Written evidence submitted by BDO LLP
1. EXECUTIVE
SUMMARY
1.1 BDO LLP is the award-winning UK member firm
of the BDO international network, the world's fifth largest accountancy
organisation, with more than 1,000 offices in over 100 countries.
We are one of the UK's top six providers of audit and assurance
services. Our public sector clients include the Audit Commission,
the Higher Education Funding Council for England, the Learning
and Skills Council and local authorities. We are a supplier to
the Audit Commission, performing limited assurance audit and related
services to "small bodies". We are committed to developing
our business, including audit, in the local government sector.
1.2 We are pleased to have the opportunity to
submit written evidence to the Committee's inquiry into the audit
and inspection of local authorities and welcome the Committee's
examination of this important issue. Our submission focuses on
our areas of our direct experience. We would welcome an opportunity
to give oral evidence to the Committee and are happy to provide
additional information.
1.3 The scale of public bodies currently audited
by the Audit Commission, ranges from principal bodies, such as
local authorities and NHS bodies, to small bodies, such as parish
and town councils. These bodies have varied obligations and assurance
needs which can best be met by a range of assurance suppliers
that reflects this diversity. Five private sector firms currently
carry out around 30% of the Audit Commission's audit work accounting
for fees of £45 million. This compares to 13 firms undertaking
15% of audit work when the Audit Commission was first established
in 1983.
1.4 We believe the disposal of the Audit Commission's
audit practice to a diverse range of large, medium and small sized
firms in the private and third sectors presents the most effective
way to create lasting competition and reduce the cost of providing
audit and assurance services to public bodies. A concurrent review
of the regulatory framework is warranted and we believe should
result in greater alignment with private sector reporting while
retaining public interest and value for money reporting.
1.5 Therefore, a transfer to multiple bidders
should be pursued as quickly as possible to avoid further regulatory
uncertainty. We would support a partial buy-out to create an employee
mutual as an additional independent player in the market.
1.6 The sale process will need to be carefully
designed to balance capability with long- term value. Long-term
value should not be assessed solely against the typical sale objective
of maximising disposal consideration, but factor in disposal consideration,
mitigation of legacy obligations and the sustainability of audit
cost savings through competition.
1.7 To enable the maximum number of firms to
bid for contracts, we recommend:
(a) Bidders should be evaluated on their ability
to build on acquired contracts (and staff transferred under TUPE)
not solely on their prior experience in public sector auditing.
(b) Contracts should be aggregated on a regional,
national and sector basis to create diverse portfolios of various
values attractive to a range of bidders.
(c) The Government should retain accrued pension
liabilities and certain other obligations, as Government is able
to fund these liabilities more cost effectively over the long
term.
(d) A transitional period of contractual protection,
during which successful bidders, notably new entrants to the market,
are partially protected from re-tendering is necessary to create
the conditions for sustainable competition.
1.8 We believe that a panel (or panels if Local
Government and NHS needs vary significantly) of approved auditors
should be established to facilitate cost effective access to audit
firms deemed fit by the relevant regulator. Use of such a panel
should not be mandatory, but provide a route to reduce the costs
of procurement and take advantage of Government purchasing power.
The existing regime for small bodies (up to £1 million turnover)
is working well and should be extended to those spending up to
£6.5 million in line with the private sector audit threshold
with additional transparency requirements to facilitate public
scrutiny.
In conclusion, we believe that a process designed
to transfer the audit work undertaken by the Audit Commission
to a plurality of providers, reinforced by a flexible approach
to accrued pension obligations, will deliver long-term value for
money by creating a sustainable increase in competition in the
audit market. We fully support this aim.
2. OBJECTIVES
2.1 Having made the decision to abolish the Audit
Commission, it is now crucial that the way in which the policy
decision is implemented provides maximum opportunity for Government
in its widest sense (ie both local and national) to achieve maximum
value from the process. Value should be measured not only financially,
but against a wider set of objectives that abolition should set
out to achieve. We believe the Government should seek to achieve
the following four objectives:
(1) Maintain and improve public confidence in
public sector financial reporting. Taxpayers require information
that is relevant, reliable, understandable and timely. High quality,
cost-effective and independent verification and audit of this
information is therefore essential.
(2) Facilitate understanding and public scrutiny
of public sector spending. There undoubtedly remains a need for
accountability and transparency of public expenditure and how
public bodies secure value for money in their use of resources.
(3) Reduce the cost of audit work through the
creation and maintenance of greater competition in the public
sector market.
(4) Signal Central Government's desire to promote
and sustain a more plural public and private sector audit market.
