Further supplementary written evidence
submitted by the Audit Commission
At the oral hearing session held on 14 March 2011,
you invited the Audit Commission to give written evidence on:
— Where
else in the world do local public bodies appoint their own auditors?
— How
much does the Commission save the public purse by taking on the
legal liabilities of auditors in their quasi-judicial role?
INTERNATIONAL COMPARISONS
As requested, we have carried out some research into
local audit arrangements around the world. This shows a mix of
appointment methods for auditors to local public bodies.
In federal countries, such as the United States of
America, Canada and Australia, many local services will be provided
and funded by a higher level of government body, eg region, state
or province, and these higher level bodies will generally be audited
by a centrally appointed auditor. In these countries, local authorities
appoint their own auditor, but only in relation to expenditure
funded through locally raised taxes. Local authorities in Scandinavia,
which raise a significant proportion of their funding through
local taxes, also appoint their own auditors. However, where authorities'
funding is heavily dependent on central government, as in the
UK, Ireland, continental Europe and New Zealand, the auditor is
generally appointed centrally.
Our analysis also suggests that, in those countries
where local authorities appoint their own auditor, the scope of
the audit is generally limited to providing an opinion on the
financial statements only, and does not extend to reviewing authorities'
performance or value for money.
It is also interesting to note that in some countries,
eg Sweden and Norway, the responsibility for the audit appointment
rests with directly elected councillors, who are appointed by
the local public bodies to independent audit boards or committees.
These councillors then procure audit services from private firms
who work directly for the independent audit board/committee, as
opposed to the authority itself, and help the audit board/committee
hold the authority to account.
THE COMMISSION'S
INDEMNITY TO
AUDITORS
The Commission contracts about 30% by value of all
audit appointments to external firms. The terms of those contracts
include an indemnity to firms facing litigation arising out of
their statutory audit functions.
The indemnity does not protect against negligence—it
only applies where the firm has acted reasonably. It is necessary
because of the special jurisdiction of auditors, which requires
them, from time to time, to take or defend legal proceedings in
the course of the audit. Typically, these might be proceedings
to determine the legality of a local authority's actions, or to
respond to an appeal by an objector against the auditor's decision
on an objection to the accounts.
If the auditor wins and recovers costs in full from
the other party, there is no call on the indemnity. If the auditor
loses, there is no basis for charging costs to the audited body
as part of the audit fee. But auditors who have acted reasonably
should not be disadvantaged financially.
In practice, calls on the indemnity are infrequent.
In the last five years it has only been called upon once, and
that case is currently subject to appeal. The case concerns the
decision of the auditor to reject a wide-ranging objection to
the legality of a local authority's car-parking arrangements.
The High Court upheld the auditor's decision, and ordered the
objector to pay £40,000 towards the auditor's legal costs
of £77,370. The Commission has paid the auditor under its
indemnity, and will recoup from the costs payable by the objector.
Payment against the costs order is currently suspended pending
the objector's appeal to the Court of Appeal.
The costs of the indemnity are borne by all audited
bodies through their audit fee. As the costs are low, the impact
on fees is negligible. However, the indemnity is worth a lot to
the firms, who can be confident that, if they exercise their audit
functions reasonably, they would not be exposed to financial risk.
Auditors from the Commission's in-house audit practice
have also faced litigation over the same period. There have been
three cases, one in each of 2006, 2007 and 2008, all of which
the in-house auditor won. The costs of in-house auditors not recovered
from the other side are met by the Commission, and are also passed
on to audited bodies in audit fees.
This gives an idea of the frequency of litigation
involving auditors across the whole regime. This is relevant as
in the future it is intended that the remaining 70% of audits
by value will be conducted by the private sector.
It is not possible to quantify the saving to the
public purse of the current arrangements. However, the risk of
litigation is likely to increase in the absence of a third party
such as the Audit Commission providing advice, guidance and support
to auditors and indemnifying them against legal costs that may
arise. This risk is likely to be passed on in increased fees.
CONCLUSION
Finally, the Select Committee has ended earlier sessions
by asking "was it right to abolish the Commission or should
it have been reformed?" or by giving the witnesses an opportunity
to make some concluding remarks. Our session was interrupted by
the division bell, so this opportunity was denied to the Select
Committee and the Commission.
Had we been asked the question, our answer would
have been clear and unequivocal. We accept that different governments
have taken different approaches to the role and nature of inspection
during the Commission's history and our role has been to implement
government's requirements. In terms of audit, we continue to believe
that auditors of local bodies should be independently appointed
and that a single regulatory body will offer better value for
money than if responsibilities are split between different organisations.
We consider that it would be possible to give local
bodies more influence over the appointment of their auditor, while
retaining the safeguards of independent appointment under the
current arrangements, and we will continue to make such proposals
to government. We hope that externalising the audits currently
undertaken in-house would enable a thriving mutual organisation
to develop based on the Audit Practice.
We also believe it is counter intuitive to disband
the Commission, with its powers to carry out national value for
money studies at a time of change and financial pressure on local
bodies. In short, we consider the Commission should be reformed,
not abolished.
In terms of finance, the government achieved 70%
of its financial objectives by stopping CAA and inspection work.
By the end of this financial year, the actual costs of running
the Audit Commission—with a retained capacity for regulation,
commissioning and value for money studies—will be about
£11 million. Our abolition will save these costs, although
some will be moved incurred elsewhere as costs of the new regime
and transfer to public bodies, regulatory organisations and the
firms. There will also be redundancy and other costs to be met
as we outlined to the Committee.
Until there is more certainty about the outcome of
the Department's consultation; the legislative timetable; and
the costs and benefits of the new regime, the old regime should
not be irrevocably abandoned. This would also make managing the
transition a less risky proposition and increase staff motivation.
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