether they should have the power to commit funds on behalf of the council. I think there is something to be said for that, to the extent that they believe there is something appropriate and they feel that it should be investigated and perhaps councillors might not take the same view.

Gervase MacGregor: I will also declare an interest. We acted in the defence of some of the councillors against Mr Pickles. If something is sufficiently serious-and let us think about this in the context of the private sector-auditors are going to say something and auditors will threaten to resign or will resign. The same thing applies to members of audit committees if something is sufficiently serious. The world of PLCs has become very challenging over the last couple of decades, as people have realised, non-executives in particular, members of audit committees have realised, that they have real responsibilities and real legal liabilities, in respect of not discharging their job properly. If something is sufficiently serious, such as you have just referred to, I find it very difficult to believe that an appropriately qualified audit committee or group of non-executives wouldn’t make sure that something was investigated properly.

Q392 Heidi Alexander: I just wonder if you think that the right of electors to challenge the financial statements of councils should be retained. If you don’t believe they should, what other process do you think should be put in place to maintain elector accountability?

Rakesh Shaunak: I think my analogy of the electorate being the stakeholders, the shareholders is particularly pertinent here, so I think that right should still be retained. As to whether there should be a direct access from the stakeholder to the auditor is something I am uncertain about. In fact, I feel it is too stark. I think there should be an intermediary; perhaps an officer, a nominated officer, a sponsor, and ultimately, the audit committee. We have mentioned the audit committee a number of times today having had experienced, both in the public sector and in the private sector. Provided the competition and the skill set within the audit committee is right, they can act as a very good buffer, so I think the right should be retained but not direct access.

Gervase MacGregor: I think that is right, the right should be maintained, but going through the audit committee seems to be an appropriate mechanism. Again, this is presupposing that you have properly qualified and experienced members of audit committees. We are hanging a lot on that being one of the big safeguards of the effect of all of these changes.

Nigel Johnson: I would make the distinction between the right to access information about the accounts and the right to challenge the accounts. I think it is entirely appropriate for access to be granted by any elector who wants to understand what money is being spent on, why it is being spent, and I think that is a natural sort of conversation and communication between the elector and the council. In terms of challenge to the accounts, I think that challenge can indeed be made and that right can still be retained to the auditor, but again that can fit very comfortably within an audited body, audit committee conversation. Again, I think it is an appropriate right for the elector to have.

Q393 Heidi Alexander: Was that what you said in your written submission, because I thought there it said that you considered that the extended audit powers to hear and pursue electorate objections should be dispensed with?

Nigel Johnson: Yes. That is objections about legality rather than matters in the accounts themselves.

Q394 Bob Blackman: At the moment, the Audit Commission both commission the private sector to do audits and control the quality consistency of audits right across the piece. With them going, how are we going to ensure that consistency and quality is maintained?

Gervase MacGregor: Currently within the private sector and other aspects of not-for-profit, our work is fairly heavily regulated, in our case by the AIU, the Audit Inspection Unit of the Financial Reporting Council, and the quad of the Institute of Chartered Accountants. So there is already sufficient regulation. When you go into other areas where we undertake audits, there are additional regulations through, for example, the involvement of the Charity Commission and all sorts of bodies in higher education.

So I think that, as far as auditors are concerned, there are sufficient controls that could absorb the current role on audit quality. We get inspected once a year; a report comes out. It is the same for Deloitte and the other large firms, so I don’t have any worries as far as that is concerned.

Nigel Johnson: To my mind, consistency would be more of an interest than quality and I think the Audit Commission indeed has played a significant part in ensuring consistency through the guidance it has issued, and so on. There are other regimes where there are mechanisms through which information is disseminated to auditors to help with the consistency in those different regimes.

The NHS Foundation Trust regime is one of those, for example, where there is guidance issued and a forum around which issues are debated and discussed among auditors to ensure greater consistency. There are ways, but I think there would need to be some mechanisms through which those involved did get some guidance about some of the areas where there could be inconsistency.

I would concur with Gervase around the quality aspect. I think firms who are registered under the various regulatory bodies and professional bodies will be ensuring that the work that they do meets the required professional standards, so I think consistency needs to be thought about more in any new regulatory framework than in quality.

Q395 Bob Blackman: So do you think there should then be some form of regulatory body that is introduced to make sure this consistency takes place?

Nigel Johnson: We have talked about the scope of the audit. I think someone somewhere-unless the legislation is going to be very detailed-needs to define, underneath the legislative principle, the scope of audit work. Beneath that, potentially, there could be some formal guidance, be it a code of audit practice or whatever, sponsored by an organisation, which does put more flesh on the bones of what the scope of the audit work here is, and indeed any further guidance that is required by auditors to provide the consistency and approach for the diversity of the providers. I think there should be somebody given that role and responsibility to set that more detailed code and guidance.

Q396 Bob Blackman: So who do you think that should be?

Nigel Johnson: It is reported to be the National Audit Office. I think they would be as good as anybody, given their knowledge of audit work. If there were to be a residuary body coming out of the Audit Commission, then there might be somebody else, but I would say-

Q397 Bob Blackman: The Audit Commission in another guise, do you think?

Nigel Johnson: An Audit Commission, a light regulatory body that doesn’t have its own in-house audit practice.

Rakesh Shaunak: If I could look at the Audit Commission first, and you mentioned the Audit Commission’s current role. It is highly unusual, in my view, for an organisation to be a regulator, a commissioner and a provider as well. I think separation of those functions is very important. Whether the oversight goes to the NAO with a very defined scope as the ultimate custodians of public funds. I think it sits quite readily there.

As far as consistency among the firms is concerned, I think if the Audit Commission does go, whether or not it does, when the new work is commissioned, provided there is sufficient scope and coverage in terms of alternative providers, and they are then encouraged to get together and define benchmarks and key performance indicators, and what have you, consistency can easily be achieved and it has been achieved in other sectors. As far as the professional oversight is concerned, the institutes, the AIU, the Financial Reporting Council, the QE, fulfil a very useful function, so I think that is less of an issue. The consistency, as Nigel says, is an issue but not an insurmountable one.

Q398 Bob Blackman: One of the concerns is going to be that, if local authorities are deciding who the auditor is going to be, they are going to put this out to a contract and there will be competition; they will de-scope the elements of audit and try and get the cheapest possible cost they can. Now, someone somewhere is going to have to oversee that, so who oversees it?

Rakesh Shaunak: The NAO, for example, and the Audit Code of Practice is pretty fundamental in this. That is not to say that the Code of Practice would necessarily be automatically followed, but it could be seen to be followed by reviews and so on. So, the NAO, I would suggest, has a role to play in this in the scoping of it, through the Audit Code of Practice in defining what the expectations of the auditor are and that would drive the process.

Gervase MacGregor: You are absolutely right to have the concern. That is why the scope needs to be properly worked out, so that is what an appointed auditor is looking to when he plans and he undertakes his work; and secondly, to avoid this concern of basically people driving down costs by self-limiting the scope of their work. That is where something equivalent to the annual inspection that we have on our private company audits takes place. That is how you stop local authorities constricting the scope by withholding the fees.

Bob Blackman: Mr Johnson, you were nodding your head sagely there. I just wonder if you have anything to add.

Nigel Johnson: Sagely? Yes, I think that there is always price pressure but I am not sure every organisation, even among the local authority fraternity, will automatically be looking for the cheapest auditor. Some people will want something other than just cheapness and price to be a factor in who they appoint and what sort of auditor they have. Some people may be looking for a proper check and balance, some assurance and choose that weighs quite properly along with a price element to the decision. So I think it is right for people to go through a local appointment process, decide what criteria they wish to apply and decide. I think price will be one of those dynamics but I am not sure it will be the only dynamic.

Q399 James Morris: Just pursuing this thing about the Audit Commission; when the Secretary of State decided to abolish the Audit Commission and stated his intention, he did say that the audit practice had done quality work and there was a lot of competency he wanted to retain in there. What do you think is the best model? A few models have been proposed, in terms of mutualisation or a private firm taking on the role and the function that the Audit Commission has. What do you think is the best model moving forward? Now that the Government has decided to abolish it, what is the best mechanism of mutualisation or another process in your view?

