Audit and inspection of local authorities - Communities and Local Government Committee Contents


5  Competition in the audit market

Domination by the few

58. The number of firms successfully competing in the public sector audit markets is small. The Audit Commission has 70% of the local government market with only five other firms involved in the remaining 30%. Foundation Trusts use only a small number of audit firms: the Audit Commission Chairman told us that, effectively, this is now down to three including the Audit Commission.[92] The NAO uses private audit firms for less than 20% of central government work.

59. The issue of market competition and choice in the public sector cannot be addressed in isolation from the private sector audit market, which is dominated by a small number of large accountancy firms. The House of Lords Economic Affairs Committee recently reported that the dominance of the "Big Four" has limited competition and choice and that attempts to introduce greater competition had failed.[93] It recommended that the Government should work to encourage the development of a competitor.[94] The Financial Reporting Council is keen to see the Audit Commission audit practice emerge as a fifth large practice, competing in both the public and private sectors.

60. The Government says it wants to see a competitive market develop for local government audit providing choice and lower audit fees. Some of our witnesses were concerned that a similar model of the dominance by a few large audit firms would emerge in the public audit sector, with limited choice and competition. The experience of the Foundation Trusts is not encouraging: only six companies provide audit services, all of which did so through the Audit Commission prior to 2004.[95] Witnesses also questioned how the market would be managed to encourage new entrants in the absence of a central procurement body. During the lifetime of the Audit Commission, the number of private firms undertaking local public audit has fallen from 13 in 1983 to five today.[96]

61. Unless the Government can crack the problem of the very limited competition in the audit market in the UK, it will be open to the accusation that the abolition of the Audit Commission is not a measure to save public money but merely a mechanism to transfer public money into private hands. For local auditor appointment to work, the local government audit market must be opened up to wider competition that provides local authorities with a genuine choice of audit firms. This will require active management and learning from developments in the private sector, such as the outcome of the OFT's current review. DCLG should work with other appropriate bodies, including DBIS, Competition Commission, FRC, the LGA and professional accountancy bodies to deliver a more open and competitive local government audit market.

Audit Commission audit practice

62. The Audit Commission audit practice is the fifth largest audit practice in UK. It is a respected, professional body, as acknowledged by DCLG and others, which has helped to raise standards in local government public audit.[97]

63. The DCLG is now developing plans to establish the Audit Commission audit practice as a separate entity from Audit Commission, possibly as a mutual, that will compete for local government audit work in future. The proposals are not part of the DCLG consultation. Financial consultants FTI were appointed on 18 April 2011 at a fee of £100,000 "to provide advice on the most cost-effective options for disbanding the Audit Commission" and transferring its in-house audit practice into the private sector.[98] It was unhelpful that the Minister did not inform the Committee during oral evidence of the imminent appointment of advisers.[99] At that stage the appointment process was well advanced, having started in February.[100]

64. The Audit Commission audit practice has proved its ability to compete against private audit firms and now audits 52 foundation trusts, comprising 38% of the FT audit market. Gareth Davies, Managing Director of the Audit Commission audit practice, was keen to emphasise to us the positive approach that the practice is taking towards securing a successful future as an all-employee-owned (mutual) business.[101] In contrast, Prospect was pessimistic[102] about the capacity of a reformed and floated-off audit practice to survive in a competitive environment:

    The idea of pulling an organisation like the Audit Commission into that competitive world within the lifetime of this Parliament, let alone in the next 12 to 18 months, is fanciful. I do not believe it has the skills, nor could it attract them.[103]

The Government made three appointments to the Board of the Audit Commission in November 2010 which it said would "bring significant private sector expertise that will be crucial in steering the organisation as it addresses new challenges".[104]

65. We do, however, note Prospect's concern that staff may be lost to the profession entirely[105] if arrangements are not handled properly and speedily, although they told us that the level of staff turnover had not changed significantly.[106] The practice may find conditions tougher in future without its core workload of guaranteed local government audit work. It is almost inevitable—and desirable, in terms of promoting choice and competition—that its market share will reduce from 70% of the local government audit market.

