Examination of Witnesses (Questions 402-441)
VERNON SOARE, GILLIAN FAWCETT AND STEVE FREER
29 MARCH 2011
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.
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