Nigel Johnson: I am not sure I have the answer. There clearly needs to be a proper thorough evaluation of what the options are. As somebody who has worked in this particular sector for quite a long time, I have no question that the level of expertise within the Audit Commission’s in-house practice is something that we need to protect and ensure has some sustained value in any new regime. If they can create a sustainable business case for mutualisation, I think that would be good and I think that would preserve a lot of that capability in one place rather than see it fragment, which I think is potentially the risk with any other alternative.

So the question: can they build a sustainable business case from what they have? Currently it has 70% or so of a market, which is a large share of any market. Again, obviously with local choice becoming available, you wonder again whether that is a sustainable level of market share from day one for any mutualisation let alone going forward. So I think it is a challenge to build a sustainable model, but I would like to think that some case could be made for maintaining the majority of that business in the whole to keep that expertise in the market.

Q400 James Morris: Do you think this move will stimulate more market competition for audit or will we have greater concentration?

Nigel Johnson: I think making local appointment will create greater choice and greater competition. There are many firms who will look at this market and think it is attractive. If it is freed up, and it has been, as I say, a very severely managed market up until now with that large in-house share, I think it will create serious competition.

James Morris: Any other views?

Gervase MacGregor: I think looking at the mutual model, yes, there are attractions and there are certainly attractions as far as keeping the talent, which is currently in the Audit Commission, in one place. The problem is that over time that market dominance is going to be eroded, through a variety of normal competitive means. I think inevitably, where this will end up is that that work is going to end up being shared among a larger group of audit providers. I think that is inevitable over time.

Q401 James Morris: Do you think that is a positive thing?

Gervase MacGregor: Is it positive? Yes, it is, I believe it is positive, but I also think it is inevitable. I don’t think you can fight the market in that respect. I don’t think you can say, "Here is an almost monopoly provider of 70% of audit services" and then go and let it compete out there in the market. Its share is going to get eroded with time.

What is arguably more important is this: there is a lot of talent within the Audit Commission. This was announced some time ago. You do want to keep that talent within audit and I think the longer it goes on before there is some sort of solution to the abolition, the more uncertainty there is obviously in terms of what the new model is going to be, so any benefits that come out of it are going to be delayed. There will also be a lot of attrition at the Audit Commission. We won’t be the only firm that has had people from there approaching us to look for positions because they are worried about what the final model is going to be. So whatever it looks like, I think it has to proceed apace.

Rakesh Shaunak: We welcome the opportunity for wider competition because the market is concentrated among very few providers currently. We are heavily biased, of course, but I think there is no dichotomy in looking at the skill set within the Audit Commission staff and that model, because fundamentally people will move with the demand and with the awarding of contracts.

Chair: Thank you very much indeed for coming this morning and giving your evidence; thank you very much.

Examination of Witnesses

Witnesses: Vernon Soare, Executive Director, Institute of Chartered Accountants in England and Wales, Gillian Fawcett, Head of Public Sector, Association of Chartered Certified Accountants, and Steve Freer, Chief Executive, Chartered Institute of Public Finance and Accountancy, gave evidence.

Q402 Chair: Good morning. Thank you for coming to give evidence to us this morning. For the sake of our records, could you say who you are and the organisation that you represent?

Vernon Soare: Yes, Chairman. My name is Vernon Soare; I am an Executive Director with the Institute of Chartered Accountants in England and Wales.

Gillian Fawcett: I am Gillian Fawcett; Head of Public Sector for ACCA.

Steve Freer: Steve Freer, Chief Executive of CIPFA.

Chair: Gillian, good to see you change your hat quite quickly.

Gillian Fawcett: Changed the scarf.

Q403 Chair: Just to say, we have quite a lot of information and questions to get through this morning, so if you do happen to agree with a comment already made, if you indicate your agreement, we are quite happy and content with that. That helps us get through the business a little more speedily. To begin with, in terms of public and private sector audits, is there a fundamental difference? We will come on eventually to the scope of the audit and public interest, which I will leave for further questions, but just to begin with, the principles of public audit do begin with the independence of public auditors from the organisation being auditors of a fairly fundamental commencement point. Do you agree that should continue to be the case or do you think now it is a time for change and, if so, how should that change be brought in?

Vernon Soare: Chairman, if I could just start. I think the audit independence is the keystone of any audit activity in any sector. I think one of the concerns that has been raised with the potential abolition of the Commission is: how will auditors demonstrate their independence? I think previous speakers have outlined the position, which I think I would agree with, that the future audit committees in local authorities should be given a statutory basis and given new powers, to ensure independence, at the appointment stage.

Of course, independence is borne out in much more than just the appointment. It is borne out in how the work is carried out, the decisions auditors take and also with issues such as fee dependence. One of the safeguards of independence is an audit firm does not have a significant amount of its audit fees tied up in one client. So I think independence is absolutely crucial but it is more than just the appointment. It is the appointment process but it is how they conduct themselves. Auditors also work against a code of ethics and that code of ethics is very similar across the public and private sectors.

Gillian Fawcett: To perhaps elaborate on that, I think, yes, independence is absolutely critical and it is fundamental to audit. In terms of an institute, I am quite torn about how you secure independence because, on the one hand, we have had 150 years or such of the independent appointment of auditors. It has been a system that has worked and there has been 150 years of learning in terms of that system, so why throw the baby out with the bath water?

On the other hand, yes, we certainly are supportive of audit committees and strong audit committees, which have the potential to fulfil that role in ensuring auditor independence, but there is a big question mark, I think as an institute, in terms of: where are you going to get those people from-with those relevant skills and experience-to sit on those audit committees? There is going to have to be a substantial investment in resource and training for those people on audit committees.

As you can see, I am quite torn there. Yes, supportive of audit committees in terms of certainly building up the resource and skills. In terms of the context in which public audit takes place, I think it is very different because, of course, taxpayers don’t have a choice, in terms of whether to disinvest, paying their taxes if they have failing services or poor governance. They have to pay it anyway. You could argue, well, yes, then they can vote you out in every four-year term, but four years is a long time to suffer poor service delivery and poor governance. So, yes, I think there is a very different context in terms of public sector audit and independence is absolutely critical.

Steve Freer: First of all, I think that public sector audit is different, and we will probably talk more about that when we talk about scope a bit later on. Secondly, to make the point that I think the principles of public audit are very important, all of them, but perhaps it is fair to say that the independence point is the most fundamentally important. I think there are dangers, if we get that wrong, that the relationship between the auditor and the public body may become too cosy and not serve the public interest. I think there is a danger that authorities might try to exert undue influence on auditors, and use the fact that they make the appointment as leverage in that exercise.

Also I think there is a danger that auditors will be influenced by considerations about their own risk in some of their decision-making in their role as an auditor. If you decide to pursue a line of inquiry that may lead to a major public interest report, for example, in that process you are almost certainly exposing the firm to significant potential liabilities, and there is a danger that those will weigh heavily on the auditor in that decision-making. So I think, for all of those reasons, the independence issue looms large.

The key issue is about how can it be assured? I think it has been assured in quite an elegant way while we have had the Commission. Question: how can it be assured if we don’t have the Commission? I think beefed up audit committees obviously are an option, but I think we really have to drill down and pursue exactly how that would work. The question about: what does independence mean? Independence from whom? Who makes appointments of independent persons and assures that they are truly independent? I think all of those are very difficult issues. If we get them wrong, there is a danger that we weaken independence.

Q404 Chair: Any ideas how we might get them right?

Steve Freer: Personally, I think that the residuary Audit Commission option-if that option exists-is quite attractive. I think the notion of a separate, independent body overseeing those kinds of processes, possibly being involved in the selection and possibly making those appointments, potentially has a lot to commend it.

Vernon Soare: Chairman, can I just say on that how we can improve that or how can we guarantee independence? First of all, we must remember that audit firms will have a reputation to be concerned about. I think it is highly unlikely that a firm-particularly if, as I mentioned, there is not an issue on fee independence-is going to cut its cloth in the face of opposition from a local authority. Secondly, as has already been mentioned, the inspection and review regime that is carried out in the private sector, and is currently carried out in the public sector by various bodies, takes these things into consideration as well. Therefore, I think that independence, if you line up with the code of ethics, the reputational issues, safeguard against fee dependency, and you have a strong audit committee, I think you probably have a safety net there that will work.

