Draft Local Audit Bill: Pre-legislative Scrutiny - Draft Local Audit Bill ad hoc Committee Contents

6  Audit fees and the market in audit

84.  According to the Government one of the key objectives of the draft Bill is to achieve lower audit fees through a competitive market in audit.[108] The impact assessment accompanying the draft Bill concludes that the current arrangement of central procurement of audit "does not include strong incentives for costs to be minimised"[109]' The Secretary of State argued that, under the auspices of the Audit Commission, "local authorities had been overcharged for their audit function".[110] Consequently, and as an interim step towards abolition, the Government asked the Audit Commission to outsource the work of its in-house practice with effect from 2012/13, under its existing powers.[111]

85.  In its latest procurement exercise the Audit Commission reduced fees by 40% on 2011/12 levels. Part of this saving resulted from the decision to end its assessment and inspection functions and its ability to negotiate bulk contracts on behalf of local bodies. However, the Audit Commission told us that these savings were not attributable to these factors alone; in addition the Audit Commission argued that they were made possible due to the Audit Commission's "twin powers of being able to impose and appoint the auditors".[112] These twin powers enabled the Audit Commission to operate what it termed a "Post Office" equalisation approach to pricing whereby Audit Firms were offered large contracts which contained a mixture of desirable and less desirable bodies to audit.

86.  Witnesses representing local authorities said that the Audit Commission had been successful in identifying savings in audit fees. For example Joanna Simons, Chief Executive of Oxfordshire County Council, noted that "one of the good things in the past few years has been the downward pressure on audit fees".[113] The impact assessment notes that it is difficult to predict what impact the unwinding of this system will have on the level of audit fees in the new regime.[114]

Variation in audit fees

87.  The majority of our witnesses argued that there would be substantial geographical variation in fees between different local bodies in the new regime.[115] According to Michael O'Higgins, former Chief Executive of the Audit Commission:

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.[116]

Sir Robert Naylor, Chief Executive of the University of London's Hospital (UCLH) NHS Foundation Trust informed us that the audit fees that UCLH currently pay are "about half" of what it previously paid to the Audit Commission.[117] This reduction in fees can, in part, be attributed to differences between the Audit Commission's and Monitor's Code; the latter's Code of Practice does not provide for VfM studies and is narrower than the Audit Commission's.

88.  We heard contrary evidence regarding whether fees are likely rise or fall overall compared to current rates. A minority of our witnesses, including Paul Woolston of PwC, suggested to the Committee that "fees will come down across the board, including smaller organisations".[118] Conversely the majority of our witnesses, including Grant Thornton, argued that "it is likely that fees will increase, not decrease, as a result of the draft Bill".[119] The possibility of increased audit fees were cited by Steve Parkinson, Society of Local Council Clerks, who suggested that when "we get to the 2017 tender exercise, I cannot imagine those fees going down, and especially for the smallest, I can see them needing to go up". [120]

89.  Sarah Howard, Head of Public Sector Assurance at Grant Thornton LLP, also told the Committee that "there will be pressure on fees in the absence of large volume contracts and the huge discounts" that they are currently able to offer. This, she argued, is due to the loss of efficiencies in procurement costs, increases in tendering costs and the loss of the Audit Commission's indemnity function.[121] The draft impact assessment highlights fourteen potential drivers of local bodies' audit fees, some of which may act as upward pressures, others as downward pressures, and others with unidentifiable effect.[122]

90.  While we recognise that there would be scope for achieving economies of scale through joint procurement in the new regime, we also consider that substantial economies could be realised through central purchasing and appointment. This reinforces our view that a central procurement capacity should be retained. However, should the Government maintain its commitment to local appointment, we recommend that local bodies be encouraged and supported in jointly procuring audit in an effort to secure more competitive fees than could be achieved if each individual body appointed its own auditor. We consider the LGA to be well placed to potentially play an active role in facilitating this process.

91.  Given the uncertainties surrounding the level of future audit fees, we recommend Government conduct a post-implementation review following both the first and second self-appointment exercises.

The audit market

92.  The Government assumes that a more competitive market in audit will be established as a result of the implementation of the draft Bill and, in turn that a more competitive market will lead to a downward pressure on audit fees. The Government argues that audit firms will "benefit from the opening up of the audit market to competition, as they will have increased opportunity to realise profits".[123]

93.  On the other hand, Grant Thornton told us that the draft Bill would not promote competition. Indeed, they suggested that the opposite is likely;[124] telling us that "the impact assessment of the draft Bill is flawed in that there is already full competition with 100% of audits outsourced. The outsourcing followed a competitive process with commercially attractive 'lots' to attract potential new entrants to the market".[125] Only two new entrants were awarded contracts during the last procurement exercise.

94.   When it considered this matter, the Communities and Local Government Select Committee recommended that a stand-alone company, preferably a mutual, should be established to capture the Audit Commission's skills and expertise.[126] The DA Partnership, named after District Audit (the forerunner to the Commission), was temporarily established as part of a mutual partnership. If successful in the bidding process, it was expected that the partnership would transfer staff from the Audit Commission under TUPE regulations.[127] However, the DA Partnership were awarded only one contract, and "the partnership could not launch as an employee-owned independent firm. Instead it became a wholly-owned subsidiary of Mazars, trading as Mazars DA".[128]

95.  We heard evidence to suggest that it is not realistic for smaller firms and organisations such as mutuals and co-operatives to bid successfully for one-off audits without an inevitable impact on quality, consistency or cost.[129] This, it was argued was because the characteristics and complexity of public sector audit requires auditors to invest in understanding the unique aspects of the public sector audit regime in order to deliver high quality audits. Moreover, it was argued, that the wider scope of audit, public reporting and the relationship with local electors distinguish local authority audit from other audits and audit suppliers therefore use highly specialised and experienced teams. These requirements were cited as likely barriers which would prevent smaller firms from entering the market.

96.  We are concerned that the provisions in the draft Bill will not produce an open and competitive audit market as envisaged by the Government which is an aim that we support. The Bill should not result in contracts being awarded to a small number of audit firms. We recommend that the Government consult further appropriate bodies including the Competition Commission, FRC, LGA and professional accountancy bodies in order to amend the Bill so that effective competition can be realised.

108   Draft Local Audit Bill, Cm 8393, July 2012, p 6 Back

109   Draft Local Audit Bill, Cm 8393, July 2012, p 152 Back

110   Q 671 Back

111   Draft Local Audit Bill, Cm 8393, July 2012, p 159 Back

112   Q 95 Back

113   Q 176 Back

114   Draft Local Audit Bill, Cm 8393, July 2012, p 154 Back

115   Q 463 Back

116   Q 94 Back

117   Q 300 Back

118   Q 464 Back

119   Written evidence from Grant Thornton LLP Back

120   Q 238  Back

121   Qq 463-464 & Written Evidence from Grant Thornton LLP Back

122   Draft Local Audit Bill, Cm 8393, July 2012, p 18 Back

123   Draft Local Audit Bill, Cm 8393, July 2012, p 87 Back

124   Written evidence from Grant Thornton Back

125   Written evidence from Grant Thornton Back

126   Communities and Local Government Committee, Audit and inspection of local authorities, para 14 Back

127   "Gareth Davies to head up new audit mutual", Guardian Professional , 30 September 201, www.guardian.co.uk/public-leaders-network Back

128   "Big Firms Scoop Up Audit Commission Work", Accountancy Age, 5 March 2012, www.accoutancyage.com Back

129   Written evidence from Grant Thornton Back

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Prepared 17 January 2013