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Oral Evidence

Taken before the Draft Local Audit Bill Committee

on Tuesday 30 October 2012

Members present:

Margaret Hodge (Chair)

Mr Richard Bacon

Mr Clive Betts

Meg Hillier

Mark Pawsey

Ian Swales

Heather Wheeler


Examination of Witnesses

Witnesses: Michael O'Higgins, former Chairman of the Audit Commission and Marcine Waterman, Controller of Audit, Audit Commission, gave evidence.

Q1 Chair: Welcome. Thank you for coming, at relatively short notice. We have got about an hour with you, so we will be trying to cover a rather wide range of issues in an hour.

I think we can start with a very general question, and I ask you to have your professional judgment hat on, rather than your Audit Commission hat. Our job is to look at the draft Bill. In that Bill, where do you think that the key risks and the key gaps are?

Marcine Waterman: Thank you very much. We believe that there are three gaps in the Bill. First, obviously, is the absence of any statement regarding NHS bodies; second is the lack of a mechanism for accountability to taxpayers and Parliament for the audit process as a whole. Thirdly, we think that the Bill needs to be strengthened in the safeguards for auditor independence.

Q2 Chair: Do you want to expand on that a bit?

Marcine Waterman: I am happy to. The key safeguard would be accountability to Parliament. There is currently no mechanism in the draft Bill to pull together the results of audit work and to inform both local taxpayers and Parliament about the outcomes of the audit. So there is no way for you or local taxpayers to know whether the accounts have been produced properly, or whether the accounts have actually been audited-whether they have been qualified and where. Indeed, there is no mechanism for you to know how £246 billion that has been given to local public bodies has been spent. To us, that is pretty worrying.

Q3 Chair: Okay. I think that the Government would argue that that mechanism is accountability to local people.

Marcine Waterman: The Government may believe that, but the local bodies are not self-funded, they are funded through a compulsory tax levy and money passed through from central Government, so surely there should be a mechanism to inform both central Government and the taxpayers what has happened to that money. How locally would the public actually be assured that the accounts have been published properly, and the results of the audits ? There is no requirement, in essence, for anyone to say who the auditor is and what they have done.

Q4 Ian Swales: There is no requirement to Parliament now is there? Just to clarify that point. We are not talking about changing, are we?

Marcine Waterman: That is quite interesting, because even the PAC’s 28th report talked about the accountability assurance that you get from the Audit Commission and its reports in order for the departmental accounting officer to provide a system statement that the money has been spent for its intended purposes. So, actually, there is indeed a process and mechanism currently.

Michael O'Higgins: And of course the Audit Commission publishes details of who the appointed auditor is for each public body.

Q5 Chair: So is your plea in this-because I slightly took Ian’s point-that there should be publication of who the auditors are on the face of the Bill or in regulations, and a duty to publish the audited accounts on a website or something like that? What is it you want to see that would at least give you the accountability locally? Then we can go on if you are saying that there is no accountability at all. Is it that there needs to be a tightening up of the legislation on publication through duties in the draft Bill or in regulations?

Marcine Waterman: Yes, I would say that there should be a duty both locally and centrally to pull together the results of the audit process, to make the Bill more robust.

Q6 Chair: Just to say to you-Richard Bacon will be better on this than me-those us of who are on the Public Accounts Committee would say that the permanent secretary at the Department for Communities and Local Government-and, indeed, other Departments-remains accountable for the money spent by that Department. So that accountability is still there, however they choose to exercise it. I am right about that, aren’t I?

Mr Bacon: The accounting officer is still accountable to us-that has not changed, that is true.

Marcine Waterman: And how will they get the information?

Q7 Mr Bacon: That is a good question. You have said that there will be no requirement to say who the auditors are. Are you saying that that information is secret?

Marcine Waterman: I am not saying it is secret. Currently, the Commission publishes it on our website, so that both local people and all parties interested can know who the auditors are and where they come from. There is nothing in the draft Bill that puts a requirement on anyone to publish that information.

Q8 Mr Bacon: So if you are a local authority, say, and you have an auditor, are you saying that there is no requirement for the local authority to state anywhere on its own website who its auditors are?

Marcine Waterman: That is correct.

Q9 Mr Bacon: There is no requirement at all.

Marcine Waterman: Not in the draft Bill at present.

Q10 Mr Bacon: No, but is there not a requirement already, under previous local government finance legislation? You sound like you are saying that, in the absence of the Audit Commission website, there is no way to compel a local authority to reveal who its auditors are. That may be true, I do not know, but most of my constituents would be under the impression-rightly or wrongly-that who a local authority’s auditors are, whether through the Audit Commission directly or private sector auditors under contract, would automatically be public information already and anyway, before the Bill came along. Is that wrong?

Michael O'Higgins: It is public information because the Audit Commission publishes it.

Q11 Mr Bacon: Hang on. They are two separate statements: it is public information; and the Audit Commission publishes it. They may coincide, they may be the same thing. Are you saying that unless the Audit Commission published it, it would not be public information? If I phoned up South Norfolk council in the absence of the Audit Commission website, I could not find out who South Norfolk’s auditors were and it would be under no obligation to tell me. Is that what you are saying?

Marcine Waterman: Let me just-

Q12 Mr Bacon: Is that what you are saying?

Marcine Waterman: I am not saying that. I am actually saying that there is no obligation on a body to publish who their auditor is, but most do locally. What we are saying is that it is very difficult to find. It is not something that is right out there so you can say who the auditor is.

Michael O'Higgins: One reason why it is important is rotation of audit appointments, which has come up in other forums. If you want to know for how long a firm has been the auditor, it helps if you know who the auditor is and when they were appointed.

Q13 Ian Swales: It sounds like we now need a parallel to corporate law in public bodies law, doesn’t it? Corporate bodies have to publish who their auditors are as a matter of company law. Perhaps we are missing a trick and by moving from the old regime to the new we are not picking-am I getting the point?

Marcine Waterman: Yes, that is the point about individual bodies, but my point is about 855 bodies. It would be very difficult to ring up each council or look on each council or health body’s website to find out who their auditor is.

Michael O'Higgins: That is a matter for judgment by Government and the Committee-whether they think it desirable that that information is easily available centrally. The key point is that it should definitely be available locally.

Q14 Mr Bacon: Already? Sorry, can I just be clear about that? They are two separate things: whether it is available and whether someone is collecting it centrally. You are saying that it should be available publicly somewhere anyway? Yes?

Michael O'Higgins: And the Commission-

Mr Bacon: Yes? Sorry, nodding doesn’t register on the transcript.

Michael O'Higgins: Sorry, can I get the point across? The Commission in the evidence it submitted to DCLG when I was the Chairman made a number of points about analogies with the Companies Act and said that as far as possible the structure should be similar. This will be one of those analogies.

Q15 Mr Bacon: I still haven’t got the answer to my question. My question was irrespective of whether it is available centrally because the Audit Commission is pulling it together. I think you said-I just want to be clear about this because it is very interesting if it is not true-that it should anyway already be available publicly somewhere. It might be in not particularly well-defined positions so that it is always easy to find on a local authority’s website. Are you saying that it should already be publicly available somewhere?

Michael O'Higgins: I am not saying that. I am saying that for the future it should be.

Q16 Mr Bacon: Yes, but at the moment are you saying there is no obligation for a local council to make public who its auditors are? Is that what you are saying?

Michael O'Higgins: The question has not occurred to me before because obviously I would just look at the Commission’s website-

Q17 Mr Bacon: That is my question.

Chair: Let us see if Marcine can answer that.

Marcine Waterman: I think the answer is they do publish. There is no requirement to publish.

Q18 Chair: Why do we need the national list? Why do we need to know nationally who the auditors are for every local authority? I can see why you want to know and my residents in Barking and Dagenham want to know, but why do we need to know nationally?

Marcine Waterman: The first reason is ease of ensuring that every body does have an auditor, that each body has appointed an auditor, that their period of appointment is for the right amount of time and hasn’t lapsed, and the second is the need to ensure that people can contact or have a direct relationship with the auditor.

Q19 Chair: Why nationally?

Marcine Waterman: This is my point about the need to assure accounting officers that the audits have been undertaken and what were the outcomes of the audit.

Q20 Mr Bacon: And also, presumably, what percentage of the audit business is being done by any one firm. There are lots of reasons why you might want the information.

Marcine Waterman: Academics might like it as well-

Q21 Mr Bacon: It is surprising to me that you are saying categorically that at present there is no obligation on a local authority to publish who its auditors are. You are saying that, aren’t you?

Marcine Waterman: I believe that to be the case.

Mr Bacon: Well if that is true it is very surprising. I am sure that the Department will correct us if that turns out not to be the case.

Q22 Meg Hillier: One of the interesting issues in this is how we guarantee the independence of audit. The Audit Commission has previously been able to provide that role. There are proposals in the Bill to have these independent audit panels and Marcine you commented on that in your submission. Do you think that the proposed regime guarantees the independence of public audit?

Marcine Waterman: It is a very good question, and it links directly with whether independent auditor panels will work and whether they can safeguard auditors’ independence. I think we all agree that robust audit arrangements in the audit process are a must. We think auditor independent panels are not workable or practicable. They are costly, and it would be very difficult to source independent members. We believe also that they are, in essence, ‘governance in limbo’. They cross over, they duplicate and they confuse the functions of local authorities’ own governance structures and audit committees. So it is not our preferred option.

Q23 Meg Hillier: Could you outline what your preferred option would be?

Marcine Waterman: Prescribed audit committees that comply with the relevant guidance, similar to what happens in central Government and the NHS.

Q24 Meg Hillier: One of the interesting things for those of us who have gone through local government is that you could say that councillors were there to hold the council to account, and they could be the people who appointed the audit committee. Do you think that would work? From what you have said, probably not.

Marcine Waterman: What is important is not who the person is; it is the skills and experience that they have. We do believe that the Bill could be strengthened by imposing a statutory duty on audit committee members to uphold the independence of the auditor. It is less important who the individual is, as long as they have the skills and experience to undertake that work.

Q25 Mr Bacon: And you are saying that prescribed audit committees, analogous to those for the NHS and central Government, would exist for each local authority. There would be, to take my example again, the south Norfolk council audit committee, which would be a prescribed body under statute and have members with certain obligations, including statutory obligations. The audit committee would have the job of appointing the auditor. Is that what you are suggesting?

Marcine Waterman: Given that the Government are against any sort of centralised commissioning body, which is the ultimate in providing independence, we think that it is practicable and workable to impose those additional statutory powers on the audit committees, yes.

Q26 Chair: Michael, do you agree with that? Do you wish to dissent from or develop that argument?

Michael O'Higgins: An additional point I would make, Chair, is that a potential reason not to have the councillors on the committee is that in a minority of cases in the past, financial irregularities have occurred. The Commission quite regularly comes under pressure from local authorities to change their auditor because they do not like the line of investigation that the auditor may be pursuing. A mechanism to ensure that there is an ability for the auditor to remain independent, and to be unpopular where necessary, is quite important.