Gillian Fawcett: I would like to concur with Steve. As I said, in terms of there being years of learning in terms of the current process in relation to auditor independence, we haven’t suffered the same vagaries in terms of what is happening within the public sector on independence, particularly around areas such as the degree to which you carry out non-audit to audit work, the spotlight that audit has been put in, in relation to the banking crisis. So I strongly support that, in terms of we need to think are we going to put those 100 years at risk?

Q405 Bob Blackman: Can we come on to the scope of audit work? Why is there a difference between the private sector and the public sector and what is it? Mr Freer, would you like to start?

Steve Freer: I think the current scope is normally summarised over the four headings that I have no doubt you are familiar with: the opinion on the financial statements; regularity; probity, and value for money. It seems to me that all of those issues are fundamentally important when we are speaking about public money. Perhaps value for money stands out among those as being a paramount consideration for a taxpayer looking to his or her local authority. Perhaps the most obvious question to ask is: how has my money been spent and has it been spent wisely? It seems to me that that package of elements that make up the scope has a nice balance to it and does feel very appropriate. Why the private sector is different, I wouldn’t venture a view.

Q406 Bob Blackman: If I was a shareholder in a company, I would want to know that the directors of the company were spending the money valuably but, okay, we move on. Can I just say if you agree, and I guess you will, who should determine the scope?

Gillian Fawcett: I think it has been proposed in terms of there will be somebody, such as the National Audit Office, that would determine the scope under the Code of Audit Practice. Currently the Audit Commission control the Code of Audit Practice at the moment and that will pass to the NAO. I think it needs to be set at a national level, to address those issues certainly around consistency.

Back to the four areas, I think you have to be clear that audit, whether in the private sector or whether in the public sector, needs to be risk based and proportionate. You shouldn’t be doing unnecessary audit work and you should be taking into account the controlled environment of that audit. At ACCA, we fundamentally believe for the opinion and regularity work, there is no real difference at all between private sector and public sector audit; there is no difference. We follow the same auditing standards in those areas. The differences lie in terms of the probity, in terms of the legislation and does expenditure comply with legislation and guidance, and the value for money.

Going back to what I said earlier, in relation to the value for money, taxpayers do not have a choice in terms of where they invest their funds unlike that of an investor in a company. So when things go wrong, they can’t withdraw their funds and, at the end of the day, they are interested in efficient and effective services being delivered and the value for money element provides some assurance that that is happening, or at least the local authority has the right arrangements in place to ensure that effective services are delivered.

Q407 Bob Blackman: Mr Soare, what would your view be on the value for money studies? How valuable are they?

Vernon Soare: I think in the past, the value for money studies carried out centrally by the Audit Commission, and then carried out at local level, have proved quite useful. If not least, that there is a common benchmark for performance that a national study can discover, looking at good practice and best practice and then disseminating not just the benchmark but how it is done.

Chairman, if I can also say on the difference between the public and private sector, and why is the scope wider? I think it interesting that pre the Audit Commission, all local authorities came out into the Department of the Environment. I am not sure that in those days it was part of the remit. I think the value for money study, as we know it, was essentially a creation of the Audit Commission in 1982.

The difference between the public and private sector, I think it is quite simple. Why is the scope wider? In the public sector, judging the performance of any public body purely on its financial results, I think is quite difficult; that is one, but there are measures of performance indicators: policy implementation, quality of services, and so on. In the private sector, and if you are a shareholder, most often you are interested in the bottom line and if your company that you are investing in is turning a good profit, you will probably be satisfied; if they’re not, you won’t. I think that is probably the genesis of some of the differences.

Q408 Bob Blackman: Could I move on to another area? Obviously there is a substantial amount of grants and claims that local authorities make on Government. For example, I can think of one, the Housing Benefit subsidy claims that need to be audited. Who is going to do that in the future and how is it going to be paid for? Vernon, would you like to start?

Vernon Soare: If I may start, yes. Under the current regime, the audit of those grants is carried out by the appointed auditor. I don’t see that there necessarily needs to be a change in that arrangement, in terms of the auditor on the ground who looks at that expenditure. I think the issue is going to be-post Audit Commission-how the instructions or the agreed procedures auditors carry out are going to be determined. Currently that is done through the Audit Commission. In the future, I think the onus will fall back particularly on the Department concerned to publish agreed procedures.

Q409 Bob Blackman: So do you think there needs to be some regulation there on that whole process?

Vernon Soare: I think there needs to be some consistency as some of the previous witnesses have said; some consistency in approach by auditors, so that taxpayers and, in this case, Government, can be assured that there is a consistency of approach to auditing the disbursement of funds under those grants.

Steve Freer: Could I just add; I think there is a question about whether every individual grant claim requires a full, separate certification with an associated fee. A possibility might be that one could design a regime where some of that could be handled within the primary audit and whether, in that process, the audit-

Q410 Bob Blackman: Sorry, could I cut across you? Do you think that should be limited by an amount of money or a particular function? How do you think that would work?

Steve Freer: I think possibly by the level of the claim, by the amount of money because I think there must be grant claims that are de minimis, which don’t require the gold plated treatment that they currently receive. I think that would streamline the process and also potentially save public money that is associated with the way that work is reimbursed at the moment.

Bob Blackman: Thank you. Gillian, do you have anything to add?

Gillian Fawcett: I totally agree, in terms of it should be the appointed auditor. I think the Commission is fairly successful in reducing the number of audits on grant claims over a number of years, but again, in terms of the onus, as Steve said, in terms of Whitehall, to consider whether it is necessary and to be more trusting if they are giving grants, particularly small grants, across to local authorities, to reduce the requirements of a full audit.

Q411 Bob Blackman: Do you have a definition of "small" in Government terms?

Gillian Fawcett: I haven’t thought about it, in terms of the definition for grant claims that are obviously moving to something such as the small audit thresholds that are being considered in terms of small parish councils and audit.

Bob Blackman: That is very helpful, thank you.

Q412 Heidi Alexander: I would like to follow on a little bit with the discussion about the scope of audit and, in particular, the value for money work that is done in local authorities by audit teams. I think it is an area that we haven’t put to any of our witnesses as yet, which is about: the Government has significant plans for decentralising services and in their localism agenda. You could see the situation where local authority services are more fragmented, geographically speaking, with an impact perhaps on the services retained within the authority, the residual services, in terms of what value for money that offers the taxpayer.

I just wonder what challenges you see with new models of service delivery perhaps becoming more commonplace across the country, what the challenges are you perceive to be for audit in this new world, and whether you think that there is any need for any guidelines to be published around how the audit function deals with those sorts of issues?

Gillian Fawcett: To be quite frank, I don’t think it has been considered at all in terms of the new audit framework, and this obviously goes beyond the remit of the Committee. So in terms of if you were to start with a blank piece of paper, thinking about the new models in terms of mutuals, partnerships, and so on, there needs to be much more thinking in terms of how audit will work and Government’s accountability for how these new bodies will work in the new regime. It is quite difficult to say but there will be issues around consistency, accountability, governance, accountable to whom, co-ordination in terms of auditors. So it raises a whole of host of issues that need to be properly considered.

Steve Freer: I think you are right to say that moving to the future you have described, inevitably there are some risks in that process and potentially that, therefore, giving an opinion on value for money looms larger as a very important function of auditors. Additionally, of course, perhaps even more importantly, we are going into this period of austerity with a whole series of further risks associated with how the financial position of public bodies may cope or not with big challenges. Again, that seems to me to raise important issues.

Then I find myself thinking that, ideally, we want assurance about those issues and how all that is playing out, not only at individual authority level but also on a system-wide basis. I think that is one of the areas in which the Audit Commission value for money work has been very helpful in the past, it has managed to give that big picture overview, in relation to particular issues, and has sometimes focused on some pretty important emerging issues in the sector. Also, it has managed to give a local perspective too, and sometimes the overall picture has been a fairly satisfactory picture but the local picture has been a matter of significant concern.

