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


Written evidence submitted by ACCA

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EXECUTIVE SUMMARY

The Association of Chartered Certified Accountants (ACCA) welcomes the opportunity to respond to the call for evidence by the Communities and Local Government Parliamentary Select Committee for its Inquiry on audit and inspection in local government.

—  We believe that there are a number of issues and outstanding questions that need addressing if local government is to have a sensible, proportionate and cost effective auditing system for local public services in the future—this is tantamount to ensuring accountability and the stewardship of public funds.

—  The disentanglement of the current audit regime has come at a time when public services are undergoing radical change and restructuring which necessitates strong governance, risk management and audit. We are concerned that if Government proposals are not fully thought through that we will have a mish mash of auditors and regulators for public services that fail to deliver both accountability and cost effectiveness for the public.

—  The abolition of the Audit Commission coupled with the abolition of the ethical standards regime for local government places governance and accountability of public services at risk. Also, as health bodies are undergoing major change it is still unclear how the audit of health services such as the new GP consortia will be delivered.

—  If the Government intends local authorities to appoint their own auditors by 2012, not only has the legislative process to be put in place, but it has no means of knowing how the audit market will react. There continues to be uncertainty about how value for money will be dealt with and how anti-fraud and corruption measures will be addressed. Not least there are questions over whether the new audit arrangements will be cost effective for local government in the long-run. We have set out a number of issues below that we hope will be considered as part of this Inquiry.

AUDITOR INDEPENDENCE

Overall, we are supportive of a mix of firms and the current proposal to establish a new audit mutual made up of what was the district audit service competing for local government audits. We also are keen to ensure that safeguards are introduced to ensure that small and medium sized accountancy bodies are not crowded out from competing for audits by the "Big Four". In our response to the European Commission's Green Paper, Audit Policy: Lessons from the Crisis we outlined that a market with greater competition and choice would be in the public interest and regulators should intervene, if only, to create a level playing field.[50]

History tells us that as far back as the 19th Century for a considerable period of time auditors which were appointed and locally elected were largely ineffectual and there was no evidence to show that local authorities (poor boards as they were then) improved or tackled fraud and corruption. Because of this in 1868 Parliament took the decision to ensure that auditors were completely independent of those they audit.[51] This model of independent appointments has largely remained unchanged for 150 years and has meant that auditors could go about their work without fear or favour. This has been one of the fundamental principles of public audit.

As a result of these arrangements even today the public sector does not have the same issues of auditor independence as in the private sector, where, arguably company management exerts more influence than the shareholders on the process of selecting and appointing auditors, a situation which could compromise independence by allowing cosy relationships to develop in fear perhaps of losing business.[52] The recent banking crisis shone a light on these issues with particular reference to the balance of audit to non-audit work offered by firms which has the potential to compromise auditor independence.[53]

As yet it has not been made clear as to who will be appointing the auditors in a typical local authority. This raises a number of questions. If one follows the private sector model where shareholders appoint the company auditors, then it would be local tax payers or residents who would be responsible for appointing the auditors and setting terms of reference. Also, given that central government funds 75% of local authority expenditure it would seem logical that it would have a say.

Current government thinking is that the full council would make the appointment. However, this in itself could lead to problems, particularly in relation to public perception and trust. Arguably, the full council of a local authority has a democratic mandate on behalf of the public to make the appointment, but where will be the safeguards to ensure that the ruling political party has not exerted undue influence over the decision? It can't be in the public interest to have those responsible for decision-making also influencing the choice of auditor and setting their terms of appointment. This arrangement would need to have checks and balances to avoid conflicts of interest arising. Again, current thinking is that local authority audit committees would fulfil this role.

We believe that strong audit committees are fundamental to strong corporate governance, but there are a number of issues that will need to be overcome if local government audit committees are to take on this role. Firstly, not all local authorities have audit committees and there is no statutory duty for them to have one. In comparison, in a growing number of countries audit committees are being mandated for listed companies. Secondly, audit committees will have to be strengthened in terms of skills, expertise and capacity to take on this new role and at further expense to local authorities.

In our view and experience of the private sector, the oversight role of the audit committee will continue to expand and grow. In relation to local authorities, audit committees will need to be mandated and strengthened by drawing upon all available sources of expertise, including internal audit functions, external auditors, and, if necessary, outside lawyers and advisors. This means ensuring that knowledgeable and independent-minded individuals are appointed to local authority audit committees and that they develop an aptitude for asking the right questions to prevent conflicts of interest arising.

THE RELATIONSHIP BETWEEN THE PROVISION OF EXTERNAL AUDIT AND OTHER NON-AUDIT SERVICES

Related to auditor independence is the extent to which audit firms will be able to perform non-audit services (consultancy) and/or provide internal audit services for authorities in the future. Arguably, as shown in the private sector it has compromised the auditor's obligation to carry out an audit fearlessly and independently. For example, most recently, MPs have raised concerns about the mix and provision of non-audit services in their review of the banking crisis.[54]

Given that local public services are exposed to wider audit coverage (financial, governance and VFM) than their private sector counterpart there has been little need to provide consultancy or advisory services outside the scope of the audit. However, what is still unclear is whether or not the wider audit remit set out in the Audit Commission's Code of Audit Practice will be restricted in scope and if so whether this will increase consultancy.