Q27 Mr Betts: When we looked at this on the Select Committee, we came up with slightly different formats for appointment and removal. Removal, which you just alluded to, is crucial. We said that appointment was the responsibility of the whole council on the advice of the audit committee, where the audit committee would have a majority of independent members with an independent chair. We said that removal of the auditor could only be done with the agreement of the audit committee and the whole council. There was a double lock to make sure that there was absolute support for auditors taking unpleasant and difficult decisions. I would like your reaction to those ideas.

Marcine Waterman: On your first point-the full council making the appointment on the advice of the audit committee, with the audit committee made up of independent members-we recognise and we have heard that that would be difficult to achieve in terms of sourcing enough independent members across 855 bodies. We are looking for a more pragmatic solution to your suggestion, which we agree with-that the audit committee would make a recommendation to the full council.

Q28 Mr Betts: I was going to come back on the point about removal of auditors.

Chair: Yes, I want to talk about removal. Who is going to deal with that?

Marcine Waterman: I think the Bill sets out the proposal as you have stated it, which is that the audit committee could make a recommendation for removal and that would have to be approved by the full council.

Q29 Mr Betts: The Select Committee was slightly tougher. We said that both the committee and the council had to agree; it was not just a recommendation for removal. We thought that was the absolutely key issue of independence.

Marcine Waterman: I agree.

Michael O'Higgins: A double lock makes sense to me, and the advantage is that it would give councillors the opportunity to ask the auditors to explain why they believe they are being removed.

Q30 Chair: How often, in your period in the Audit Commission, did you have occurrences of local authority councillors trying to get rid of their auditors because they did not like what they were saying?

Michael O'Higgins: It is not always the councillors; it could sometimes be directors of finance, because they are the ones who are closer to the petard if things get hoist. There are two types of incidents I can give you. One is where there is pressure to change an auditor. Another is where there is a suggestion that fees will not be paid because they do not like what the auditor is doing. One of the strengths of the commission in its existence thus far has been its ability to say to auditors, "We will continue to pay your fees while this dispute goes on, because we will stand behind you." Similarly, in the case of one very large local authority that had a disagreement with its auditor-one of the major firms-and wanted it changed, we refused to change it until the issue had been resolved.

Q31 Chair: How often does that happen?

Michael O'Higgins: Certainly once or twice a year there will be pressure, either very explicit-sometimes-or, more often, rumbles.

Q32 Chair: I am just not sure that the new system of double lock will stop it.

Michael O'Higgins: It might not, and that is one of-

Q33 Heather Wheeler: You just said that fees sometimes were not paid because councillors did not like what the auditor was doing. A perfectly reasonable opportunity to have a dispute with the accountants is if they are running up massive fees for no good reason. I think that you ought to put it on the record that it is not just that councillors might not like what the auditor is doing; it might be that they do not like their time wasting. I am certainly aware of accountants reducing fees from £70,000 to £40,000 quite amicably, but if you had stood behind them that would not have happened.

Michael O'Higgins: It depends on the reason why there is a dispute. Clearly, that will happen, but-

Q34 Heather Wheeler: I think it needs clarification-there are two sides to it.

Michael O'Higgins: Right. There are other times when there is a dispute because the councillors do not like what the auditor is doing because it is painful. To finish off the example I was giving, the large authority wanted its auditor changed, but the Commission refused to do so until the issue had been resolved. At the end of that, we changed the auditor because there had been a breakdown of trust, but in order that the firm involved did not suffer as a result of pursuing its integrity, we gave it another very large, similar-sized account instead. So we ensured that there was no commercial loss to the firm from doing the right thing.

Q35 Mr Bacon: I would like to pursue this because it relates directly to the issue of public interest reports. Under the draft Bill, there is an obligation on auditors to issue public interest reports, after advising the audit panel, in circumstances in which they consider that there has been serious financial mismanagement or underperformance. Under the new structures proposed by the Bill, do you think that auditors would feel inhibited in issuing public interest reports on the basis that they might lose business-they might lose business or not get awarded it in the first place if they got a reputation for issuing such reports?

Michael O'Higgins: I am on the record as saying that no public interest report has been issued on a foundation trust since they got the ability to appoint their own auditors. That may be coincidence, but it is not as if the NHS has been a paragon of virtue in the past seven years, and some of the troubled institutions have been foundation trusts. It is not that someone would sit down and say to themselves or to the team, "Look, we are in danger of losing an audit if we pursue this"; the process is more subtle than that-understanding that the tender is coming up and feeling that your relationship is going to break down if you pursue the matter and it is then, maybe, a question of having your judgment shifted several degrees to one side.

Q36 Mr Bacon: Is that not the point, that all these audit questions are questions of whether it is, first, de minimis or not-not a complete black and white issue, but one that has to be looked at in context-and then questions of judgment are always involved. What you are really talking about is not instant corruption but a series of nuances that move you slowly in one direction rather than another. Yes?

Michael O'Higgins: Cultures of corruption or misappropriation rarely begin with one big step. They usually occur as a result of a series of small culture changes that are a little insidious but do have an impact over time.

Q37 Chair: How would you counter that? I think we completely understand the point that is being made, which has been made by most people who have given written evidence to the Department and to ourselves, but how would you counter that on the face of the Bill or in regulations so that you maintain the integrity and the power of the public interest report?

Marcine Waterman: There are a couple of examples. One of our recommendations is where the Bill talks about the auditor seeking advice from the auditor panel-that could actually fetter the discretion of the auditor. The auditor should be able to pursue an investigation that results in a public interest report, regardless of whether the auditor panel or the audit committee agrees. Secondly, we believe that there should be a mechanism in the draft Bill that guarantees-or a mechanism to recover-reasonable costs associated with pursuing an investigation.

Q38 Chair: That is a thing of interest. As we were discussing just before you came in, Westminster was the great example, which probably ran into millions, but the Audit Commission stood behind I cannot remember which company-

Michael O'Higgins: Touche Ross.

Chair: Touche Ross did it-they only went ahead with pursuing the public interest route because they knew their fees were covered. I just don’t see how that is going to work in the new environment. Again, because we are looking at the draft legislation, can we ask what you would place in the draft legislation to ensure that you could have that, we hope very infrequent, public interest audit of the report, as we had in Westminster.

Marcine Waterman: That is why I suggested in our response that you should have a statutory mechanism for the auditor to recover the costs.

Q39 Chair: From whom?

Marcine Waterman: From the local authority.

Q40 Chair: But if that is £2 million, in today’s money that would be a fortune.

Marcine Waterman: If there is a dispute about costs, there needs to be a third body to help mediate the dispute. It could be one of the bodies that will have a role in the new regulatory framework set out in the Bill.

Q41 Chair: Who?

Marcine Waterman: The FRC or the NAO, but you need to protect the auditors’ independence in order for them to be able to issue such a public interest report.

Q42 Ian Swales: On the issue of public interest, one key element-if we think about some of the scandals over the past few years-is how we deal with whistleblowers. Whether it is my local police force, or my constituent who blew the whistle in an academy, it is often that route by which these things are uncovered, rather than audit. How do you think we can strengthen that channel in the Bill? Is what is in the Bill adequate? How do we protect whistleblowers, and how can they get in touch with their auditors?

Marcine Waterman: That is quite interesting, because actually the Bill makes no mention of whistleblowing at all, and we think that is one area that needs to be strengthened. You are absolutely correct-both the Audit Commission and its auditors are prescribed people under the whistleblowing legislation. Right now, that is not included in the Bill, and it needs to be. We need to be able to ensure that people can raise issues. You are absolutely correct. Just think about Wirral council-that issue came from a whistleblower, not direct from an auditor’s investigation.

Q43 Ian Swales: Can you just tell us briefly how it works now, and what you think needs putting in the Bill in the new regime around whistleblowers?

Marcine Waterman: Currently, in the Public Interest Disclosure Act, both the Audit Commission and its relevant auditors are prescribed persons. The Audit Commission has a direct public interest disclosure telephone line, and we then alert the relevant auditors, or the auditor is called directly. Going forward in the future, the appointed auditor should be the relevant prescribed person, but you do need to consider whether another body has the relationship that we do, and will be able to pass information to an auditor. The Bill does not currently allow anybody to have any type of direct relationship with auditors.

Q44 Ian Swales: Say a bit more about what you mean by prescribed. I presume you are saying "prescribed", not "proscribed".

Marcine Waterman: Sorry. It is my accent. It is ‘prescribed’.

Q45 Ian Swales: No, it is okay. Just say a bit more about what you think we would need to do in the new regime. Clearly, if I work in my local council and I want to blow the whistle, then if we get the other parts right, I will know who my auditors are so I can contact them. What needs to happen? What protections do I need, and what needs doing in order to make sure that channel is as open as it should be?

Marcine Waterman: As long as the Bill directs the whistleblowing powers to the auditor, you have that element covered. If you have strengthened the element that allows someone to find out who the auditor is, that should be fine. The issue, I suppose, is that you cannot always get hold of your auditor. Who else, in this new framework, could be available to help pass on that information?

Q46 Ian Swales: Do we need to tighten up how the auditor behaves with such information? Does that need to be in the Bill? In other words, things like anonymity and so on. Do we need to say that?

Marcine Waterman: That is covered already by the framework around auditors.

Q47 Chair: Which is the other body you would look at in this instance?

Marcine Waterman: Obviously I haven’t spoken to anybody about who would like to take that on, but it needs to be somebody who has been assigned some of the regulatory functions, so either the RSBs, the ICAEW-type people, the FRC or the NAO. Somebody in the framework needs to have another role that can actually pass on additional information.

Michael O'Higgins: The sort of instance where a single local authority might not be enough is, for example, if there is a combined purchasing agreement between several local authorities and somebody believes that there is some corruption somewhere. They may not know which of the local authorities to go to, but if they put it to a central body, that can be checked out using the powers of the central body.

Q48 Ian Swales: Is that where we could use the management of the Department to be that? I am concerned, listening to this discussion, that every time we turn around we build another body in, and we will end up with an incredible superstructure. At the end of the day, the Department for Communities and Local Government, in this case, has massive management responsibility for what is going on.

Michael O'Higgins: I can perhaps now say that in my experience, the management of the Department for Communities and Local Government has quite enough challenges to be getting on with.

Marcine Waterman: I would add that one of the results of this draft Bill, obviously, is the fragmentation of the audit regime. I appreciate that the Government’s policy decision is not centralisation, but rather than one body managing this process, you are introducing six to have a role. There is going to be fragmentation, and of course that will increase costs.

Q49 Meg Hillier: There is centralisation, peppered through the draft Bill. Powers are passed to the Secretary of State. I am not sure on this point, but I think the Secretary of State could probably do what he wanted. He could do what you are suggesting.

Marcine Waterman: Yes.