By prioritising the creation of long-term competition in the public
sector audit market when implementing the abolition of the Audit
Commission, the Government can send a strong signal to users of
audited accounts that a wider range of audit firms have the skills,
capacity and willingness to participate in the whole of the audit
market.
2.2 Objectives 1 and 2 set out above can, we
believe be best handled by the creation of an appropriate regulatory
framework, potentially under the auspices of the Financial Reporting
Council. We believe that aligning the public and private sector
financial reporting and auditing frameworks should, in the absence
of specific reasons for retaining different requirements, be an
objective of Government. The benefits of such an alignment include
access to an expanded pool of financial expertise, cross fertilisation
of ideas and a general reduction of the barriers to the transfer
in either direction of people.
2.3 With regard to objectives 3 and 4, we believe
that Government has a significant opportunity to facilitate a
step change in the level of competition in the audit market as
a whole. The scale of public bodies currently audited by the Audit
Commission, ranges from principal bodies, such as local authorities
and NHS bodies, to small bodies, such as parish and town councils.
These bodies have varied obligations and assurance needs.
2.4 We believe that the abolition of the Audit
Commission gives an opportunity for the reassessment of their
needs and that the diversity in these needs can best be met by
a range of assurance suppliers that reflects this diversity. We
believe that giving public bodies the freedom to appoint their
own independent auditors will create a more plural and competitive
market and is the best way to drive and keep costs down.
3. ROUTES TO
ABOLISH THE
AUDIT COMMISSION
3.1 We believe that there are four principal
ways in which Government could reconfigure the audit services
currently provided by the Audit Commission. A summary of these
routes and the principal pros and cons is presented below:
| Description |
Pros | Cons
| Our View
|
| Option 1
Fully contract-out the remaining 70% of audits carried out by the Audit Commission to private firms, with Central Government retaining solely a commissioning and regulatory role
| —
—
—
—
—
| Provides a mechanism to maintain competition by spreading contracts across firms.
Could generate cost savings. Bought-in services have realised savings of £30 million over five years. Recently renegotiated contracts have produced further savings of £11 million over the period to 2016-17.
Economies of scale can be achieved through the same firm auditing different bodies in the same geographical location (assuming contracts would be structured and awarded in such a way).
Facilitates the (continuation of) pooling auditors' costs to spread, what could otherwise be, significant regional variations from free market pricing.
Emphasises the independence of the audit role, by the appointment being made centrally rather than by the body being audited.
| —
—
—
—
—
| Unlikely to generate short term value to Government.
Retains central control over audit appointment.
Potential for incumbent providers to dominate unless competition is prioritised over the short term.
TUPE and pensions transfer negotiations may be lengthy and complex.
May reduce incentives to innovate
| —
—
—
—
—
| The complete contracting-out of audit work to private firms represents an evolution of the current structure of the Audit Commission and is potentially the simplest option available.
Contracting-out has in the past reduced prices significantly and would most likely extend lower prices to much of the market.
In effect, it would facilitate the "management" of the market, potentially to maintain competition.
The Audit Commission (or another Central Government body) would retain solely a commissioning and regulatory role.
However, this route does not create freedom to appoint with the customer, which does not appear to satisfy the policy objectives of CLG by creating a free market.
|
| Option 2
Sale of the audit practice as a whole with no further commissioning role for the Audit Commission (or other Central Government body)
| —
— | May provide short-term value for Government.
Continuity in customer relationships, contracts and staffing.
| —
—
—
—
| Does not meet the objective of increased competition in the audit market.
Incumbents capable of outbidding new entrants, potentially allowing Big 4 dominance of the public sector audit market.
TUPE and pensions transfer negotiations may be lengthy and complex.
Less likely to generate or maintain long term cost savings.
| —
—
—
—
| This is in our view, unlikely to generate significant additional competition in the public sector audit market.
Market incumbents are likely to be capable of outbidding new entrants as they have better knowledge of the market and existing divisions into which to absorb the new business.
It is probable that only Big 4 firms have the infrastructure and resources to execute an acquisition on this scale - the audit revenues exceed those of all other UK firms. As a result, any auction process is unlikely to attract many, if any, potential new entrants to the market. There would therefore be a strong chance that an outright sale would result in Big 4 dominance of the public sector audit market.
This in turn is unlikely to create the competitive conditions for the cost savings already achieved by the Audit Commission through outsourcing audit work to the private sector to be maintained in the long term.
|
| Option 3
Break-up and transfer to the private sector
| —
—
—
| May provide short-term value for Government.
Could create greater competition. Multiple, small lots would be attractive to and within reach of more bidders, allowing new firms to enter the public sector audit market.