Q413 Heidi Alexander: Okay; different question now about the national value for money studies that were carried out by the Audit Commission. Do you think they were valuable and useful pieces of work to do and if they continue in the future, who should specify them and who should carry them out?

Gillian Fawcett: I think, in the terms of the Commission’s national value for money studies, they have had a significant impact in terms of across the sector, in that they have had the ability to address the wicked issues. Those are perhaps issues at a local level that a local authority at a local level would not want to address. They have helped to transform some public services and to spread practice, not necessarily best practice because I know we get into other ground there. They should continue and I think what has been proposed is the National Audit Office, which would be the logical place to go, given that they have a very excellent track record in carrying out such studies.

Vernon Soare: I have nothing to add to that, I agree.

Steve Freer: I agree too. I would say though that I do think it is important that there is a consultation process associated with the specification of those projects, which the Commission has always consulted authorities on, on its draft programme, and so on. I think that is a helpful arrangement.

Q414 Chair: The LGA are saying they would rather like to have a stake in this as well. Do you think that is a bit too close to home? That they will be able to effectively look at value for money across their own member authorities? Some of them are probably not their member authorities, as we understand, or do you think they could play a role with the National Audit Office?

Steve Freer: First of all, I think that in that consultation process that I just referred to, it would be really helpful for the LGA to be an active participant giving its views about what studies should be undertaken and how they should be designed. Secondly, in a way, that question almost bridges us over into the inspection functions that the Commission has carried out, and I think that the LGA taking some responsibility for what they are calling self-regulation and improvement in the sector, I think that is a very positive step. I don’t think it is an easy step and, clearly, we don’t know yet how successful the LGA will be in taking on that responsibility or accepting that responsibility. I do think that is a very positive move by the LGA.

Vernon Soare: Just one thing to add. I think whatever happens in future on studies, I do think we need to be careful to bear in mind proportionality. I think there has been some criticism in the past that some of the Commission studies were too heavy, too onerous at the local level to carry out. I think we need to take a step back sometimes and remember that local authorities are a subset. In one sense, they are not insignificant but not as large as some areas of public spend. Therefore, when you look across the range of work that is done by auditors across central Government, the health sector and local authorities, we are saying maybe we need to keep a little bit of perspective on occasions, so that we don’t get into potential overemphasising, depending on the size of the authority and the significance of the activity that is being carried out.

Q415 Mark Pawsey: We heard earlier from the private sector audit companies that are going to be carrying out public sector audit that they will be happy and keen, in fact, to carry on public interest reports. They are quite happy for that to be paid for by the bodies they are auditing and they don’t see any conflict of interest or any way in which their independence might be compromised. They might say that, mightn’t they, because they are the ones who are going to be fishing for the business and they see that as quite an interesting additional revenue source. What is your view?

Steve Freer: I think public interest reports are very important and do need to be continued. We need to make sure that in these new arrangements, we don’t create any obstacles to public interest reports being produced where they need to be produced. I think there is a logic in them being paid for by the authority concerned. That makes sense to me. I think what we need to avoid, however, is a situation where the auditor has to negotiate that fee with the authority. Again, I think we are then left with a very difficult circle to square. That takes me back to the residuary Audit Commission option. Again, for me, that would be a very sensible function for an independent agency to be able to mediate if necessary.

Q416 Mark Pawsey: So you think there is a danger that their independence might be compromised, that there needs to be somebody separately funding and managing that.

Steve Freer: I am not so sure it is about independence being compromised. It feels to me more like a very difficult conversation to take place between an auditor wanting to pursue a matter-

Q417 Mark Pawsey: So do you fear then that on occasions that conversation might not take place?

Steve Freer: Yes.

Gillian Fawcett: Yes, public interest reports should continue obviously, in terms of they bring to light serious failings within authorities. So who should bear the cost? I think we perhaps need to look across at the Companies Act and what provisions are within the Companies Act for big scandals, such as the Maxwell scandal, in terms of where those sorts of serious failings resulted in investigative inquiry and an inquiry by the Government, in terms of maybe drawing the lessons there and whether it should be in terms of the Government picking up those costs.

Q418 Mark Pawsey: Do you share Mr Freer’s concern that, on occasion, an auditor might find something and not want to have this difficult conversation with the client local authority?

Gillian Fawcett: Absolutely.

Mark Pawsey: You do share that position?

Gillian Fawcett: I do share that.

Vernon Soare: Maybe not a contrary view but a step back. When we are thinking about the future of local public audit and local authority sector, I think this period does represent a very key time to look at the landscape and to decide whether some of the things pertaining to the local authority audit should continue in exactly the same way. The point I just made is you look across the public sector, audit regimes are quite different and local authorities are virtually unique in some of the aspects of the audit procedures and some of the powers and some of the responsibilities. When we are talking about public interest reports, I think maybe it is just an opportunity to stand back and say, "What is their purpose? Could they potentially be delivered in a different way because they are very expensive?" That is not the reason for saying you shouldn’t do them. If you look across other parts of the public sector, in the health sector there is not an equivalent, in the sense that the report goes to the Secretary of State; it is not a public report and I don’t think there is an equivalent in the central Government area. There may be a very good reason for continuing in the local Government sector but I think, probably before we carry on business as usual, it might be worth stepping back and saying, "What is the purpose? Could it be achieved in a different way?" Maybe not, but I think it is an opportunity to look up a little bit.

Q419 Mark Pawsey: broadly, you think it is acceptable for the company carrying out the audit to do the public interest report or would you rather see another independent body stepping in, in those circumstances?

Vernon Soare: Again, I think it comes back to the issue of independence. My own view is that, looking at what has happened over the period of the Audit Commission, I think public interest reports have been issued without fear or favour. Personally, I don’t believe that there has been a lot of connivance, or anything of that sort, but if it was deemed to be appropriate in the public interest, you could imagine a separate appointment of either another audit firm or some other specialist to look into that particular issue. Hopefully, what we are talking about is incidents that do not happen every week. What we are talking about is catastrophic issues. Yes, they have come along perhaps more than they should have done, but this is not something that is essentially part and parcel of local Government life.

Q420 Mark Pawsey: On that basis, is there a danger that an auditor might find more opportunities to have a public interest report in the interests of enhancing their fee?

Vernon Soare: I think, from the point of view of ethical standards, auditors would be ill advised to do that. My experience is that, if we are getting down to fees, the sort of fees that auditors generally receive from local authority audits are generally less than those in the private sector. There will be an opportunity cost issue there I suspect. I certainly don’t think that auditors will be going out trying to make work for themselves in the public sector.

Steve Freer: Could I just make the point that I am more worried about the opposite set of circumstances, where the auditor can see the possibility of a public interest investigation and can see the potential liability that that exposes the auditor to. So you end up with an unenthusiastic auditor contemplating having a discussion with a potentially unenthusiastic client authority. It is in those circumstances that I think these conversations might never take place. The Commission has helped to keep everyone honest in those situations in the past.

Q421 Chair: So you would see a situation where the auditor wasn’t appointed in future by the Commission; there could still be a role for the National Audit Office, or whoever, in supervising and overseeing these processes?

Steve Freer: Possibly.

Q422 Simon Danczuk: How should the quality of local Government audit in audit firms be assured? You have talked about consistency of service. Whose responsibility is that, and the Audit Commission played some role in that. Whose job is it then?

Vernon Soare: Yes. The Audit Commission has arrangements currently for assuring the quality and consistency of audit across audit firms and indeed their audit practice arm. Up until recently, that was done through an arrangement where the Audit Commission would have its own quality assurance reviewers. More lately, some of that work has moved to the Audit Inspection Unit of the Financial Reporting Council. In the future, there are various options. It could be carried out by the audit bodies such as ourselves, but we are not exclusive in that domain. Also some of it could be carried out by the Financial Reporting Council. There are various ways in which it could be done, in the sense that I think the potential demise of the Commission will not change the potential, the resource for doing that work.

Q423 Simon Danczuk: Do you have a preference?