Q50 Chair: The interesting thing, thinking about it, is that you would have thought that whistleblowing would go to members of the local council.

Marcine Waterman: I am not as familiar with the whistleblowing legislation and what their powers are, but we could find out and provide information to you.

Michael O'Higgins: It depends on the nature of the concerns that the whistleblower has.

Q51 Ian Swales: It depends on the council as well.

Chair: It depends a little bit on the council, but I am thinking of the way we work on the Public Accounts Committee. We are inundated with whistleblowing. It is sort of an analogous situation, is it not?

Ian Swales: From the evidence that we are hearing, it is vital that the auditors have a key role. We all know of cases-I can think of some hardly a few miles from my constituency-in which people who are apparently independent of the executive of an organisation are not really, and that is where the trouble started. The very times when you need to blow the whistle are often the times when that part is not working.

Q52 Heather Wheeler: Carrying on from that but moving slightly away from it, we are really interested in the amount of detailed work and the robustness of the benchmarking. Where should it sit now, this business of benchmarking across local authorities? We have heard that instead of 16 reviews, there will probably be only six. Will it be strong enough? Where will it all be pulled together?

Marcine Waterman: I think what you are asking is how the commission uses the information we collect to produce national studies. We have two very important tools. One is called the value for money profile, which benchmarks all local authorities on important indicators of both cost and quality. We use that information to inform some of the national studies that we do; we have one coming out on foster care. This tool is valuable and we would not want it to be lost, but it is also a fundamental tool for auditors in reaching their value for money conclusion, because it provides them with factual evidence as to how the bodies are putting in arrangements to achieve economy, efficiency and effectiveness. It is a fundamental tool in our regime.

The proposed Bill talks about the NAO picking up and producing the code, which would include what the auditor would do under the value for money conclusion. Our view is that that tool is quite important to that process if everybody agrees, as we have heard, that the tool is of value.

The commission is also able to collect quite a lot of information directly from auditors about their audit work, either around financial ratios or on financial resilience in the current economic conditions.

Because we have that direct relationship with auditors, we can survey auditors at no additional cost, because we specify what they do. They produce that information for us, and that is what our reports are based on. We have that direct relationship with the auditors. Again, that will be lost in the proposed arrangements, because there is no mechanism for the NAO to have a direct relationship with the auditors to collect that information. Indeed, if they have the power to collect that information, how will they pay for it?

Q53 Heather Wheeler: Would that then be quite a cute way of reversing it back, by saying that, for every single audit of every single council, health authority or whatever it is, a copy is just sent to the NAO? The NAO can then do what they want with it, and pick the bones out of it anyway. If the NAO want to publish them, they can publish them.

Marcine Waterman: Auditors’ reports are based on the auditors’ code of practice and what they need to report. Some of the information that we collect is actually in addition. For instance, on financial resilience, whether they think that the audited bodies are coping with the cuts and how resilient they are going forward are not things that auditors are putting in their public reports, because they can stand behind us and the commission can give the central message about how many councils are struggling rather than individually naming them.

Q54 Ian Swales: That is a very important point. To what extent do we expect the new regime to look at financial information and to what extent do we expect it to look at the management information? If you get in an auditor of a corporate body, they are essentially looking at financial information. You have to ask them to do management information studies or data or whatever, and I am not sure we are clear on that.

Q55 Chair: Building on that, what I am unclear about-and we have great concerns about this on the Public Accounts Committee-is whether the framework that the NAO will devise, which auditors will be obliged to adhere to, will be sufficiently robust and detailed to enable us to pull out of the NAO and then through to ourselves all of that rich data that you currently collect, which allows you to do resilience, and VFM, and all these things.

Michael O'Higgins: It is a question of what power the NAO is given to request information from auditors and whether they inherit our powers to ask for that information.

Q56 Chair: Do they, on the face of the Bill?

Michael O'Higgins: No. So that might be something to look at, if you take the view that there may be occasions when the management information will be important as well as the financial information. If I go back again in my time to when we did the report called "Tough Times", which was the first report looking at how local authorities are coping, central Government asked us to come in and give evidence to the National Economic Council about this. We were able to get that information very rapidly by asking each of the auditors to do a quick return that we devised. It may be that you take the view that that power is not necessary or that you think that it would only be used very infrequently, but I think it is worth considering whether or not having a power like that available to the NAO would be helpful.

Q57 Mr Betts: Could I make an additional point? The Secretary of State still has a fall-back power to intervene with an authority that is seen to be failing. Is the sort of information you collect not merely helpful when looking at the overall picture, but in spotting particular authorities as well-those that are in difficulties, maybe, in managing particular situations?

Michael O'Higgins: Absolutely. For example, when we were doing "Tough Times" and "Tough Times 2", we were looking at authorities. We did not know whether a particular authority might be having problems that were sui generis or were just problems that were shared by other authorities. For example, with district councils it became clear that income from parking charges and from planning permission requests had gone down sharply. You could look across authorities to see which were most heavily hit, which had become most dependent on this.

Q58 Mr Betts: In the end, that collected information could form the basis for the Secretary of State saying, "Actually, there is something going wrong here. We have got to look at this authority in particular."

Michael O'Higgins: It is an example of where the auditing process can collect information in advance of failure rather than simply dig up and pronounce on the causes of failure afterwards.

Q59 Mark Pawsey: So would you say that in the absence of this work there could potentially be more problems within local authorities or that a problem could persist for a longer period than would otherwise be the case?

Michael O'Higgins: The Local Government Association or other body might want to have some mechanism to enable a chief executive or director of finance to know whether their position was more extreme than the norm. At the moment we can provide that information. It is not clear where that would come from in the future.

Marcine Waterman: We currently support the Local Government Association’s peer review process by that valuable tool, in giving information across the piece. It is not just about one indicator. When you start to see indicators building up across a range of financial and service indicators, then that starts to tell a story.

Q60 Chair: We think this is very important. So, to toughen it up, you would want, on the face of the Bill, a specific power for the NAO to require auditors to provide certain data to the NAO?

Marcine Waterman: Yes, but with that you would have to think about how the auditors would be remunerated for that work and how the NAO can actually pay an audit firm to collect that information. Obviously currently that is a top slice from the commission, on our fees.

Q61 Mark Pawsey: At the same time as you are doing that work you identify issues that can go to the National Fraud Initiative. How will they be alerted in future?

Marcine Waterman: The National Fraud Initiative is widely seen and recognised as really adding value in identifying fraud and error. Indeed, we have now identified nearly £1 billion in fraud and error across all of our participants. We are glad to see that the Government want the NFI to continue and to find it a home. Regardless of where its home is though, that connection with the local auditor again will be lost. It is the auditor that chases and pushes the public body to pursue the recommended matches. There is nothing currently in the plans that would allow that relationship to continue.

Q62 Mark Pawsey: Where would you see that work placed?

Marcine Waterman: The Government have identified three homes for the NFI: DWP-

Q63 Mark Pawsey: Sure, and which is your preference?

Marcine Waterman: Our preference currently from the ones that have been announced would be the Cabinet Office in meeting most of the requirements. But we are aware that respondents to CLG have recommended the NAO.

Q64 Mr Bacon: The NAO?

Marcine Waterman: Yes.

Q65 Mr Bacon: Wasn’t the Home Office one of the suggested homes?

Marcine Waterman: The National Fraud Authority, which is in within the Home Office.

Q66 Mr Bacon: So there are four suggested homes are there?

Marcine Waterman: The Government has suggested three.

Q67 Mr Bacon: Which are?

Marcine Waterman: DWP, the National Fraud Authority and the Cabinet Office. In response to the Government’s consultation on the Bill some respondents said the NAO would be a good fourth option. Again you might have that relationship with auditors and if you remember the code, if the NAO continues with the wide scope of audit, which includes auditors’ responsibilities around probity and governance, there might be a good link to having them look at the fraud agenda.

Q68 Mr Bacon: Your preference is the Cabinet Office?

Marcine Waterman: Of the three that are currently proposed. If the NAO were to come in as a possible home I think we would like to have a discussion about how they could take this forward. What is important is that we maintain the NFI and continue to develop it so it can address future operational and financial risks.

Q69 Mark Pawsey: Do you think the way we are moving gives enough power? Would things get spotted as quickly as under the existing regime or is there a danger that more fraud and loss could occur under the new regime?

Marcine Waterman: Well if the NFI is not found a suitable home where it can develop and continue and have that relationship to push to have the matches addressed, then it could unravel and you could start to lose the benefits of having the initiative.

Q70 Mark Pawsey: So with a suitable home you could carry on as before?

Michael O'Higgins: It is not just a suitable home. It is slightly more than that. What the National Fraud Initiative does is identify transactions that may be suspicious. They are then passed to the relevant body for investigation. The advantage of the current arrangement is that the auditor can pursue with the relevant body whether they have investigated those potentially suspicious transactions. So there would need to be a nexus not just to identify potentially suspicious transactions but to have somebody with responsibility for following up on them.

Q71 Ian Swales: We are mainly spending our time addressing the Bill for the new state but also, clearly, we have concerns about the control regime in moving from the old state to the new state. What does the Bill say about transition? Is there more we need to be doing on that front?

Marcine Waterman: It says very little about transition and that is one of our biggest concerns about gaps in the Bill. There are two transitions. There is a transition from the current Audit Commission, when we are abolished in March 2015, until when the audit contracts that we have recently let expire in 2017. So there needs to be a residuary body to oversee those contracts and ensure high-quality delivery of audits. So there is a two-year period where again if a home has not been found-

Q72 Chair: Has the issue been identified by the Department?

Marcine Waterman: They have identified the issue.

Michael O'Higgins: I would rephrase that. I think the issue has been identified for them.

Ian Swales: It is a shame you cannot capture body language on the transcript. The issue has been identified. Very good.

Q73 Mr Bacon: As George Orwell said, never use the passive when you can use the active. Is one potential answer that those powers in some residuary body would just rest directly with the Secretary of State and the Department?

Marcine Waterman: Yes, the Secretary of State could have the residuary body, if he would like to oversee the contracts and ensure the delivery of the audits.

Chair: The Secretary of State does not run much in DCLG.

Q74 Mr Bacon: So it would be possible to set up a contract supervision unit in the Department? I am not recommending it, but that would be one possible solution.

Marcine Waterman: You would have to have staff who understand it.

Mr Bacon: Well, that has never stopped them in the past.

Q75 Meg Hillier: Presumably, if you are going down that route, for expertise reasons you would expect some of your staff to be TUPE-ed over? So you would be adding to the payroll.

Marcine Waterman: Absolutely, because, if you remember, these contracts were set up, agreed and signed under the auspices of the Audit Commission Act, so our code continues, our providing auditors with guidance continues and our regulation of the auditors continues. All of that needs to continue in order to ensure that the prices are not changed from what we agreed.

Michael O'Higgins: I would add one further complication, which is that the contracts that we signed provide for five-year contracts, with the possibility of extensions of up to eight years at the same prices-fixed in current price terms.