66. It is vital that the Audit Commission audit practice's skills and expertise are not lost and that it remain a significant player in local government audit market, in order to provide fee competition and choice. Our favoured outcome is the establishment of a stand-alone company, preferably a mutual. If this proves to be unviable, merger with another audit firm outside the Big Four would be our second preference. Failing both of these, the audit practice should be broken up so that capability is spread to a number of other smaller firms. It would be entirely unacceptable for the practice to be bought by one of the existing Big Four as this would further reduce the already-limited choice and competition. DCLG must also carefully consider the transitional arrangements and ensure that the necessary assistance and stability is provided to assist the audit practice through this period, particularly if the practice is established as a mutual.

Audit fees

67. Lower audit fees are, according to the Government's consultation document, one of the four key design principles of the Government proposals.[107] The minister told us that, with local appointment and without the 20% overhead charge added by the Audit Commission, he was confident that the overall cost of audit fees would come down. By contrast, the Audit Commission pointed out the savings that it had been able to deliver as a result of centralised purchasing of audit services over a long period. The NLGN report, drawing on international experience, found limited evidence on which to predict how fees will change; it found both positive and negative examples of decentralisation of audit and fees. Its UK research found opinion divided over whether fees would rise or fall.[108] We heard concern that fees may rise, both in general and in particular for small or remote councils. Auditors Grant Thornton expected that fees would fall in areas such as London but rise in more remote areas such as Cornwall and Cumbria.[109]

68. The proposals for local government contrast with the situation in central government, where the NAO is reducing the percentage of work that it contracts out to private audit firms:

    Our percentage is low, because we use the private sector to supplement what we do. For completeness of disclosure, it's probably becoming even a bit less [than 20%], because as we work more efficiently and use our resources better, we find it cheaper to work our in-house resources.[110]

69. Developing a fully competitive market will be an important element in achieving lower overall audit fees—a key design principle of the Government's proposals. All local authorities should be required to publish annually their audit fees, showing separately the cost of the mandatory (code) audit and any additional audit or consultancy work. The figures should be published in a consistent way that allows comparison and analysis.

70. It has been suggested that,[111] without the indemnity provided by the Audit Commission, private audit firms will have to purchase their own indemnity to cover costs that may arise from PIRs or other litigation and that audit fees may rise as a result. This, however, seems unlikely to be significant. The cost of undertaking the PIR has always been charged to the audited body. The Audit Commission indemnifies the private firms with whom it contracts against costs arising out of their statutory audit functions. The indemnity does not protect against negligence. The frequency of litigation appears to be low. Over the past five years, only one call on this indemnity has arisen and the Audit Commission has faced only three cases of litigation.[112] Moreover, audit firms are accustomed to working in the private sector, which is more litigious than local government and where the amounts of money at issue are often very high. In the case of Westminster Council, had the Audit Commission lost its appeal to the House of Lords, it stood to lose £12million[113]—a substantial sum but not enormous by private sector standards.


92   Q 209 Back

93   House of Lords Select Committee on Economic Affairs (2011), Auditors: Market concentration and their role, HL Paper 119-I, para 33 Back

94   House of Lords Select Committee on Economic Affairs (2011), Auditors: Market concentration and their role, HL Paper 119-I, para 53 Back

95   NLGN Show me the money-accounting for localism, April 2011, p 35 Back

96   Audit Commission, The Future of local audit: issues for consideration, September 2010, p 19 Back

97   Ev 228 Back

98   http://www.communities.gov.uk/newsstories/corporate/1889668 Back

99   Qq 568-577 Back

100   HC Deb, 17 May 2011, col 145W Back

101   Ev 169 Back

102   Qq 287-293 Back

103   Q 290 Back

104   DCLG press notice, The Audit Commission-appointment of new commissioners, 10 November 2010 Back

105   Qq 284-285 Back

106   Q 282 Back

107   DCLG consultation document, para 1.17 Back

108   NLGN, Show me the money-accounting for localism, April 2011, Chapter 3. Back

109   Ev w49 Back

110   Q 514 Back

111   Q 26 Back

112   Ev 171 Back

113   Follow the money, p 506 Back


 
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Prepared 7 July 2011