Vernon Soare: If you are asking me who should be doing it, of course we would like to do it. You might say we are biased in that, so we will leave it to policymakers but we are ready for the call.

Simon Danczuk: Any other views?

Gillian Fawcett: I think with the Audit Commission it was generally well understood across a number of stakeholders, in terms of how quality assurance and consistency was maintained, and that is with local authorities themselves through to the professions. I think, yes, as Vernon outlined, there are all sorts of alternatives there but, at worst, you could get a fragmented approach in relation to consistency with the professions overseeing bits in an uncoordinated way: the FRC having a role; the Audit Inspection Unit, part of the FRC, having a role there. So you could have a fragmented approach that might not be the best possible outcome for local authorities.

Q424 Simon Danczuk: A fragmented approach does not sound like the best solution, does it?

Gillian Fawcett: It doesn’t, no. It needs to go with a single body, possibly in terms of the body that is overseeing the Code of Audit Practice.

Vernon Soare: Yes. The fragmentation issue: there is a parallel in the private sector, in that there are a number of-what are called-recognised supervisory bodies under the Companies Act who carry out work in audit quality. Their work is overseen by the Professional Oversight Board of the Financial Reporting Council. Therefore, the consistency issue is dealt with in that way.

Simon Danczuk: It sounds very complex to me.

Steve Freer: I agree with the points that have been made, although this takes us back in a way to a wider scope. It is important that quality understands the wider scope of the public audit. So I suppose this is about saying that it is important, if we start from a private sector model, that we don’t implement that thoughtlessly on the basis that a public audit is the same as private audit. We do need to recognise public audit is different and wider.

Secondly, I thought in the earlier session one of the panellists began to make the point that there is a sort of difference between quality and consistency here. Again I think it is terribly helpful that, under current arrangements, the Commission do help to create a degree of consistency across the sector in terms of how particular types of transactions are regarded and treated, and so on. One thinks of obvious examples like PFI schemes. I am not sure that that consistency, in that very helpful sort of way, will be addressed straightforwardly in quality arrangements.

Q425 Simon Danczuk: So who do you think should do it, Steve?

Steve Freer: I do think there is a huge benefit in having a body that can convene all of the auditors in the sector, ensure that those kinds of issues are debated and that there is then a process for issuing guidance to all auditors to promulgate consistent interpretations.

Simon Danczuk: Sort of a commission for audit.

Steve Freer: Yes, an excellent idea.

Q426 David Heyes: The Government have claimed that fees will reduce due to the increased competition. Is there any evidence to support that?

Vernon Soare: If I could make a comment on that. In a sense, we are going into unchartered territory. For the duration of the Commission’s reign, it has been a regulated market. The Audit Commission have acted as a regulator on audit fees. In future, if the policy is to have local authorities appointing their own auditors, you are potentially in an unregulated market. At that point there will be a number of issues that come into play not least the fact that, under the present regime, the Audit Commission takes a large share of liability issues away from the audit firms and the in-house practice. In future potential markets, those sorts of issues will be dealt with at a firm level with the local authority.

It also depends particularly on the complexity issue. Under the current arrangements, I believe firms are offered in a sense a package of work, some of which might be fairly straightforward; others might be quite challenging. In a future market, the difficult audits or the risky audits will be priced accordingly unless there is some other mechanism for regulating audit fees.

Gillian Fawcett: ACCA is supportive of the wider market in terms of opening up competition, and we said that in our submission. We have also said though there is little evidence or no evidence, in terms of knowing how the market will react; and thirdly, in terms of you obviously have to think about what will happen with the Audit Commission in the future because that will have a direct impact on the market. As Vernon quite rightly said, the Audit Commission basically underwrote a significant limited liability for the firms. That will have an impact in the firms having to potentially take out additional insurance to shore up that liability; so no evidence as such.

Steve Freer: I agree with that, and I think it is likely that some audit appointments will not be particularly competitive, because of the location of the organisation or its reputation or whatever. In those circumstances, there must be a risk of fees increasing. Also, I think, not only the removal of the Commission but also the removal of a public auditor, the sort of district audit arm of the Commission, has in effect had a price regulator function. In a sense, it has also been an auditor of last resort, in that it has been able to be directed to undertake audits anywhere in the country. I think all of those aspects of the current system; their removal creates risk around the market being less than competitive and prices increasing.

Q427 David Heyes: So, from all three of you, no evidence that there is likely to be reduced costs but significant risks that there could be increased costs; the removal of the Audit Commission is a kind of regulator of price. Will there be competition in this market, I think is the question. There are going to be four big dominant firms. Is it not the case that that is likely to result in less competition?

Steve Freer: In all of this, it is important to say that none of us know because this is the future. From experience we do know that it is quite difficult for firms to break into this market because of its specialist nature. We know that firms do need to attract a critical mass of work in order to sustain their involvement in the market. That presents a difficulty too. Additionally, I think it is important to recognise that local authorities are like lots of other entities; almost certainly, they will not be making these decisions purely on the basis of price. Like large listed companies, large local authorities will be attracted to the firms with the greatest cache associated with their names. So I think for all of those reasons-again, while emphasising no one knows-there are dangers that there may be a concentration of the market in the hands of quite a small number of players.

Q428 David Heyes: Is this another argument for a residuary Audit Commission then, to have some oversight of this model?

Steve Freer: I think this is where we find ourselves focusing on the district audit partnership and what happens to that. Again, I think, for me the best option there, sadly, may be the option that is not available. I think a significant public sector auditor in this equation is extremely helpful. If you think about it that is what we have with the National Audit Office and its arrangements in central Government. I think there is a very interesting debate about mutualisation and I am sure that, in some ways, there are some positives in that option. It is important to recognise that a mutual is not publicly owned. It is just a different part of the private sector, and won’t straightforwardly carry out some of the functions that a public auditor can carry out in the market.

Vernon Soare: If I could make one more comment on the market, following on from Steve, about the position of the Audit Commission practice arm and its future. In one sense, it represents a little bit of a conundrum. You could view the fact that if it is able to continue in the market that it will act in one sense as a regulator in the short term, because of its market share. However, the flip side of that is that there will be an immediate market concentration issue into one large firm, which has obviously been the subject of much debate in the private sector. So there will be some issues there to grapple with. One other point to make on the in-house practice arm, as it currently is. Currently, it would not be capable of auditing in the private sector. It would not be capable of auditing, for example, in the university sector, housing associations, because it is outside its remit at the moment. Generally speaking, it does not have the staff with the right kind of background. I know it is on public record that there is a desire for that in-house practice arm in the future, if it is able to stay together, to move into some of those areas. I think it is important that if it is retained it is given as much commercial freedom as possible so it is, in a sense, competing on a level playing field.

Gillian Fawcett: I think we need to look across, in terms of what is happening in relation to market concentration; particularly, the House of Lords’ inquiry and its recommendations in terms of what are the implications for the public sector there. I think that is important. I think there is a real opportunity to look at the audit practice arm of the Commission and make them operational, in terms of an opportunity to make them a fifth player in the market. , as Vernon quite rightly says, you need to think about giving it commercial freedoms and flexibilities to be able to do that in a sustainable way. I disagree slightly in terms of staff. We have many members working within the Audit Commission and I can assure Vernon they are well equipped to work, both within the private and the public sectors.

Q429 James Morris: You started to touch on this issue about whether the Audit Commission should go down a mutualisation model or other, and, Ms Freer, you were expressing some concerns about that. Are there any other models that you think might be more appropriate to stimulate this market competition that you are talking about?

Steve Freer: I think I have already said that the option of the service staying in public ownership should be seriously considered.

Q430 James Morris: Don’t you recognise the issue, which was brought up in the previous session, about a body being both a regulator and an auditor? Don’t you think that that poses potential conflict of interest issues?

Steve Freer: If what used to be called the District Audit Service stayed in public ownership, it could stay in public ownership and simply be an audit provider. It doesn’t necessarily have to have the regulatory function. Although, I would say that I think I disagree with the points that were made in the earlier session. I think there is a strong track record of both the Commission and the NAO, and other auditors in other parts of the UK, managing to carry out those different functions successfully under the same umbrella. If public ownership is not possible then I think mutualisation is a very interesting option to consider. I know that the staff concerned are working hard on that, and I think there is a significant head of steam for that option. They are very keen to make it succeed. As I understand it, they are very keen to carry distinctive values from the Commission as it currently exists or from the District Audit Service as it currently exists, into the new mutual organisation.