Q76 Mr Bacon: Is that an additional eight years, or is it that after five years you can get an extra three?

Michael O'Higgins: It is a possible eight-an addition of up to three years, at the discretion of the commission, or whatever the successor body is. So the period over which the transition will continue could conceivably extend as far as 2020. Commercially, it would be very attractive for whoever takes over from us to extend those contracts, because you are not going to get those prices again.

Q77 Meg Hillier: There is a practical issue here. I imagine you may be losing staff already because of what is coming-is that a fair assumption?

Marcine Waterman: We have reduced the size of the Audit Commission in line with the policy decisions to stop CAA inspection, so we are now downsizing to an organisation of only 66 in size, which is needed to fulfil our statutory powers for these contracts.

Q78 Meg Hillier: But in all honesty, there will be temptations for a lot of the staff you have, as human beings, because there will be a lot of opportunities coming up in the private sector, and, with the expertise that your organisation has, those companies will be very keen to offer jobs to Audit Commission staff.

Marcine Waterman: These people are not auditors, these are policy people who oversee audit regimes, so whether they go to a firm-

Q79 Meg Hillier: What I am driving at is which is more attractive, going to a firm or possibly being taken in by DCLG? The danger is that the very people who understand the regime might be poached by the private sector and not be available to DCLG, so then the benefit of any residuary body being within DCLG would be diminished.

Marcine Waterman: That would be a very real risk. There is already a risk, which we must manage in order to maintain these 66 people until we are abolished. So yes, indeed, it is a very severe risk.

Q80 Chair: So on the transitional arrangements, they need to sort out who is running the audit. What else is there?

Marcine Waterman: Then you have the second transition. As Michael said, you need to decide whether it comes in 2017 or you lock in the prices and it comes in 2020. Obviously, there is a critical policy decision about retaining the lower audit fees and the cost of the whole regime until 2020, or whether it is more important to introduce local appointment. That is a balancing act. The next regime transition would be from the commission’s regime in 2017 or 2020 to the introduction of this new framework. One of the issues with having two transitions, obviously, is that you are going to be running two regimes, and I think that that can add to confusion as well as costs.

Q81 Mr Betts: Whose choice would it be to extend the contracts in 2017?

Michael O'Higgins: The successor body to the Audit Commission.

Q82 Mr Betts: So the local authorities themselves would have no say about that?

Michael O'Higgins: Unless they were consulted about it. They were consulted about the current contract, because, as you may know, we asked for three-year and five-year bids to see what the price difference would be. The bids came in, and there was not much difference between three and five years-I think it was about 1.5% per year over the duration of the contract-but the prices were so low, and they were fixed current price rates, so it was a commercial no-brainer to go for five years. When it was put to the Local Government Association-I took the view that it needed to be consulted-it decided that it needed to discuss this with the Secretary of State, who acceded to the request for five-year contracts.

Q83 Mr Bacon: What about the accounting officer? Presumably, in 2017, he or she would have a role with whatever the subsidiary body was, testing whether the move away from the existing contract and its potential extension for three years to an eight-year contract, which would be stupendous value for money, could be justified. He might well turn around and say, "This cannot be justified on value-for-money grounds. The best thing to do is to stick with what you’ve got, and if you want to move away from it you had better issue me with a letter of direction because I cannot justify it." The accounting officer could easily do that, couldn’t he?

Michael O'Higgins: Yes, I believe so.

Mr Bacon: If the gap is sufficient.

Michael O'Higgins: What the mood will be in 2017 or 2015, when a Secretary of State in the next Government-whoever that may be-makes a decision about this, is hard to call at this time. When we discussed with local government about three or five-year contracts, in the balance between wanting local freedom to appoint an auditor sooner versus getting really good prices locked in for a long time, people came down on the side of the latter.

Q84 Mr Betts: We have had a lot of figures about the actual or potential savings from the abolition of the commission. I think the latest ones are that the Department has said that it will save £1 billion over 10 years and £650 million over the next five. The commission is now saying that there will be savings of £1.7 million a year, so there is rather a big gap in expectations. Could you just explain simply and clearly what your understanding is of the savings figure you have come up with and why it is so different from the Government’s?

Marcine Waterman: I am pleased that you asked that, and I am pleased that we can clear this up. We are not disputing their numbers, and obviously we did not calculate them. We all agree there are savings, but our difference is that 99% of the £650 million has been banked already. All that is left from abolishing the commission is a mere £1.5 million. That is using DCLG’s own figures in their impact assessment. They have assumed that the cost of moving some of the aspects of our regime to the NAO and to the Financial Reporting Council is £5.8 million. If the Audit Commission costs £7.5 million, all you are saving from abolishing the commission is £1.7 million, and I am already bringing those costs down since I have been appointed.

You have got to remember that as soon as the prices are let loose in the market those savings will be eroded anyway, because we truly believe that audit fees will increase. Then there is the cost to the audited bodies themselves of having to run an EU-compliant procurement every five years. Just using the numbers that the LGA provided to us, we have costed that to be £19 million. Boom! There goes your £1.7 million. We are not disputing the £650 million. It has been banked. It has been saved by the Government’s policy decision to shut us down-

Q85 Mr Betts: Just explain to us what that saving is.

Marcine Waterman: That saving has been achieved from the Government asking us to stop inspection and comprehensive area assessment, and from outsourcing the audit practice. That is how those savings have been achieved.

Q86 Mr Bacon: How much is one and how much is the other?

Q87 Chair: Yes. How much did you save from outsourcing?

Marcine Waterman: We have given back £50 million with a 40% reduction in audit fees. We have reduced fees by 40%.

Q88 Mr Bacon: We are talking about £650 million. You are saying that it has been banked already and that there are two sources. One is the scrapping of comprehensive performance assessments and the other was-sorry, could you repeat it?

Marcine Waterman: Outsourcing of the audit practice.

Q89 Mr Bacon: Right. How much of the £650 million was due to the scrapping of the comprehensive performance assessments, and how much of it was due to the outsourcing of the audit?

Marcine Waterman: I do not have those precise splits, but I am more than happy to provide the Committee with those numbers if you would find that useful. We will write to you.

Michael O'Higgins: They are cumulative numbers. We tend to look at the annual saving, so we would need to look at the exact time period over which it was done.

Mr Betts: It would be very helpful to have a comprehensive but clear and simple statement of those.

Q90 Mr Bacon: Very roughly-by all means, please do write to us-proportionately, without signing your name in blood, how much is roughly one and how much is roughly the other?

Marcine Waterman: I really would not like to say, but I assume because the £650 million has a lot of compliance cost from the audited bodies having to comply with CAA, which I think they estimated-

Chair: Comply with what?

Marcine Waterman: Comply with comprehensive area assessment. So I believe that the majority would come from the policy decision to stop inspection in CAA.

Q91 Chair: Let me get this clear; it is an annual saving of £130 million. The £650 million is a five-year saving.

Marcine Waterman: That is correct.

Q92 Chair: So it is an annual saving of £130 million, of which probably half goes to comprehensive assessment, and the other half to outsourcing.

Marcine Waterman: Which stopped two years ago. That is our point about the savings having been banked.

Q93 Mr Bacon: So they should have banked £260 million already, of which a significant proportion is due to the assessments.

Michael O'Higgins: We stopped the work on comprehensive area assessment the day that the Secretary of State announced that he was minded to stop it. We did not wait to receive the letter from him.

Q94 Mark Pawsey: Can I ask you to confirm your assertion that audit fees will go up and that you are getting a very good deal now? How can you evidence that? What is your assessment of by how much audit fees will go up, and why?

Michael O'Higgins: I am happy to take part of that. I have a professional services background as well. We were able to look at the savings from the outsourcing exercise that was recently completed when I was still chair by comparing the prices offered then to the prices offered for the 30% of the market that had previously been outsourced. We had an existing 30% outsourced to professional firms, so we could see by how much further they were taking the prices down with the new prices. It was clear that there were a couple of firms that chose not to go for low pricing. They made a different commercial decision and held their prices at the previous rates and won no contracts as a consequence. The others went down significantly.

Why did that happen? First, they were very large contracts. It was £100 million of work a year. Secondly, the economic climate meant that that £100 million was even more attractive than normal. Thirdly, firms wanted to be in the market before it liberalised, because they would have no credibility if and when it did liberalise. In my judgment, the likelihood is that, should liberalisation happen, very large or attractive authorities-the Birminghams and the Westminsters-may well be able to get quite good deals, but there will be many smaller and more remote authorities that will not benefit from the sort of Post Office pricing that the Commission carries out.

Q95 Mark Pawsey: So you got the prices down by being cleverer on your procurement and doing that better. Why are we not able to keep that clever procurement going forward?

Marcine Waterman: Because we did not achieve these just from bulk procurement. It is because we have the powers of being able to appoint and ultimately impose the auditors. That is how you achieve those savings.

Q96 Mark Pawsey: Sure, but why can those savings not be maintained going forward?

Michael O'Higgins: If you look at an individual authority tendering on its own, it is going to have the costs of doing that and it may not have the expertise to do that in the same way. It is also not going to be particularly attractive for a major audit firm to bid for one authority, so they will be pricing quite differently depending on the type of authority unless there is some mechanism for bulk procurement.

Q97 Mr Bacon: Given the pressure that local authorities are under to share services, whether they are legal, financial or HR-Kensington and Chelsea, Westminster, and Hammersmith and Fulham all have the same chief executive-do you think that there will be an inevitable pressure on local authorities, to which, for all I know, some are responding already, to do joint procurement of auditors in a larger framework to achieve more or less the same result?

Marcine Waterman: Joint procurement can work, but two issues need to correspond. One is that you must be willing to audit all of the bodies in the joint procurement. Second is that you have to be able to. There can be no conflicts of interest. Some of these very good-priced audits are where the firms are actually selling quite a lot of non-audit services, which would preclude them from being able to bid. They will make very big commercial decisions about joint procurements, and they will already be having conversations such as, "We’ll give you a good price if you don’t include these others," because they will be looking at having to recover five-to-eight years’ worth of pent-up inflationary pressures as we have locked in the prices. They will have to be factoring in these additional regulatory costs that are coming their way, and they have to bid multiple times, whereas for us they have only had to bid once. All those factors together pretty much ensure that you are going to see increased prices.

Michael O'Higgins: Can I give an example of joint procurement? If you take, for example, the 10 local authorities in the Greater Manchester area, they work together quite a lot. You might ask why they cannot do joint procurement, but the chances are that any of the firms that might bid will be doing other work in at least one of the 10 authorities and therefore may be conflicted. By doing national procurement, they do not bid to audit particular authorities; they bid for blocks of work, and the Commission then allocates them to authorities so that they get the quantum of work that they bid for.

Q98 Mr Bacon: They have no say in advance as to where they will end up putting their auditors on a train to.

Marcine Waterman: That is correct.