As it currently stands the Audit Commission monitors consultancy work carried out by a firm that is providing an external audit service so that it does not compromise auditor independence. Consultancy contracts can be more lucrative and strategically important to the firms than individual audits and we believe that checks and balances need to be introduced to prevent conflicts of interest arising. Similarly, it is not clear what will prevent a firm providing both external audit and internal audit services to the same local authority. Most recently, questions have been raised where the external auditor of a UK listed companies has carried out internal audit work for the same client. In 2010 the Financial Reporting Council (FRC) made a decision to carry out a review of "extended assurance services". The review is currently in progress.

IMPLICATIONS FOR VALUE FOR MONEY REPORTING

We understand that the Government proposes that the Audit Commission's value for money work will pass to the National Audit Office (NAO) and discussions are currently underway about how this could work. Whilst the NAO has an excellent record of value for money with central government departments, NDPBs and agencies, it has no track record of value for money in local authorities. There are a number of issues that arise from this potential arrangement.

Firstly, if local authority VFM reporting becomes a function of the NAO it will require additional resources and will need to build the necessary capacity and skills to undertake the work. In other words it will cost more. There will also need to be arrangements put in place for it to liaise with the firm carrying out local audits. The House of Commons Public Accounts Committee (PAC) workload is already at stretching point with on average of 70 VFM reports being reviewed each year. In our view it hasn't got the time or capacity to follow up existing VFM reports so it is questionable how it will deal with the additional VFM workload without having to consider other mechanisms for reviewing VFM reports as part of the Parliamentary process.

Secondly, if it is the case that VFM reports on local authorities are undertaken by the NAO, then it is not unreasonable to think that one day a local authority chief executive will appear before PAC. This doesn't quite fit in with the localism agenda and muddies the waters in relation to accountability. John Tiner in his review of the NAO's governance arrangements pointed out that the "constitutional background and lines of accountability for the audit of central government and local government are, properly, quite different and could become unclear if one body is responsible for both". It is not clear how this concern will be taken on board in the new arrangements.

Thirdly, and perhaps most importantly, because of the Audit Commission's "arms length" position it was able to comment on government policy when that policy was failing (irrespective of the government in power) and was able to criticise authorities if policy was being badly implemented by them. A key difference between the Audit Commission and the NAO is that the Auditor General does not have the authority to comment on government policy. The move of local authority VFM reporting to the NAO may seem a natural one, but this will take away one level of accountability—the scrutiny of policy for local authorities.

Benchmarking and identifying good practice was an important aspect of the Audit Commission's VFM studies and is highly regarded across public services. We acknowledge that there are other organisations such as the Improvement and Development Agency, CIPFA etc. which provide similar data and benchmarking services, however, it needs highlighting that the reason the Audit Commission's benchmarking data was held in such high esteem was that, unlike other data, it was independently audited. We already know that the public and stakeholders have more confidence in data which has been independently verified.

THE REGULATION OF AUDIT

Historically, the procedure for setting the audit fee is different between the private and public sectors. The pricing structure for performing an audit is generally criticised for potentially compromising the quality of an audit in the private sector and used as a political football in the public sector. In the private sector, authority to agree the auditor's fees is invariably delegated by the shareholders to the directors. In the public sector, fees are at present determined by the audit bodies that regulate the sector.

Currently the Audit Commission sets the audit fee for local authorities: both private firms and the Commission's auditors adhere to this benchmark. They cannot charge whatever they want without full consultation. Arguably, this process has resulted in low audit fees across the sector. Now that this process will be dispensed with, a key question is whether market competition will inevitably result in lower audit fees for the public sector as a whole. One only needs to look as far as a study conducted by the London School of Economics (LSE) in 2002 which highlighted a hike in audit fees following the reduction from five large firms to four. According to the LSE audit fees increased by 2.4% and have continued to grow since then.[55] Arguably, the Audit Commission has had a successful record in regulating fees so without such regulation our concern is what is to stop a hike in audit fees for local public services without some form of regulator such as the NAO stepping in.

In the absence of comprehensive research in this area we would suggest that the impact of any new proposals and levels of audit fees across public services are monitored. We understand that 410 local authorities will be tendering for auditors, notwithstanding fire and police authorities and health bodies. This would inevitably mean that costs are involved.

Safeguards will also be needed to ensure where there is no ready audit market because it is not of strategic interest or profitable for the firm that the gap will be filled. Also, cherry picking of local authorities will need to be addressed. For example, if a local authority is performing poorly it will be less likely that a firm would want to undertake the audit because of the risk and costs involved. It would be more preferable to go for a high performing authority without the risks.