Q431 James Morris: Sorry to cut across, but, Mr Soare, you were saying you thought it was important that any new body had quite a wide commercial scope.

Vernon Soare: Yes.

James Morris: so how would you see that working in this mutual model?

Vernon Soare: I think, in terms of the form and the structure, that any ongoing audit practice arm might take, I think in a sense it does come down to whether you retain it within the public sector, in some shape or form, or whether it goes in to the private sector. If it then goes into the private sector mutualisation is one option. It could be bought out as a private firm and put on a similar basis to others. There are advantages and disadvantages to that. I would agree with Steve, that I think the ethos of the Audit Commission practice arm will probably lend itself more to a mutualisation model than to a straightforward partnership model, but I would say that is something that you would have to give the management the opportunity to determine.

Also just to clarify one thing because maybe I wasn’t quite clear, when I mentioned about the Audit Commission’s current capabilities that was no reflection on the staff. I think all the bodies represented here, and others too, have staff working for the Audit Commission. It is just that, under the current regulatory framework, there need to be individuals in the organisation that can be recognised under the Companies Act. There are few of those currently within the Audit Commission, but that could be rectified in the future through training and hiring.

Q432 Mark Pawsey: To go back to the question of audit fees, isn’t it the case here that there is a whole new market becoming available to the private sector. In other areas where big, new markets become available, the private sector competes very aggressively to get a toehold into it. So, isn’t it likely to be the case that we will see those savings in early years? A greater concern might be that, having established the market, the cost may be higher in later years, but in the intermediate years we should see a significant saving as the sector goes for it.

Steve Freer: Yes.

Gillian Fawcett: Yes, I think that is one possibility. , as I say, we really don’t know.

Vernon Soare: Just to say, of course, 30% of the market is already with the private sector, as in central Government as well. So there is some private sector involvement already. , yes, absent the Audit Commission, it will be for the market to decide and I think that is a policy issue as to whether that is an appropriate way going forward, or whether there does need to be some-not the reinvention of the Audit Commission or Commission for Audit-sort of regulatory function.

Chair: David?

Q433 David Heyes: Yes, I wasn’t on the right page, Chair. It is the question about the threshold for audit. It has been a subject of much debate and we now know that it is going to be set at, I think, £6.5 million. Is that the right level and what are the risks attached to setting it that way?

Vernon Soare: Can I just say, that that audit threshold is taken directly from the Companies Act and the current upper thresholds set by the European Commission, so that is an entirely private sector concept. I think from our point of view-and I think Steve mentioned this earlier on-we would caution applying things across from the Companies Act without stepping back and thinking. Members of the Committee will know that there is a thought that in future that threshold for the companies might be pushed up even further, even to £25 million. I would probably say that for public money you need to be thinking about a different set of thresholds. I can’t give you a figure, but the point I am trying to make is that just translating over from the Companies Act, which is a £6.5 million limit currently for where statutory audit starts, is probably not the best way to go for the public sector.

Gillian Fawcett: I think, in terms of moving the threshold up, you could put at risk a significant amount of public funds. So £6.5 million might not sound a lot for a single district council, but when you start to add them all up perhaps the question needs to be asked: are we going to accept less assurance and accountability for the size of funds? If you look at expenditure, in terms of local authorities and totality, it is around £200 billion. So, adding up the district councils, how much of that spend will be at risk?

Steve Freer: I agree with the points that have been made, particularly Vernon’s point about this figure not rising routinely without careful consideration. I think £6.5 million is not an unrealistic figure at the moment.

Q434 David Heyes: There are risks attached. What sort of risks might we face at this level?

Steve Freer: Any misuse of public money is potentially a matter of significant public concern and the audit is a process that has the potential to expose issues of public money. It is tempting to want a full audit of all public expenditure at any level in our systems, but I think there is a proportionality question. We do have to take a view about the point at which we suspend full audit and have some alternative arrangement, or else we end up with a very expensive audit regime.

Q435 David Heyes: Your colleagues are saying, quite clearly, the Government have it wrong, translating across from the private sector and setting it at too high a level. What level would your expertise cause you to suggest?

Vernon Soare: Chairman, I can’t give you a figure but I would just say this: the difference between £6.5 million in the private sector is that suppliers and others can choose, either to do business with a company that is below the audit threshold and therefore does not need an audit or one above it. I think the issue for taxpayers is that, generally speaking, they will not have a choice of where their service comes from. Therefore, I think careful thought does need to be given before you go with £6.5 million. If that is the decision in the end all I would say is to decouple it from any idea that this is part of the Companies Act threshold, because as I say every time the Companies Act threshold goes up, which is a completely different policy decision, it would be unfortunate if, de facto, it was linked to the public sector threshold and that went up too. I think there needs to be a separate bit of thinking going on.

Chair: We will move on briefly to the last two points.

Q436 Bob Blackman: Obviously one of the points of concern is going to be auditor independence and one of the ways that can be achieved is rotating audits. If you agree with that what should the period of rotation be? Steve, do you want to start with that?

Steve Freer: I am not particularly enthusiastic about auditor rotation in these circumstances. I think if we put the emphasis on independent appointment then I think that is the right place for it to be. I think-

Q437 Bob Blackman: Sorry, just to cut across on that, should there then be an annual appointment process or should it be for a period of time?

Steve Freer: No, I think auditors should be appointed for a term but with the potential for that term to be renewed. Within those considerations, I think a public body responsible for making those appointments would naturally consider whether it was healthy for a body to have the same auditor for a very extended period, 15, 20 or whatever years. So I think that would be dealt with naturally as part of that policy responsibility. I think, moving away from that kind of model and making individual organisations responsible for their own appointments but then saying, " you will have to change your auditor every X years" seems to me to be a less good model. Because, of course, every time that you get to the point of change there is a whole range of experience and knowledge, about the audit and about your organisation, that is walking out the door and you are back to the bottom of the learning curve. So, for me, it is an unattractive model in a fundamental way.

Gillian Fawcett: In terms of to preserve independence, I would say there should be a set term in terms of rotation of the firm not just the partner. Again, in terms of very much what happens in the private sector, it is occasionally-well, not occasionally, on quite a significant number of times-translated into the public sector. So, for example, the European Commission has published a Green Paper and one of the issues that it will be making recommendations on is, indeed, auditor appointments.

Q438 Bob Blackman: So if you agree with rotation, what should that rotation period be? How long should an auditor be there for a term?

Gillian Fawcett: I would have thought no more than five years.

Vernon Soare: Just a comment from ourselves on this, going to back to a principle that I think we should not overcomplicate issues in one part of the public sector unless there is a very good reason. I think we should probably step back from making different arrangements and different regulations for one part of the public sector. I would say that the ethical code that currently exists for audit, which insists on the rotation of the main engagement partner at least every seven years, should be something that should be translated across into the public sector. In terms of localism-the local agenda-I believe that this should be a decision for the audit committee. It will be empowered to contract with an auditor for a certain period of time. That will then be reviewed and either, through a tender process, reappointed or move to a new auditor. If the same firm is retained, I think the general principle that applies across the private sector, and some parts of the public sector, is that the audit engagement partners should be rotated after a maximum of seven years. That is in line with standard practice.

Q439 Bob Blackman: One other area I just want to touch on: the potential for consultancy studies in local authorities is huge. Should the firm that is appointed to do the auditing be barred from even competing for the potential for consultancy studies? Vernon, would you have a view?

Vernon Soare: Right, well, this obviously has been an issue of great debate across the private sector as well but, referencing the Audit Commission, I believe that there was very limited scope for auditors in the public sector appointed through the Commission to carry out consultancy work, and that was for this independence issue. Now in the private sector we have the situation where an audit firm auditing a public interest entity, under ethical standards, is not allowed to do consultancy work for that particular client but can do consultancy work for clients that it does not audit. Therefore, I think if you translate that across into the public sector, because we are dealing with public money, it is probably a good idea that there are some restrictions put upon the amount of consultancy work that a firm auditing a local authority could do for it. Anything major, I think, the same principle should apply, that it is open to firms to do consultancy but not for the authority they are auditing.