Michael O'Higgins: And the Commission has always followed the apples and lemons policy. If you want to get some of the juicy apples or plums, you have to take some of the lemons as well.

Chair: You have given us very clear and full evidence, for which we are grateful. We have come to the end of the sitting.

Q99 Mr Betts: I have one quick point. What you are effectively saying to us is that you could carry on with the body as it is now and achieve the savings that you have achieved and do the job without any need for the draft legislation. Is that what you are really saying to us?

Marcine Waterman: Yes, if that was politically acceptable, that is correct. We could maintain the 66 people organisation at a very small cost and carry on.

Q100 Mr Bacon: You might have to change your name.

Marcine Waterman: We understand that. We are happy to have a new name.

Mr Bacon: Do you have any ideas? Perhaps we could suggest one or two.

Q101 Chair: I hope that we have covered most of the issues, but are there any issues that you wanted to bring to our attention relating to the draft legislation that we have failed to ask you about?

Marcine Waterman: I just think it is important that, throughout your scrutiny of the Bill, somebody addresses what is the position with regard to health bodies.

Chair: We are having a session on that. We are great experts here. The PAC members know it inside out.

Michael O'Higgins: Can I add one thing, wearing one of my other hats? The Commission has argued that pension funds should be treated as separate entities for auditing purposes, rather than as part of the authorities to which they are potentially connected, and this is consistent with the regulatory changes that have been put through in the Public Service Pensions Bill. I would ask that you have a look at the issue and, on the face of the Bill, have the pension fund be designated as separate entities.

Chair: Right. That is a good point. Thank you very much, that was really helpful.

<?oasys [np[pg6,cwe1] ?>Examination of Witnesses

Witnesses: Robert Black, former Auditor General Scotland, David Walker, former director of public reporting at the Audit Commission, Professor David Heald, University of Aberdeen, and Jessica Crowe, Centre for Public Scrutiny.

Q102 Chair: Welcome. Thank you to all of you. I particularly thank David Heald, who I know has put himself out to come back to London yet again to give evidence this afternoon. We have about an hour and four people, all of whom have a huge amount to say, so the more succinct we can keep our contributions, the more we can get through. We have identified five or six areas and no doubt you will want, at the end, to mention some that we have not.

I am going to start with a general question.

David Walker: Before you do, the figure that you are after is in the annexe to the Bill.

Q103 Chair: Which figure?

David Walker: The figure for the cost of abolishing CAA, which was given by the Government as £28 million in the baseline year of 2009-10. That is the cost to the commission. The cost of compliance with the inspection regime-and it sounds plausible-is £218 million over 10 years at NPV, gets you near to the figure-

Q104 Chair: Thank you.

David Walker: The figures are there and you can argue about whether compliance costs are as much as that, but there is a real figure in the Bill.

Q105 Chair: I shall ask David Heald to start with this one, but all of you chip in, please. Our job is to look at the draft Bill, so we would find it really helpful if you, again, told us what you think are the key risks and key gaps in that proposed legislation. All of you have a go at this.

Professor David Heald: I think it is a bad Bill and I think that reflects the evidence I gave to the Select Committee on Communities and Local Government last year. Nothing has happened to make me change my mind about that. I believe fundamentally in the Sharman principle that public sector bodies should not appoint their own auditors. It was quite striking when the Government Resources and Accounts Bill was going through Parliament that the then chairman of the Public Accounts Commission, Robert Sheldon, and the then Chairman of the Public Accounts Committee, David Davis, persistently raised this issue, often at quite irrelevant times, and kept going on the issue about public bodies not appointing their own auditors. Essentially, it was about executive non-departmental public bodies, but after the Sharman report, the NAO got the appointments of these bodies.

I find it astonishing that, not much more than 10 years later, we have gone off completely in the opposite direction. The critical point was when, as a political decision, the Audit Commission lost the foundation trust audits. That was the critical point, and nobody made a big fuss about it at that time. Subsequently, one see that everybody says that they want to appoint their own auditors.

The detailed discussion that you were having with the previous witnesses shows the actual, practical difficulties of establishing a satisfactory regime. I believe that there are strong reasons for having a central appointment organisation to do the appointments of auditors. If that is politically off the agenda, as the very least bad solution I would go along with Mr Betts’ argument of a double lock.

Q106 Mr Bacon: Can you just remind us: the double lock being the audit committee and the full council?

Professor David Heald: The auditor panel strikes me as a crazy idea. I cannot see where the independent expertise for so many authorities is going to come from.

Q107 Mr Bacon: I am asking a question about the double lock, not about the panel.

Professor David Heald: Yes; so given the fact that I think the auditor panel has got to go, I think the right place to put it is in the audit committee, making a proposal that is accepted by the full council. I do not regard it as satisfactory, because of my principled objection to public bodies appointing their own auditors. If the Bill is going to go through in broadly its present form, I think the double lock is actually the best. The audit committee proposes and the council accepts, and I think the same kind of arrangement would have to happen about removal of auditors.

Q108 Chair: Can I just ask you, because Michael O’Higgins said in an article in The Guardian, or something, on trusts that now appoint their own auditors, there has been no public interest report: I do not know whether any of you have done any work that demonstrates-because in a sense that is our example of where you have a public body appointing its own auditors-where is the detriment. Is there evidence of detriment in that mechanism that has now been around for three, four or five years? I cannot remember when it was first implemented.

Professor David Heald: I do not know of any academic work on that. It takes quite a lot of time, because the statistical techniques need a number of years to establish that. I do not know of anything that has actually been done yet.

David Walker: Hearsay says Monitor is sitting on 25, 30 or 40 foundation trusts that are in imminent financial difficulties. If, in the period preceding the announcement of their difficulties-we have seen announcements in south-east London-the auditors have been silent, that must say something critical about the audit regime, surely.

Q109 Meg Hillier: I wanted to ask Robert Black what the situation is in Scotland, in terms of maintaining independence, because I think that might be a useful comparator.

Robert Black: I am very happy to do that. If I may, I will just give you a quick thumbnail, and then perhaps comment on this very important issue about the appointment of auditors.

In Scotland there is a single audit agency, Audit Scotland, of which I was the head until this summer. May I just put in the record that I am speaking in a personal capacity now, but I am sure nothing I say will be at variance with what my erstwhile colleagues consider appropriate? There is a single public audit agency, called Audit Scotland, which in a sense captures a large number of the properties of the National Audit Office, and some of the properties of the Audit Commission. That gives the advantage of the single point of contact. We can do very good analysis of delivery chains, cross-cutting studies, and so on. We do not have any institutional or organisational barriers to that.

The audit process is managed through Audit Scotland on my behalf, so rather like the Audit Commission used to operate, there is a tendering of the audits every five years. If you take public bodies in Scotland-something over 200 of them-they each have an appointed auditor, who is either someone supported by a team from Audit Scotland, rather like the old district audit service, or is someone from a firm. We employ the same large firms as feature in England.

On the specific point about the advantages of independent audit, what I would say in Scotland is that I would be confident that the Scottish Parliament would be very concerned if there were a suggestion that each and every local authority or health body appointed their own auditors, because what they see in Scotland is that the audit reports are coming to them through the Auditor General or through the Accounts Commission. So when I was reporting to the Scottish Parliament-I must use the past tense for this-I could dwell on the content of all the audit reports for the umpteen health authorities, and so on. There is a body called the Accounts Commission, which oversees the local government; we work in the same partnership. So the strategic insight provided on the performance of the health service and the finances of the health service is found in the local audit reports.

The final point I would make on that is there is a sense in which he who pays the piper calls the tune. So the audits are conducted according to a code of audit practice, and all the established standards at UK and international level. There is no question about that, but you can influence the shape of the audit according to the issues of concern either to me or to the Scottish Parliament. So you get that degree of control as well as giving a public reassurance about the fact that the auditors are not in any sense beholden to the bodies that appointed them.

Finally, when it comes to the public interest reports, what invariably happened in Scotland is that issues would arise in a local authority, there would be a fairly good professional conversation between senior colleagues in Audit Scotland and the appointed auditor. Then Audit Scotland would come in behind the auditor and support them, and ultimately make the reports to Parliament or to the Accounts Commission. In a sense, it limits the risk and exposure of the firms, because the tough stuff is taken by Audit Scotland to take it into the democratic arena.

Q110 Chair: Going back to my original question, that has been a helpful exchange of risks and gaps, but is there anything else you think we need to build on?

Jessica Crowe: We start from perhaps a slightly different point from some of those already made. To add something new is that we would say that it is important for audit to be seen as part of a wider culture of accountability in local public bodies. For us, one of the big gaps and problems with the Bill is the increasing fragmentation and gaps in accountability.

It is a missed opportunity, as lots of public bodies are increasingly working together and there is a prospect some day of community budgets becoming quite significant, more pooled budgets and more joint budgets. The fact that health is missing has been referred to, but more widely it is a missed opportunity to do something about looking more sensibly at how public bodies spend their money in the round, and how they account to local populations.

For us, there is a bit that is not in the Bill and is not talked about unless something follows on. We would say that the important thing is the simplicity and the way in which accounts and audits are presented to the public. If the Government are serious about transparency being an aim, all this process about who is the auditor and who appoints them, is not going to make it any simpler for any resident to understand how their council or anybody else spends their money, because public accounts are completely opaque and incomprehensible.

Q111 Chair: So, that is your ambition. In terms of the draft legislation, what is not in there that you would want in order to realise that ambition?

Jessica Crowe: Something about the NHS and how health bodies are going to be tackled.

Q112 Chair: We are having a separate session on the NHS.

Jessica Crowe: It may be something that comes more into regulations because there are lots of powers in the Bill for the Secretary of State to make regulations. If we are going to go down the path of bodies appointing their own auditors, we think there are more safeguards that could be put in, either in the Bill or through regulations, about how panels and independent members of committees are appointed. Things such as confirmatory hearings would make it much more local and public, and the role of the monitoring officer could act as an additional safeguard separate from the section 151 officer. There are things one could do within what is being proposed to strengthen it a bit.

Q113 Meg Hillier: Can I just ask about your role? You are in a way representing local authority and other members through the Centre for Public Scrutiny, in a sense, although we have other representatives. We talk about independence, and there has been discussion about council members having a role. Do you think there is sufficient independence? Sometimes scrutiny differs from authority to authority in how independent it is. Do you think there are some issues there? Perhaps you could develop that. The other question to think about is: you were a commissioner in Doncaster.

Jessica Crowe: I still am.

Q114 Meg Hillier: You still are? Perhaps it is a lifelong appointment. We have also had problems in Westminster in the past. Perhaps you could give some flavour from your experience about what happens when things get really difficult, and the impact on the independence of auditors there.

Jessica Crowe: Yes, there are all sorts of issues there. We would very much endorse the findings of Clive Betts’s Committee about the potential for scrutiny to be enhanced and strengthened, to play more of a role in backing up the more technical role of looking at financial statements. What you cannot do in a single audit of a single year’s accounts is assess the long-term or social value that is being achieved through spending public money-the social impact. That is something that we feel that scrutiny functions could play a role in.