Likely to generate short-term cost savings. Bought-in services have realised £30 million over five years. Recent renegotiated contracts have produced further savings of £11 million over the period to 2016-17.
| —
—
—
—
| May favour incumbents with existing public sector audit practices.
TUPE and pensions transfer negotiations may be lengthy and complex.
Disperses knowledge and expertise of public sector auditors (although this can also be a "pro" in the context of developing a wider market).
May be disruptive to customers.
| —
—
—
| This is, in our view, most likely to allow the creation of greater competition.
A diverse market can best be met by a range of audit firms. Any tender process should be designed to facilitate the maximum number of firms to bid for contracts.
New entrants will need to invest in people, training and systems in order to build the expertise necessary to service the public sector audit market. We believe that a period of contractual protection, especially for new entrants, is necessary to create the conditions for sustainable competition.
|
| Option 4
A full or partial management or employee "buy-out"
| —
—
—
—
| May provide short-term value for Government.
Consistent with wider government policy to encourage employee ownership.
Retains knowledge and expertise of public sector auditors in one place.
Some continuity in customer relationships.
| —
— | Unless combined with option 1 or 3, does not meet the objective of increased competition in the audit market.
Resultant audit practice would, initially, be less diversified than firms servicing multiple sectors. Servicing a single year-end is likely to be less efficient and reduce the scope for cost savings to customers.
| —
—
—
| A "buy-out" should be seen in the context of the process to implement option 3 above and should be considered along with other bids.
Accordingly, the assessment criteria should evaluate the benefits of continuity in customer relationships and the retention of knowledge and expertise within the organisation.
It may also be appropriate for Government to attach value to the creation of an employee owned audit business in supporting its new "Rights to Provide" policy goals.
|
4. RECOMMENDATIONS
4.1 Regulatory Framework
4.1.1 The existing regime for small bodies that spend up to
£1 million (c9,800 bodies) is working well and should be
retained. It provides a proportionate amount of scrutiny by independent
firms working to a code of practice with obligations to make Public
Interest Reports where breaches of regulations are identified.
We believe that reliance on internal auditors to carry out this
task or any replacement assurance work, as has been suggested
by some commentators, could reduce the quality of work and in
many cases challenge independence.
4.1.2 An alignment of the regulatory framework with the private
sector in terms of accounting thresholds (£6.5 million turnover)
and the removal of the need for an audit would seem appropriate.
The small bodies regime should therefore be extended to bodies
spending between £1 million and £6.5 million (c100 bodies).
4.1.3 Public interest reporting has acted as a powerful tool
to ensure public bodies address their responsibilities as they
are keen to avoid any adverse reporting. Accordingly, this duty
should be retained and a process will be required to mediate on
who should bear the costs in contentious cases.
4.1.4 Auditors of local government bodies also have specific
responsibilities to members of the public who have the right to
ask questions about the accounts and make objections to them.
The wider scope of public audit reflects the accountability of
the public body to its electors and tax payers. The normal performance
measures on directors to deliver shareholder value do not apply
as the shareholders of the public body is a taxpayer who demands
accountability in terms of high standards of propriety and the
best use of scarce resources. The auditor in the public sector
therefore has to review corporate governance, both legal and propriety,
and review arrangements to secure value for money and separately
report thereon. The costs of dealing with electors' questions
or objections can be disproportionate to the issues raised and
a mediation process will be required to agree what should be investigated
and who should bear the costs.
4.1.5 A number of the Audit Commission's roles will continue
to be required, including setting codes of practice and ensuring
all bodies are subject to an audit or review. This could be absorbed
by existing organisations such as the Companies House and the
Audit Inspection Unit (AIU).
4.2 Abolition of the Audit Commission
4.3 In light of the above analysis, we believe that the optimum
route to achieving the Government's policy objectives is the break-up
of the Audit Commission and the transfer of its audit functions
to the private sector (option 3 above). This could be combined
with a partial employee "buy-out" (option 4 above),
creating an independent additional player in the market.
4.3.1 The creation of an employee mutual or similar structure
would be consistent with wider government "Rights to Provide"
policy to encourage employee ownership, facilitate the retention
of extensive public sector audit knowledge and expertise in one
place and provide valuable continuity in customer relationships.
4.3.2 The creation of greater competition starts with maximising
the scope for a diverse range of audit firms to bid for contracts
- large, medium and small-sized audit firms as well as incumbents
and new entrants. We, therefore, recommend that the Audit Commission's
client base should be divided into a wide range of portfolios
of contracts. These portfolios should be regionally based allowing
local as well as national firms to bid for portfolios. Subject
to the regulatory regime, it may be appropriate to split local
authority and NHS bodies into separate portfolios.