Bob Blackman: Thank you. Gillian, do you agree?

Gillian Fawcett: Yes, I do agree.

Bob Blackman: Thank you. Steve?

Steve Freer: I agree with that too. I think that it does have the potential to, again, query the independence relationship. So I think it is important to have those kinds of restrictions, perhaps just with a caveat that there might be a situation where there is an absolutely compelling case, because of specialist expertise, that the right decision would be to involve the auditor. Authorities ought to have to jump through some hoops before they get to that and I think it ought to be very much the exception rather than the rule.

Q440 Mark Pawsey: Can I ask you about the Audit Commission’s anti-corruption/anti-fraud work, what arrangements should there be in a post Audit Commission era?

Vernon Soare: Again, this is a role that the Audit Commission carried out in terms of co-ordinating the work and even leading on methodology, particular computer interrogation technology and applications. I do not have an easy answer to this one. I think it is an area where, if you are going to get consistency, you do need a body of some sort or somebody taking on the function of leading on this and then disseminating the good practice, the techniques and the technology across other suppliers.

Q441 Mark Pawsey: What happens in the private sector?

Vernon Soare: In the private sector what you will find is that the firms will develop their own non-assurance service in this area and they will make it an issue of competition, in terms of their expertise. So it is different in the private sector but, as we are dealing with public money, I think there is a good argument for saying that this is not something that necessarily lends itself to a market solution and there should be some co-ordination of it.

Gillian Fawcett: Yes, I think in terms it certainly is a valuable function. It has identified areas of fraud across a whole host of areas, certainly through its data matching exercise, and I think it does need to continue; with what body? I think there have been various bodies mooted such as the National Fraud Authority, which might well be an obvious place for that. Again in terms of the way different functions are potentially being fragmented across different bodies in an uncoordinated and inconsistent way, which is possibly of concern, but certainly it is a function that should continue because it does identify areas for potential fraud and significant fraud across local authorities.

Steve Freer: I agree with the points that have been made, and just to say I think it is also important to recognise this expertise, centre of excellence, and so on, has been built up at considerable public expense. So there is a public investment here that needs to be protected.

Chair: Thank you, all of you, very much indeed for getting through a wide range of issues for us. Thank you.

Examination of Witnesses

Witnesses: Paul George, Executive Director of the Professional Oversight Board and Director of Auditing, Financial Reporting Council, and Dame Barbara Mills, Chair of the Professional Oversight Board, Financial Reporting Council, gave evidence.

Q442 Chair: Thank you very much indeed, both of you, for joining us. For the sake of our records, could you indicate who you are and the organisation you represent?

Dame Barbara Mills: Yes, I am Barbara Mills, I am the Chair of the Professional Oversight Board and I am on the Board of the Financial Reporting Council.

Paul George: My name is Paul George. I am the Executive Director of the Professional Oversight Board and the Director of Auditing within the FRC.

Q443 Chair: In terms of looking at the expertise of your organisations, under what circumstances has the FRC inspected local authority audits and how many inspections did you carry out in the last financial year?

Dame Barbara Mills: What, the audit unit?

Chair: Yes.

Dame Barbara Mills: Yes, about 100 last year.

Paul George: The 100 is the number of audits we inspected in the private sector. As far as the work of the Audit Commission is concerned, we have been doing some work monitoring the quality of their work for the last four years. That is an arrangement that we have entered into with the Audit Commission voluntarily. They wanted to benefit from the same type of monitoring inspection that the private sector was subjected to. We do a combination of monitoring activities. We focus only on the financial statement audit; we do not get involved in some of the other aspects of their work. We look at their overall quality control procedures, to make sure that they have systems and procedures in place to ensure that they have a reasonable chance of delivering a high quality audio and then we look at how those procedures are applied on individual engagements.

The number of engagements we look at has depended from year-to-year. In the initial years our focus was primarily on what we call the firm-wide procedures, the internal quality control. We then review a small sample of engagements, both engagements that they conduct directly themselves and also some engagements that are undertaken on their behalf in the private sector firms. We typically would look at somewhere between five and 10 engagements a year across those two.

Q444 Chair: In terms of the number of local authority audits, how many?

Paul George: Between five and 10 each year.

Q445 Chair: Between five and 10. So why do you want to seek a greater role in an area where perhaps you have had limited experience in the past?

Dame Barbara Mills: I think we would start from the other end, if I might, which is we are mightily concerned, and have been very concerned for a long time, about the concentration of audit in the four major audit firms. What is happening now seems to us to give an admirable opportunity to get more competition in that world. Obviously we are mightily concerned by some of the questions that you were asking in fact about how the work is going to be spread out, if I can put it that way, if the proposals go ahead. What we would not want to see is-actually, it is three of the Big Four and two other firms-the Big Three, if I can call it that, of the Big Four, enlarging their concentration, by virtue of the fact they have been there already they are going to pick up a lot of the work. What we would very much like to see is that the remainder of the work is distributed in a different way.

Obviously we have heard quite a lot about it just now, but one of the things I think that would be very helpful would be if the remainder of the work could go into a mutual, possibly, but possibly a partnership with another of the firms. There are two who have been involved already, as I say, but whether any of the other firms would like to come in. Because it seems an admirable opportunity to achieve something that we have been trying to do-rather unsuccessfully I have to say-for quite a long time.

What we would not like to see is the break up facilitate the Big Four or the Big Three getting yet more work in this field, because we think that would be very deleterious for competition. So that is our main interest but we are also interested in the NAO.

Q446 Simon Danczuk: I share that concern about the Big Four dominating the work that is available in local authorities post Audit Commission, but the question then is: how do we tackle that? How do you create greater competition?

Dame Barbara Mills: I think it is very difficult to change a market, let me put it that way, which is what it has been. However, I do think there is an opportunity here. Let’s look at the figures at the moment: that work would, as a unit, make it become the fifth largest audit firm. That is very big, and I think that there is definitely a possibility that another firm, who have already had interest in this, could well wish to join up with them or part of them. So that would create some more competition, not only in this field but generally, which is important to everyone because, if you look at the private side of things, after all it is the shareholders’ money; if you look at the public side, it is the public’s money and it is equally important that you should have competition throughout that.

Q447 Simon Danczuk: I am not hearing anything that is going to get beyond that. Your proposal then is that the Audit Commission and some of the staff there create their own company that competes with the Big Four, but that is not much better than the Big Four dominating it. How do we get beyond that?

Dame Barbara Mills: Five is better than four.

Simon Danczuk: That is what you are aiming to do because that is what you are saying you want to do?

Dame Barbara Mills: Yes. That is one way you could deal with it. Five is definitely better than four. If one of the four were to fall at the moment, for one reason or another, then you would be down to three, there would be a real-

Simon Danczuk: You are talking small numbers-

Dame Barbara Mills: Small numbers but big organisations.

Q448 Simon Danczuk: So that is all you hope to achieve, to go from four to five? That is the competition.

Dame Barbara Mills: That is one of the things we would like to do.

Paul George: Perhaps if I can just add on that. I think that is very much the case in terms of the private sector, and we do see that the abolition of the Audit Commission does create an opportunity for increased competition in the private sector audits. I think your question, perhaps, was a little bit more targeted toward: how do you get more competition in public sector audits? I think that, clearly at the moment, all of the appointments are commissioned through the Audit Commission. They undertake 70% of the work themselves and then they allocate the balance of that work to appointed firms. At the moment the balance of that work goes to five firms. You asked a number of questions earlier on around the independence and how do you safeguard independence, but if you move the appointment process to a local level then you are likely to stimulate some competition.

What one needs to make sure, from the starting point, is that only those that are competent to do the work have the licence in order to conduct that work and I think there needs to be a process to make sure that there is adequate competency to start with. Once you have people who have the competency to undertake that work then one would hope that by moving the appointment process to local communities, that that could stimulate some competition.