We would say that such powers could be strengthened; there is a power to require people to attend auditor panels to give evidence, and we have long argued that scrutiny committees should have that power-as Select Committees do-to call for persons and papers and to require people to attend if they have concerns. We think that there are things that could be done to strengthen that side of how local authorities are held to account.

It is a truism wherever I go, people say "Scrutiny is a bit patchy, isn’t it?" That is the word used to describe scrutiny. I think that that is true, but if local authorities are going to be set free in this localist world, then it has to fall to local elected members who have the democratic accountability to do more holding to account of the officials who spend the money. There do need to be more resources and the powers I talked about; those things are both difficult, particularly the resources in the current climate. That is a challenge, that we are loading more responsibilities on to the local level at a time when local authorities are struggling financially.

Q115 Chair: I was going to go to David Walker, just on gaps and the main risks.

David Walker: You do not want to hear me repeating what Jessica said. It is a missed opportunity. Here are inconsistent audit regimes across local government, schooling, further education now, and health-this could have been a great chance at least to try to introduce principles of consistency, such that if you are spending public money in the local space you observe the same audit code and the same regime for ensuring that that money is well spent. You have taken that on board, so I suppose the main point that I would make is that this is an own goal. Here we are-cliché-in the midst of the age of austerity, and here was an opportunity to bed down a regime for maximising value for money from local public expenditure. That has been missed.

If you asked yourselves the question, as I am sure you will be asking other witnesses, "Who is now responsible for value for money in the local space?", you will get a cast, literally, of thousands, from the NAO through to the members of audit panels and auditors themselves. There is no obvious mechanism now for linking up the work that auditors do with the thrust to secure, for example, benchmarking material that would allow you to say whether a given public body or local authority is spending that money as effectively as possible. You could argue that at this moment we can least afford that potential for waste.

To add to that briefly, let us not forget that the Audit Commission-according to the 1981 Act-was not really about VFM; it acquired value-for-money duties as the years went by, under the Conservative Government and under the Labour Government. It established a regime, now thought to be excessive, for looking at public services in the round, in the shape of the comprehensive area assessment. That was intended to be a mechanism for demonstrating to local people and local elected members that the spending they were doing matched up with the spending in comparable areas. Comparability remains the huge, huge issue in trying to see whether spending is being done appropriately. I cannot see, looking at the draft Bill, where you would extract proper measures of comparability and proper benchmarking that alone would give you, locally or centrally, a purchase on whether the spending is effective.

Q116 Chair: So would you all agree with what our previous witnesses said on that issue, that there ought to be a duty-probably on the NAO-or a power for the NAO to instruct auditors to collect particular information to enable that comparability and benchmarking to take place? Do you think that that would be the way to deal with it? Any views on that?

David Walker: Short of creating a new body, and we are not in the business of creating new quangos, let us at least go with an organisation that has demonstrated capacity-

Q117 Chair: But you would have to give them a power that is not in the Bill.

David Walker: I would give them a duty.

Chair: A duty.

Professor David Heald: What concerns me is that the NAO has been given a hospital pass. The NAO cannot win out of these changes. It either makes a success of them and people will say, "Well, just privatise the audit function within the NAO", or it fails and it will actually be held responsible for serious problems at the local level. The notion that six value-for-money studies done by the NAO, within the Bill’s rather limited powers of access, could possibly replace what was done by the Audit Commission is fallacious. The NAO is in a very difficult position. Also, accounting officers are going to be in a very difficult position, because they will not be able to give Parliament the same kind of assurances about value for money and probity having been achieved.

I was personally against outsourcing the audit practice of the Audit Commission. The one point I would make is that when it comes to financial certification audit, the private audit firms are perfectly capable of doing that work, although in the past they were greatly helped by the framework set by the Audit Commission. They have got much less of a track record in the value-for-money area, and it seems to me that one thing that is happening in public audit is the rolling back of value for money. There is an interesting point about individual attention-about the NAO not looking at individual local authorities. How can you give an assurance to accounting officers and to Parliament without any power in respect of individual local authorities?

On the financial audit side, I do not think that there is a particularly serious problem, and I do not doubt that the outsourcing programme brought genuine savings in the medium term, but there are fundamental questions about accountability to Parliament from the point of view of accounting officers. When I was preparing for today, I re-read "The Proper Conduct of Public Business", which was one of the publications of your predecessor Committee, and reflected on how long it would be before we got a similar kind of report. I think there are very serious dangers.

Q118 Mr Betts: Is this a concern about the general spending of public money and lack of accountability, or is it a concern that individual authorities could start to get into the difficulties we talked about with the previous witnesses? Although the Secretary of State has the power to intervene, ultimately, in such a conflict, the information may not be coming through to allow that intervention to be timely.

Professor David Heald: Yes. There is a difference between the councils or public bodies that reach the point of intervention. The Audit Commission had early warning knowledge of where there were difficulties. If I were a Minister, what would worry me is being caught by surprise, whereas with the Audit Commission regime you were much less likely to be caught by surprise. The Audit Commission had a direct relationship with auditors, which, under the Bill, the National Audit Office will not have. It is a question of having inside intelligence of which councils are likely to be in trouble.

I did research on the use of resources assessment, and contrary to the view that is promulgated in the impact assessment that there was zero gross benefit from the CAA and such systems, I found that local authorities were actually quite positive about the use of resources assessment. It helped them to benchmark themselves against other people.

Q119 Mr Betts: Without going back to the CAA, which I think is quite likely not to happen, you still have a duty on the NAO to take the oversight of what is happening in local audits and have that information fed back to them so they could anticipate problems and advise the Secretary of State accordingly. Outside any reconstruction of the CAA you could still have that duty to assist in that way, could you?

Professor David Heald: I have publicly objected to dumping functions of the National Audit Office. I think that is a dangerous tendency. Given where we are, the NAO having the audit procurement role, and hence access, would strike me as the best option.

Q120 Mr Betts: They have to have the procurement role as well.

Professor David Heald: The NAO would procure and regulate audit as well as having codes of practice.

Jessica Crowe: It is important not to confuse the audit role and the Commission’s other work in improvement and performance in the inspection. The question about Doncaster is relevant here, although that is separate, and the LGA and the local government sector are setting up a whole separate way of gathering that kind of early intelligence about local authorities that are in difficulty. In my experience, both when I was a councillor and in my current role as a commissioner, it is not primarily or solely about the financial controls in an authority. Weaknesses there are a symptom rather than a cause of an authority getting into difficulties. It is much more about the culture and behaviours of the organisation in terms of how to do your business properly and about governance more widely. Those things can be tackled in other ways and audit is an important contributor to that, but it does not have to be relied on to do everything.

David Walker: Can I just interrupt? The Local Government Association has for two years now been putting together a website called "Inform", which was meant to be a pool into which the public-people-could dip to find information about local expenditure. I tried to access it yesterday and the message came back, "You can only access it if you’re a local authority elected member, or"-There is a problem with local government’s own capacity to look at itself in a potentially critical way. I think that is something you will need to deliberate upon as you think about this Bill.

Robert Black: Could I just reiterate that I have no deep knowledge or expertise in the situation in England? So anything I say is designed to be as helpful as I can be to the Committee, from the experience of an increasingly different audit regime which is operating north of the border.

I recognise what David Heald is saying: the audit of financial statements will kind of take care of itself, because it is core business and is well regulated. On the specific point of no surprises, just to share with you how it would work in Scotland, two points. I would regularly, personally, meet the auditors to understand the issues which are emerging and developing at the local level. From many years ago-although I was an honorary auditor for 12 years, as the Auditor General-I have a planning qualification and I am used to being asked, "What are you achieving? Stopping bad things happening?" There is an element of that around audit. The public value is to prevent mistakes and one can only do that by early conversations and detection. That is the first point. There is something about that "no surprises" which is really important, which we do have in Scotland.

The second thing is that we are faced, as you can imagine, with the same pressures for efficiency. The way in which that is happening in local government is that we developed a regime which provided for a joint risk assessment of each local authority-each of the Scots local authorities-prepared by Audit Scotland, if they were appointed auditor, and the firm and also the inspectorates, and they would work with the management of a local authority to do that. So it would be an agreed document. That shared risk assessment now informs and shapes the audit work and it has also helped us make the scrutiny work more proportionate, because you can concentrate on issues that matter. It does not mean that something will not jump out of the woodwork, but nevertheless it is a system that kind of tries to manage that.

Q121 Ian Swales: I think you have raised an interesting point about other bodies. We have talked about the NHS. You mentioned education. Of course, virtually every department has some kind of dispersed activity, so it raises the question, we have this clunking tome for DCLG, how does it compare to what everybody else is doing? I think that is one for the Committee. Of course, the Public Accounts Committee has big concerns about the amount of public money that is disappearing out through arm’s length bodies, although I guess that is outside the scope of today’s sitting.

On performance and value-for-money work and thinking about it from the professional firms’ point of view, we know that lots of corporations-I was part of this at one time-got their audit bills down simply by giving the auditors sufficient assurance that they could sign off the legislative true and fair view, and all that kind of thing. That is one extreme. I wonder, when a professional firm is taking one of these contracts, how do we ensure that we get the quantity of activity that we think we are actually buying? In other words, could they make a lot more money by simply doing a heck of a lot less work than we expected? We do not have the framework in which they are going to operate. How can you give us an assurance that we can make sure that the professional firms, who, let’s face it, are in it to make a profit, will actually deliver the quantity of activity, particularly in the optional areas, around management information, performance assessment, value for money, and so on, and does the Bill adequately put the framework in place?

Professor David Heald: My experience is that private audit firms do what they are paid to do. If you get the audit bill down, you will get less work. It may be a cost saving in the short run but subsequent difficulties may emerge. It may also make the audit firm less willing to have big fights. One of my research interests is about private finance initiative accounting. I have kept making the distinction about the attitude of the National Audit Office to PFI accounting. Under UK GAAP, where accounts were audited by the NAO, generally things were on balance sheet. If they were audited by the Audit Commission or its appointed auditors it was generally off balance sheet. In the whole of my career I have never known a subject where people were willing to tell me things in private which so departed from what they said in public. The game was about the public sector comparator versus the PFI and everybody knew what the answer had to be at the end of the day.

It was an insider secret that these assessments were manipulated. That has been put right by the move to IFRS and to a control criterion rather than the abused risks and rewards criterion, but I worry during the period of fiscal austerity that we are going to find all sorts of other things coming up. The Public Accounts Committee is going to have to start worrying about things like fragmented bodies and about guarantees. The number of times I have read that guarantees are costless to the public purse-I just find it amazing that anybody can suggest that. There will be a whole set of other issues.