IMPLICATIONS FOR THE AUDITOR'S LIABILITY

Until recently the auditing profession in the private sector has resisted the idea of extending the scope of the audit. It has been concerned that doing so would increase the exposure of the auditor to what is already a substantial liability. This gives rise to two concerns. Firstly, there is a wider scope of audit in the public sector so firms will have to take out additional insurance which will inevitably impact on the size of the fee envelope and secondly, although the public sector is considered to be less litigious than the private sector, this may well not be necessarily the case in the future. Firms will be more than aware of the potential risks posed following the Westminster "homes for votes" scandal and a catalogue of failure and judicial reviews. The new arrangements could have the potential in creating a more litigious environment across local public services.

In the public sector, there are more complex relationships between the Audit Commission, its auditors and public bodies than in the private sector. Appointed auditors are required to discharge their statutory and other responsibilities, and to exercise their professional judgement independently of the Audit Commission and its officers, and of the audited body. These decisions can only be challenged in court. The Audit Commission indemnifies its auditors against any charges, losses and expenses should legal proceedings be taken against them. The loss of the Audit Commission will mean that firms will have to take out additional indemnity insurance which will have to be reflected in the price of the audit. It is not yet clear how this will be addressed in the new arrangements to minimise the cost of the audit.

ANTI FRAUD AND CORRUPTION WORK

It is not clear what will happen to the Audit Commission's anti fraud and corruption work. One suggestion was to move it across to the National Fraud Authority (NFA) although this has not been confirmed. In the light of the abolition of the Audit Commission this may well be the most appropriate place given that the Chairman of the Fraud Advisory Panel, an independent fraud watchdog, has called upon government and businesses to develop a more consistent approach to combating fraud which costs the UK around £30 billion a year. However, there are outstanding issues to resolve such as resourcing, capacity building and sorting out data sharing and whistle blowing arrangements between the audit bodies, firms and NAO to ensure that additional responsibility and ensuring initiatives such as the national fraud initiative (NFI) which has helped trace £646 million of fraud and error payments since it was established are not lost.

POWER TO INTERVENE IN CASES OF EMERGENCY

What has not been clearly set out by the Government is whether or not there will be some form of regulatory function/body such as "Monitor" for foundation trust hospitals which will have the powers to intervene where there are severe operational failings or in aspects of its leadership. It has not been made clear by the Government whether this responsibility will pass to the NAO or will remain with the home government department. We would like to see some clarity on the form of regulatory process to be put in place.

REPORTING IN THE PUBLIC INTEREST

It was recently clarified by the Minister for the Department of Communities and Local Government at a House of Commons Communities select committee that auditors will be expected to report in the public interest where there are serious failing. This in our view is an important part of ensuring accountability and sound stewardship of public funds. However, it hasn't been outlined how a number of issues will be addressed—for example, the potential impact on the audit fee resulting from a complex public interest matter and how public interest reports will be co-ordinated for shared services and/or partnerships where multiple audit firms are employed.

WHERE WILL THE AUDITORS BE ABLE TO LOOK FOR GUIDANCE AND SUPPORT?

When significant and common issues across authorities arise such as councils combining together not to set a rate or deal in rate interest rate swaps, how will the response be co-ordinated amongst firms, if at all? Previous experience has shown that these issues were successfully tackled because of combined resources, support and guidance. If the plan is to leave it to each individual firm to their own devices not only will this increase cost, but ultimately the audit fee. Most importantly it may lead to an inconsistent audit response and unintended consequences for the authorities and government. We believe that full consideration should be given to how and who will deliver on-going technical support and guidance, as well as setting out arrangements for co-ordination. This is an important point if audit is to continue to be responsive to common and significant issues.

ENSURING THAT THE ACCUMULATED EXPERIENCE OF THE AUDIT COMMISSION IS NOT LOST

We acknowledge that there are a number of national bodies providing good practice and drawing out lessons learnt so that comparisons can be made. Nonetheless, in the current financial environment it would be foolhardy to suggest that these bodies will continue to provide these services without any additional resources. These bodies are suffering just as much as public services.

We are acutely aware that if the new audit and VFM arrangements are not implemented effectively both local authorities and the government will lose the capacity to address "wicked issues" across services and between services, capture comparisons and benchmarks to drive up standards and ensure the overall economy, efficiency and effectiveness of public services. We would like assurance that the infrastructure to capture good practice and lessons learnt is not lost in the new audit framework being developed.

January 2011


50   http://www.accaglobal.com/documents/cdr991.pdf Back

51   District Audit, Celebrating the achievements of District Audit, 2003 Back

52   New South Wales, Auditor General's Report to Parliament, Volume One, 2003 Back

53   "Auditors Not to Blame for Banking Crisis, Academic Tells MPs", Accountancy Age, 29 January, 2009. Back

54   "Auditors Not to Blame for Banking Crisis, Academic Tells MPs", Accountancy Age, 29 January, 2009 Back

55  Thomas Kittsteiner and Mariano Selvaggi, Concentration, Auditor Switching & Fees in the UK Audit Market, LSE, 2008. Back


 
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Prepared 7 July 2011