4.3.3 The tender process will need to be carefully designed
to achieve the objectives set out above. Specifically, the bidder
assessment criteria need to balance capability with long-term
value. Capability covers:
(a) Expertise - we would envisage that many existing Audit
Commission staff would transfer to successful bidders under TUPE
regulations. Accordingly, a track record in public body assurance
work should not be heavily weighted. Instead, evidence to demonstrate
the ability to integrate a new team and provide leadership and
management should be assessed.
(b) Quality - an assessment of bidders' regulatory quality
should rely on their overall compliance record, as evidenced by
AIU reports and in the areas of tone at the top/leadership, systems
and processes. Knowledge and expertise should be assessed in the
context of the Audit Commission staff transferring to the bidder.
(c) Independence - audit independence should be in line with
existing Auditing Practices Board (APB) guidance and will be a
statement of fact based on the regulatory conditions applicable
under the new regime.
(d) Scale and regional coverage - while a minimum firm size
is likely to be necessary in practice, we do not believe specific
thresholds should be set. Existing ethical guidelines could be
used instead. The sufficiency of bidders' operations must be assessed
in the context of the contracts being bid for.
4.3.4 We believe that long-term value should not be assessed
solely against the typical sale objective of maximising disposal
consideration. Rather the value criterion should be long-term
value to the public sector as a whole taking into consideration
the time values of: any disposal consideration, any mitigation
of legacy obligations of the Audit Commission such as accrued
employment and pension rights and cost savings to public bodies.
The evaluation of cost savings, which must factor in long-term
sustainability of savings through competition, will necessarily
include judgement and subjectivity.
4.4 Other factors to consider
4.4.1 As stated above, a period of contractual protection
is necessary to attract new entrants into the market. A transitional
period, during which successful bidders, notably new entrants
to the market, are partially protected from re-tendering, is necessary
to create the conditions for sustainable competition. We suggest
that this protection is aligned with the existing term of outsourced
contracts to 2016-17.
4.4.2 A properly structured period of contractual protection
should balance this incentive for new entrants to bid at competitive
prices (aside from employees transferred under TUPE, they will
need to invest in people, training and systems to build the expertise
necessary to service a new market effectively) with mechanisms
for public bodies to hold auditors to account. Coupled with the
new, simplified regulatory regime, we believe service standards
could be maintained or improved.
4.4.3 While it is reasonable to expect bidders to operate
with the TUPE regulations in effecting the transfer of staff from
the Audit Commission, the defined benefit pension scheme and certain
other employment undertakings, represent a very significant barrier
to many bidders. Unless addressed these barriers will significantly
reduce the number and value of bids. We would, therefore, urge
Government to structure a disposal process such that the employment
terms of transferring staff are as closely aligned to private
sector practice as is possible. This would entail the Government
retaining the accrued pension liabilities and certain other obligations
(for example excessive redundancy packages) as it plans to do
in relation to the privatisation of Royal Mail through the Postal
Services Bill. We would further suggest that the long-term funding
risks of these accrued liabilities would be funded more cost effectively
by Government than by bidders. Consequently, long-term value is
most likely to be delivered by the Government structuring the
disposal so as to retain these liabilities.
4.4.4 Allowing each (larger) local public body to procure
its own auditors does create a risk that the audits of some (smaller)
bodies, by virtue of their size and/or geography, prove to be
unattractive to the market as individual contracts. Currently
such audits are bundled with larger audits. Small bodies may,
therefore, attract few bids and/or find their audit fees significantly
higher than the current scale fees. Collaborative procurements,
which local authorities are experienced in for other services,
may mitigate this to some extent, but ensuring that all local
public bodies are able to benefit from the reform of the market
should be a fundamental requirement of the way in which any competition
process is structured.
4.4.5 We believe that a panel of approved auditors should
be established by means of a framework or similar arrangement.
The purpose of such a panel (or panels if Local Government and
NHS needs vary significantly) should primarily be to facilitate
cost effective access to audit firms deemed fit by the relevant
regulator. Panel membership would necessarily be broad and perhaps
split regionally. Use of such a panel should not be mandatory,
but provide a route to reduce the costs of procurement and take
advantage of Government purchasing power.
4.4.6 An employee mutual will initially be less diversified
than other market participants by virtue of solely supplying the
public body audit market reporting to a single year-end. A potential
solution is the creation of a strategic alliance or partnership
with a third party. This could provide financing, management,
back-office/systems, but also share staff to service different
markets and improve utilisation of resources. The viability of
an employee mutual would therefore need to be assessed carefully
in the context of any such strategic arrangements proposed.
Philip Prince
BDO LLP
January 2011
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