Coming back to your question, if you force audit fees down too far, people will not have the stomach for a fight. The justification I got in private from the big firms was that the rest of them did it like that as well. So people took safety. This is not based on direct evidence, but my impression was that the auditors in the Audit Commission dare not go against what the private firms were doing.

Q122 Ian Swales: That is an interesting dark view of the world. We raised with the earlier witnesses the question of whistleblowing. One of the possibilities was that access to a body’s auditors was one way that whistleblowers might operate. Being realistic and looking at it from a professional firm’s point of view, do you see that as a function that they could perform? Would it work and does it need covering in the Bill somehow in terms of their duties?

Professor David Heald: I would not have any experience on that topic but if they have signed up to a particular audit regime they are going to want incremental payment for additional activities.

David Walker: There is a very brief historical part answer to your question. I appeal, as it were, to the municipal experience of the Chair and Clive Betts. Once upon a time the district auditor was a figure who carried civic authority and was regarded by, for example, local authority leaders as someone who would be proactive in the public interest. It is not inconceivable that a private auditor would carry public interest, but it is much less likely. Unfortunately, one of the aspects of what is happening is the loss of an historic identity of the district audit. District audit was for a hundred years or more a very important part of the local service delivery landscape because auditors were always there potentially.

Q123 Ian Swales: Just one point on that. You have raised another interesting point which is that if we nail the fees down through this process then we are not paying for proactivity and that kind of independence and extra work, are we? So that function you described in a district auditor we have designed out as a result of this regime. Is that correct?

David Walker: To be fair, there is a large debate going on in various parts of the private accountancy world about the role of auditors in their audit of private companies, which debate might lead to a redefinition of the "public" responsibility of private sector auditors in the private sector, which might in turn feed through and make private auditors appointed to public audit more aware of the wider context. As things stand, there is an issue.

Q124 Mark Pawsey: Can I ask about the deterrent effect of the auditor? One of the reasons the audit is there is that the police and people know that if wrongdoing takes place the auditor will find it. If it becomes known that there is a less stringent regime, with less value-for-money work being done, is there a danger that those who might be contemplating doing something inappropriate are more likely to proceed, in your view?

David Walker: That has to be the case, otherwise why would we employ police officers, even if reduced in number? Again, you might privately ask the Chair and Clive about their experience a generation ago-as it were, in terms of municipal history-and the role of the district auditor in crimping the activist authorities of the day. I think it is having in mind somebody who has an interest in the local public good. Again, not to say that private auditors would not have that, but the belief under the previous regime was that district auditors were there, as I said, to carry out a civic purpose. Take that away and-

Ian Swales: We should also remember that although, obviously, we automatically think of fraud, on an 80:20 basis it is incompetence rather than corruption that we are looking at in terms of value for money-it is professionalism and all that kind of thing. Obviously, we get the headline cases but, day to day, it is whether people are doing their jobs effectively and efficiently.

Q125 Mr Bacon: I wanted to ask about the capacity of Audit Scotland, Mr Black, and the references made earlier to the National Audit Office not having a direct connection with the auditors in the same way. Could you just paint a picture for us of the shape and size of Audit Scotland when you were there? How many staff were there and how many were devoted to Scottish Government audit, whether financial or value for money, and how many devoted to local government?

Robert Black: Up until about three years ago, there were roughly speaking-the scale is entirely different-about 200 of us doing financial audit in Audit Scotland.

Mr Bacon: In total?

Robert Black: Yes. My colleagues and I committed ourselves-we could see the way the wind was going with public spending-to a 20% real efficiency saving. By the time I left in June we were well through that, so the financial audit staff numbers had come down to about 160 or something like that.

Q126 Mr Bacon: And of those how many were doing national Scottish Government work and how many were doing local?

Robert Black: There would be a team of auditors who primarily do the Scottish Government resource accounts and who would also do a few of the large agencies. On orders of magnitude, maybe 10 maximum would be in such a team-I am sure that Audit Scotland could give you exact numbers now, because I am not up to date with this. There might be about 50 or 60 of the total staff who were working on overall performance audits, value-for-money audits or best-value reviews of local authorities. About two thirds of all the work, whether financial audit, the best-value reviews of local government or performance audits, was done by in-house staff, and about a third of the audits were done by others.

Q127 Mr Bacon: We are still not clear. Of the 200, or be it 160, how many of them were working on local government issues, whether financial audit or performance audit? You said 50 or 60 but you were talking about the performance audit.

Robert Black: I would encourage you to get a note from Audit Scotland on that, just to be absolutely accurate. Part of the problem was, because we were an integrated organisation, you would actually need to do a time apportionment of where people were working.

Q128 Mr Bacon: Were most people doing a bit of both?

Robert Black: Not most, but a significant number were doing a bit of both. If we were doing, let us say, a major performance review of drug and alcohol policy in Scotland, we would be drawing on people with expertise in health, people with expertise in local government or people working at the centre-people would be working on mixed areas of work with that. So I cannot give an exact figure, I am sorry for that.

Q129 Mr Bacon: The analogy is between Scotland and England, which is roughly 10 times larger and where you have 800 or so staff-slightly less than 850 at the moment, I think-of whom a couple of hundred do performance audit and the other 600 or 650 do financial audit. That is all of central Government and its agencies-none of it is related to local government. There is none of this direct connection that Professor Heald was referring to earlier, so it is all very well to give the National Audit Office a duty, but the question is whether it would have the capacity as presently structured to take on something of that size. If England is roughly 10 times larger than Scotland, at present there is no capacity in the National Audit Office to have this direct connection with local government audit.

Robert Black: May I give you one more piece of information that might be helpful? The budget of Audit Scotland is about £27 million a year. We do all of the work out of that total.

Mr Bacon: The budget of the NAO is about £70 million or £80 million, and that does not include any local at all. It strikes me as unlikely that in its present constitution the NAO would have the capacity to take on all this additional work.

Q130 Chair: What do you feel about that, as it is a key point?

Robert Black: My comment is an obvious one. It would be for the Comptroller and Auditor General with his team to think about relative priorities, in consultation with yourselves. We regularly had to do that with the Public Audit Committee in Scotland, to cut our coat to the cloth.

Q131 Mr Bacon: To use your own phrase it is an order of magnitude difference, if there is all this work that is not going on at the moment.

Professor David Heald: I would argue strongly that that is a matter for Parliament; most directly a matter for the Public Accounts Commission and the Public Accounts Committee, in conjunction with the Comptroller and Auditor General, to think about. We are where we are now, having effectively abolished the Audit Commission, and lost its capacity. The question about where capacity ought to be rebuilt is a matter that should be discussed among those parliamentary bodies.

Q132 Chair: We are, but we are interested in your views. Richard Bacon is saying that it is such a qualitatively different set-up. Can the NAO do both?

Professor David Heald: Obviously it can’t do it without more budget. That is an obvious point. I find it astonishing-

Q133 Chair: If it has more budget. The interesting thing is that with the National Audit Commission, in a sense we can pre-empt resources. It is for us to determine the budget but it is really whether the magnitude of the task could be fulfilled.

David Walker: Can I briefly echo Richard’s point qualitatively? It would need to be a cultural shift of a huge magnitude. The NAO’s culture is directed towards Whitehall Departments. Its capacity is not just a volume question; it is an attitudinal question. It would need to think in terms of local service delivery, and think in terms of those strange animals, elected local authorities. That would be a major shift.

Q134 Mr Betts: Would it also be true to say that the NAO tends to look at things totally after the event, to analyse what has happened. The Audit Commission has a more proactive view about trying to anticipate problems and head them off.

Professor David Heald: Mr Black and I were both members of the Financial Issues Advisory Group, which led to the proposals that became the Public Finance and Accountability (Scotland) Act 2000. There was discussion in Scotland about whether one wanted two audit bodies, one for central Government and one for local government. The consensus of the Group was that Scotland wasn’t big enough for that purpose.

There is a complex structure in Scotland involving the Accounts Commission and Audit Scotland, which was to take account of sensitivities of local authorities having a separate democratic mandate. I think that issue has come up firmly on the agenda. If the Government are not willing to accept the continuation of the Audit Commission under a name that Richard Bacon thinks of, the question of the role of the NAO has to be thought through. It is not something that should be dumped on the NAO. It should be something that comes out of a parliamentary procedure.

David Walker: But Bob Black has some interesting thoughts about the regionalisation of the NAO, have you not?

Robert Black: Oh, gosh. On the record, David, thank you for that passed ball. I prefer not to go there. There is something in there. To generalise at a philosophical level, there is something very much around the accountability of the auditors to the public. It has always struck me that within England, given the large and complex state it is, there is something about the regional dimension of transparency and accountability to local communities, but doing that in a way that is structured. In other words, for example, the opaqueness and the arcane technology of doing audits are difficult for the public to understand, not least under IFRS. Therefore, it was a core purpose of Audit Scotland, where possible, to attach meaning and significance to that in lay terms by putting a lot of emphasis on plain English final reports, which were very short form. Of course, that resonates at the level of Scotland, because it is like a large region, so there is something about that lacuna at the sub-national level, but I would prefer not to say more than that.

Jessica Crowe: One way of thinking about it conceptually is to follow the logic of the departmental accountability system statements; that there is one process that is very much the NAO looking at the systems for which the accounting officers in Whitehall Departments are directly responsible. So, in other words, how do they, you as the PAC, and others in Parliament, get assurance about money that is spent at local level, based on local mandates?

Q135 Chair: We are finding it very difficult, I can tell you.

Jessica Crowe: Yes, exactly, but that is what the NAO would need to bottom out to take on this additional responsibility.

Q136 Mr Bacon: The answer we often get is that the question is whether the systems were in place. It is always systemic and always nobody’s fault. The issue that would concern the public is if, in the absence of the right regime-I do not pretend to have all the answers to this now-more Doncasters happened, and they did not get known about until it is, as it were, too late. So, they did not get known about until they were already extant and happening, rather than there being an early-warning system. How do you see the installation in the Bill of a sufficient early-warning system?

Jessica Crowe: I am not sure that it can be done just in a Bill about audit, because as I said, I think it is much broader than that. It is worth remembering that the problems of Doncaster go back many years and were brewing up, under the old regime, which we were talking about, with all of its inspection, intervention, monitoring, performance assessment, and all the rest of it. That was all in place and Doncaster still happened, so in a way, you cannot legislate away authorities that are going to get into difficulty, because I think it is all about culture, and the culture and behaviour of an organisation. Organisations have to find a way of instilling the culture.

Research has been done in some private firms into how the top FTSE 100 and FTSE 250 companies work. It is all about the ‘tone from the top’, as they call it. It is all about how a local authority assesses itself, what local authority members do, and what the chief executive, senior officers and statutory officers do. There may be something more about the powers and roles of the statutory officers, because they are very important. Part of the intervention in Doncaster was absolutely to reinforce the powers and responsibilities of the three statutory officers, because they were what members were effectively ignoring. There may be something around enshrining that, and maybe the triumvirate of the head of paid service, the monitoring officer, and the section 151 officer. That then may be a connection to reinforce some of those issues, but it cannot really be done by audit.

