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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