So I think the competition issue needs to be looked at from two angles: first of all, the opportunity this creates for the private sector-and perhaps that is not your primary concern here-but also the opportunity to create greater competition for public sector audits. However, we need the safeguard within that that there is an appropriate level of competence before somebody is available to conduct that work.

Q449 David Heyes: I understood you to say that you have been advising the Audit Commission on the quality of their work for four years now.

Paul George: Yes.

David Heyes: Was there any stage during those four years that you said to them, "The quality of your work is such that you face a serious prospect of being abolished"?

Paul George: No, we didn’t. I think the discussions around abolition is not really one that we have-

David Heyes: It has been proposed partly on the basis of the quality of the Audit Commission’s work.

Paul George: If that is the case then that is not something that we have been involved in.

Q450 David Heyes: You didn’t spot it coming?

Paul George: I think what we have focused in on is providing reports to the Audit Commission on the quality of the work that we have seen. The Audit Commission has been very positive in responding to the concerns that we have raised and have put in additional policies and procedures in order to mitigate the concerns that we identified. What they have also done, which I think is great credit to them and is perhaps different to how some of the private sector firms have responded to our comments, is that they have been very transparent in their transparency reporting, in their corporate report on an annual basis, of the type of issues that we have identified, but to answer your question directly, we did not say that, "As a result of these issues you are at risk".

Dame Barbara Mills: I think we could say that it was rather a useful relationship for them because they came to us, which when you are a regulator is always a nice thing to happen as opposed to people being sent to us. I think they absorbed and understood what we were looking for and showed a great willingness to improve. That was gratifying. Not quite the relationship we always have. That was a very good one, and I certainly haven’t heard anything that is very adverse, let me put it that way.

Q451 David Heyes: What are the advantages of the oversight arrangements you propose, over and above those currently being delivered by the Commission?

Paul George: Shall I?

Dame Barbara Mills: Yes, you deal with that. I will come in.

Paul George: I think perhaps it comes back partly to the first question. We have not sought any additional responsibility as part of this process. We have engaged in a debate with the Department around their early considerations of what might happen, post the abolition of the Audit Commission, and it would be fair to say that we had some concerns that rather more regulatory burden was going to be imposed than we would perhaps seek to put in place ourselves. Therefore, we were very keen that any regime that emerged from these discussions was very proportionate to the risks associated with that. So we have sought to perhaps narrow down the degree of involvement of the FRC and, in particular, the role of the Inspection Unit within the FRC to only those entities that are of the greatest public interest.

Q452 Bob Blackman: Obviously, at the moment the Audit Commission will funnel work and make sure that the individual bodies that are doing audit work are controlled. The issue that you have raised is one of registering and licensing bodies after the Audit Commission has gone. Why should that process rest with just one of the professional bodies?

Dame Barbara Mills: We have been proposing the licensing of the audit for the public interest companies, so it should be licensing in the private and the public sectors. We think that that is rather important, because we have seen some cases in the private sector where a firm that is not properly equipped has been doing some of these audits. So we do want some sort of regulation. I absolutely back up what Paul says, which is: we do not want to have heavy-handed regulation, but once things are fragmented, as indeed these are going to be, then I think that you do need some proper oversight-is the way I would put it-of what is going on. Because once you have central control, or central standards, then they can be applied and seen throughout whatever organisation you are talking about, but if you have a situation, which is likely to happen, where you are going to have rather a large number of organisations, some small, some very large, then they should have some sort of regulation. Of course I was very interested in how much, and if in the same proportion, when the previous witnesses gave evidence. That seems to be absolutely essential.

We have been talking through, in many ways, the practicalities with the Department of how this can happen. Personally I think one of the most important things is that the audit committees are composed of capable people who are able to give proper consideration to what is being proposed, because there is going to be a bit of a circle between the appointees, the appointed and the audit committee.

Paul George: At the moment in the private sector in effect there are four bodies that licence the competence of firms to conduct audits. In our evidence submission we used the term "one of the professional bodies". I don’t think we would have any difficulty if it was more than one professional body, so long as whatever professional body undertook that function it undertook it with appropriate diligence and on a consistent basis.

Q453 Bob Blackman: One of the concerns will be that could potentially limit the individual companies that might come in and compete in this market. If it is only one of those professional bodies.

Paul George: There is that potential risk. I think there are in the order of 8,000 firms of registered auditors at the moment, a significant proportion of those are registered with two of the professional bodies.

Q454 Bob Blackman: What criteria would you use in terms of determining who is going to do this licensing and registration?

Dame Barbara Mills: Sorry, I am losing my voice today, which isn’t helpful. Both professional bodies, the two big ones, have 80% of the members. I don’t think it will necessarily limit it, it shouldn’t. They should have some competencies that are applicable, irrespective of which body the person who is applying belongs to. I would not have thought it would act to shut people out, if that is the point you were making about that.

Bob Blackman: Clearly, it sets another hurdle in terms of people coming into this market.

Dame Barbara Mills: That is right. On the other hand, I don’t think you want to have too many because then you have the problem of standardisation, and it is likely that the two bigger ones are going to have more sense of the competencies you are going to have across the board.

Q455 Bob Blackman: So are they going to be funded to do this, and who is going to pay for this work?

Paul George: At the moment they receive a licence fee, in effect from the firms that they regulate, and that is part of the cost of doing business, which ultimately is passed on to the recipient of the service.

Q456 Bob Blackman: You see that working in the same way for the public sector?

Paul George: I don’t see any reason to have a different approach.

Q457 Chair: What has been put to us is that, while the Audit Commission is obviously going to go and the hands-on audit work may go off to some mutual organisation, which we have talked about, and the Commission won’t exist anymore, there is still this number of regulatory functions that are around. Wouldn’t it be helpful if those remained in one body to stop the sorts of fragmentation that we have been talking about?

Dame Barbara Mills: I personally would be in favour of it remaining in one body but I am not sure that is an option that is open at the moment. I would think it is much easier to do that through one body. Otherwise when you get down to the practicalities of this-and we have been talking quite a lot to the Department to try to help with the practicalities-in my view there are some serious problems. Mainly how you hold up standards and values and also how you have it properly supervised, monitored, whatever word you are going to use, throughout all these fragmented bodies. That I do think is a real problem. That is why we have been trying to help to point out the pitfalls but more positively to say, "Look, we think this might work or that might work" but it is obviously up to the Department, the Minister and the Secretary of State to decide.

Q458 Chair: Any ideas who that body might be? Would it be the National Audit Office?

Dame Barbara Mills: They are the obvious people to do it. They are all ready.

Q459 Chair: Finally, a question about the principles of public audit. You basically said that you were happy that public audit closely mirrors that which is carried out in the private sector. One of the current principles is that public bodies do not appoint their own auditors. You seem to be fairly comfortable with that changing. Is that the case or do you have reservations, or do you think they need to be safeguarded and, if so, just briefly say what they are? Just a final point.

Paul George: I think what we suggested in our submission was we supported the proposals that the appointment of the auditor-and this is obviously to safeguard independence-should be through an audit committee accountable to the local community that the auditor is there to serve. So I don’t think we were suggesting in our submission that it would be down to the management of a local authority to appoint the auditors, we were supporting the proposals that we had heard, that audit committees would be put in place in order to provide appropriate independence from management over audit appointment and audit quality type issues. We appreciate there are some challenges in that, and I suspect at the larger end of the market it will be relatively straightforward for a principal district council to find suitably qualified and experienced people to undertake an audit committee role. It might be more difficult the smaller the authority. Therefore, perhaps one needs to look at alternatives to ensure there is appropriate economies of scale, because if it is a very small organisation there is probably not a huge amount of work for the committee in those circumstances.

Q460 Chair: That is the sort of function that a regulator-one overarching body-could have some oversight over and maybe assistance with?

Paul George: That is a possibility, yes.

Chair: Thank you very much indeed for the evidence you gave to us. Thank you very much.

Dame Barbara Mills: Thank you. I am sorry we couldn’t help you further but our expertise is not really-

Chair: No, that focused on the points in question very nicely, thank you very much.