Q137 Heather Wheeler: To be honest, I wonder whether you guys are living in a different world, because in terms of the value-for-money stuff and new ways of working, councils get in different types of firms to do those jobs now. If they want to go to KPMG, fine, they can, but it is nothing to do with the audit. Things have been separated out, and you are almost talking as though all that lot still ought to be bunged in together. It is just not like that any more, and that is what the Bill is saying. You seem to be talking from a different era.

David Walker: But there is a link, and the link is the financial numbers. Why auditors became the leaders of value for money was because they were the first and often the only people to see and invigilate the financial numbers. Just coming in and doing VFM, you often will miss the numbers that you are going to need to make a proper assessment. I have no need to draw the Committee’s attention to an excellent article that appears in the current edition of "Public Finance" by your expert adviser, Tony Travers, in which he takes us through numbers of missing pieces of data in the system locally, regionally and centrally. One gap, one might say, in the Bill is that data assurance function, which gradually, though not very well, the Audit Commission had been moving into, to at least assure whoever was looking at the numbers that they were there and were meaningful. I think VFM needs somebody to attest to the quality of the financial data coming through.

Q138 Chair: I want to bring Clive in on the savings, but following on from what Heather said, the Bill is there and I suppose the question is what will happen if it goes through unamended.

David Walker: You are going to confront financial disasters. You, us, the public, the taxpayer. Sooner or later. Probably sooner.

Q139 Chair: Financial disasters in local government or in health trusts?

David Walker: Financial disasters in a generic sense that we will not get proper value for money from spending public money.

Q140 Chair: Because?

David Walker: Because nobody owns value for money. Heather is right. There are a lot of people milling around this, but there is no central ownership of the project of squeezing scarce public resources to their maximum, and you are going to get local disasters because there will be failures. Look at the number of people who are qualified to sit on audit panels already, let alone the independent audit bodies. There is a real capacity issue.

Professor David Heald: It will operate at two levels. One is the disaster that the Minister has to explain in Parliament. Second is the more technical difficulty that will be found by accounting officers when accounting whether the money that goes out of central Government to local authorities and health bodies has actually generated value for money and has been administered with probity.

On my earlier point about the cycle turning, the "Proper Conduct of Public Business" report from 1994 was one of the factors that led up to the accruals accounting revolution in central Government, which led up to Sharman, and the wheel comes full circle. My prediction would be that there will be particular disasters because the early-warning intelligence will have gone, but it will be difficult for central Government Departments that are heavily dependent on distanced delivery organisations to convince Parliament that they have delivered value for money. The Public Accounts Committee will find a loss of information, because when the Comptroller and Auditor General is auditing and concerned with value for money for health and services that are largely delivered by local authorities, there was the infrastructure of the Audit Commission regime there, and that will not be there anymore.

Jessica Crowe: If the Bill goes through as is, the attention then would need to turn to what goes into the regulations to try to make it as safe as possible given the weak statutory thing. I think there are some things that could be done in regulations, and we would just have to fall back on those to see what can be done to put some more safeguards in place.

Q141 Chair: Just to insist on data collection? What are the things that you would put in there?

Jessica Crowe: There are some process things about how you get a robust system at local level for bolstering the independence point. There may be some things that could be done there. It would depend what goes into the code of practice that the NAO puts together that auditors will work to.

Professor David Heald: One of the significant problems is that local authorities get accounts on a UK GAAP basis or an IFRS basis now, and not on what drives council tax. You have the complex reconciliations between the accounting numbers that get audited and the council tax numbers. It is probably not something to be done on the face of the Bill, but one thing that regulation should try to do is to clean up the regime. It seems bizarre that local authorities actually now charge depreciation, but that gets added back and loan charges substituted before you strike council tax. There are all sorts of complications and tensions between the statutory and financial control framework and the actual accounting numbers on which the financial certification is done. That is a fundamental difficulty, because it makes it much more difficult to engage councillors and members of the public when the numbers become so complex that you require a substantial amount of knowledge to actually understand why these adjustments are made.

Q142 Mr Betts: That is an interesting point, because we talk about the public understanding, but my guess is that not 5% of councillors even read the accounts, let alone ask any questions about them. They are just too complicated.

Jessica Crowe: That is the real challenge at the heart of this whole drive towards transparency. If people cannot understand it because it is all so complicated, it is not going to achieve that policy objective. There used to be public reporting awards that David and I sat on, but they were dropped.

Mr Bacon: Was this armchair auditor of the year?

Jessica Crowe: Exactly. I wonder why they were dropped, but possibly-

Mr Bacon: Because people turned over to watch Sky Sports.

Jessica Crowe: It is just too complicated. We could not find organisations that were doing it well, because the regime is too complex. It made it very difficult to report.

Q143 Meg Hillier: This may be an unfair question to throw at you, Jessica, but given that you sit at the centre of public scrutiny, do you have an idea of the percentage of councils that do a really good job on financial scrutiny? Scrutiny by its nature can be very hit and miss.

Jessica Crowe: I could not give you a percentage. We know from our annual survey that budget and financial scrutiny is one of the things that scrutiny functions feel that they struggle with. They find it hard to do because of this technical issue. On the other hand, where scrutiny committees are doing well and where they are increasingly moving into is the kind of broader value for money and looking at the outcomes from the spending of money, so not trying to second guess the auditors. We try to tell them not to do that because they are not financial experts. Looking at what the outcomes have been from that expenditure, there are some good examples of where local authority scrutiny functions have found savings of hundreds of thousands of pounds for their local authority. It can be done.

Q144 Mr Betts: I suppose the argument has been-whatever the difficulties and the significant changes-that it will all be all right because £1 billion will be saved by abolishing the Audit Commission. The Audit Commission basically said in evidence to us earlier that the savings that were available will be banked by the removal of the CIA and now the move to the procurement regime that it has adopted, which has found significant savings on audit this time. What would your take be on the Government’s claims and the Audit Commission’s response that the best savings have been made already?

Professor David Heald: I would be more impressed with the impact statement if it acknowledged the fact that there were some benefits from the assessment regime. The assessment regime was helpful with the long tail of performance and over time, there were significant improvements, bringing councils and other authorities up. The first point is that the Audit Commission spent a lot of money on assessment, but there was absolutely no benefit in it whatever. I do not accept that point. We do not know what the long-term effects on audit prices will be. To go back to my comments to Mr Swales earlier, I actually get worried-I am one of the few people who tend to think that audit fees are too low. You actually get what you pay for. Once you get into a mindset where you want to drive down audit fees without worrying about whether you are getting the same quality, that can lead to problems in the longer term.

Q145 Mr Betts: There is a bigger problem of that with individual authorities doing their own appointing of auditors.

Professor David Heald: That will become worse, yes. With a central procurement agency, there will be an inbuilt reserve about driving the fees too low. The point I want to make is that people who are not accountants or auditors tend to misunderstand what financial certification audit is about. It is about whether the accounts present a true and fair view of the position of the authority. There are large materiality questions, so lots of things that are wrong would not necessarily be big enough numerically in relation to that authority to be material to the financial statements. The amount of detailed checking that goes on in audits now has gone down dramatically over the years, so people should not expect too much. They are a judgment of a particular point in time about whether there is a true and fair view subject to the materiality issue. They are nothing about economy, effectiveness and efficiency.

Q146 Chair: Does anyone want to add anything to that on the money side?

Robert Black: Simply on that point, if I may. I heartily agree with David Heald that there is a difference between materiality for the purposes of the audit certificate and public interest in some of these things. One could be talking about significant but rather smaller sums of public money, where the public have a right to know and Parliament, whether the Scottish or the UK Parliament, has a right to know whether that money was spent properly. In my past, or in Scotland, that would come in to try and make sure that that was happening, alongside the co-audit.

Q147 Mr Bacon: You bring to my mind two examples, both from financial accounts-one in the Revenue and Customs prosecutions office and one in the Foreign Office-where the amounts of money involved as a proportion of the organisation as a whole were not significant. When the Revenue and Customs prosecutions office, which was the hived off prosecutions department of HMRC, was set up the new director, who knew nothing about HR or finance, appointed a chief operating officer whose first act was to appoint his wife to do £100,000 worth of HR consultancy. This was flagged up in the financial accounts. In the case of the Foreign Office, which was a £2 billion organisation, some satellite phones were stolen in Iraq and were used to telephone betting lines and sex chat lines, and when the bill came in the Foreign Office just signed the cheque and carried on paying the bills. It was £600,000, which was a lot of money but might not have been thought material in light of the size of the Foreign Office. But in each case those examples were flagged up in the financial accounts. So if they are doing their job, should not these things be identified anyway within the financial accounting framework, entirely aside from VFM?

Robert Black: I would like to think that, certainly in the regime of which I was a part, that would happen. You would not be guaranteed to identify everything, but I could entertain you for some hours about peccadilloes involving five-figure sums rather than six-figure sums. But the serious point is that these are public interest matters, because these issues resonate with local communities-I need hardly tell you, as elected representatives, of that-and they can be insidious in undermining trust in government as a whole. Trying to find a way to balance this-

David Walker: There is-briefly-another form of criminality, too, which one should worry about, and that is the pursuit of money which is given to contractors. This is something that I know that you on the PAC have been thinking about. What happens when, increasingly, public services are delivered by a variety of bodies inside/outside the public sector-some social enterprises, some for-profit? Does the auditor have the gumption to try and follow the money? Does the auditor have the right to try and follow the money? A proactive public auditor might think, "Yes, I will follow the money." A private sector auditor might think, "Not me, Guv."

Q148 Chair: To be honest, I think the public auditor would like to follow the money and says he hasn’t got the statutory authority to do so. That’s the real worry. It is only statutory authority, but this is another thing that the PAC is pursuing.

Q149 Mr Betts: Could you put a right in the Bill?

Q150 Chair: Yes, you could. That is not a bad idea. You could put a right in the Bill to follow the taxpayers’ pound. That is a really good idea.

Jessica Crowe: That is a really important point and something that scrutiny committees have tried to follow and require contractors to appear, but they have been told, "You don’t have the right to call us. We’re accountable to our client and we don’t have to come and account for ourselves in public."

Q151 Chair: We are coming to an end. I am conscious we have not covered everything, so is there something that you think is key in relation to the draft legislation that you want to draw our attention to?

Robert Black: No.

Professor David Heald: I would just underline this point about data assurance. It is something that, fumblingly, the Audit Commission was getting towards. It is now even more necessary to try and build into an accountability regime.

David Walker: No.

Jessica Crowe: Nothing from me.

Chair: Thank you very much. Those of us that are not on the CLG Committee found that helpful and useful in getting our brain around the issues. I am really grateful to all of you, and particularly grateful to David Heald and to Bob Black for coming down from Scotland.

Prepared 11th January 2013