115.There was a consensus amongst the witnesses to our inquiry that the Accounts need to be accurate and credible. Julian Kelly, from the Treasury, told us that it was key that Annual Reports and Accounts were set out “in a way that Parliament then knows is a true and fair view”.165 The Organisation for Economic Cooperation and Development told us that most Governments have adopted independent standards for their Accounts, to ensure they meet “the need for objectivity, independence, and integrity”.166
116.In order to explore whether this important standard is being met, this Chapter first analyses the format of the UK Government Annual Reports and Accounts. Secondly we analyse the accuracy of the information contained in Annual Reports and Accounts and lastly the independence of the Comptroller and Auditor General.
117.There is a consensus amongst professionals that current UK public sector accounting practice is considered as an exemplar of best practice internationally. The International Federation of Accountants (IFAC) said that the UK “is a model to which other countries might well aspire”.167 The Chartered Institute of Public Finance and Accountancy (CIPFA) said “the quality and timeliness of Government Departmental annual Accounts has improved over the last two decades”.168 Both the Institute of Chartered Accountants in Scotland and the Institute of Chartered Accountants in England and Wales agreed with these views.169 The rest of this section explains why this adherence to accounting standards is a positive position for the UK.
118.Experts agree that accruals accounting enables better scrutiny of Government finances than cash accounting. Despite this, progress in adopting the practice has been slow, with still only 72% of OECD members currently using accrual accounting.170 The International Federation of Accountants (IFAC) provided, in their evidence, a practical example of how this information enables better scrutiny:
In the past, the UK Governments may have increased employees’ future pensions instead of offering a pay raise. This potentially solved an immediate cash flow (and cash budget) concern; but created a present obligation that had to be settled in the future (a liability).171
119.For instance the Whole of Government Accounts now includes details of estimated public sector pension liabilities. This has become the basis for public debate about the real size of the deficit. For example, in 2016, the Adam Smith Institute, Telegraph and City AM used this figure to suggest that the UK’s fiscal challenge was bigger than most conventional analysis suggested.172
120.This example is one instance where, as Dr. Lawrence Ferry, Associate Professor in Accounting at Durham University, and Dr. Danny Chow, Lecturer in Accounting at Durham University, argue “under accrual accounting the revenue and expenditure statement will include items previously hidden from view”.173 For this reason, the National Audit Office told us that “accrual Accounts can provide insight because they reflect, transparently and comprehensively, the financial consequences of each decision made” by the Government.174
121.Other related developments have also helped. For a number of years Parliament has been able to see how much expenditure is meant for investment (capital spending) compared to how much is devoted to running costs and consumption (resource spending). For instance, in 2017, the House of Commons held a debate on the way in which, for the third year running, the Department of Health’s Supplementary Estimate moved budget from capital to resource. The Department therefore moved money from its budget for investment in buildings and machinery to its budget for running costs. The Chair of the Public Accounts Committee, Meg Hillier MP, described the switch as ‘worrying’, commenting that “those sorts of capital expenditures are important to save money in the long term, so the Estimate really is very short-sighted”.175 Without a separate capital and resource budget and account, Parliament would have been unable to see and comment on this switch in the estimate.
122.Annual Reports and Accounts have also been appearing earlier. While the statutory deadline for Government Accounts of 31 January (10 months after the end of the financial year) remains, due to a “faster closure” initiative within Government most Annual Reports and Accounts are audited and published within four months of the end of the financial year, before the summer Parliamentary recess.
123.Currently, in terms of accruals accounting, timeliness, standards of preparation, technical standards, and audit, UK Government Accounts meet international standards for good practice-indeed they are recognised as amongst the best in the world. The Government is right to manage public spending and publish its Accounts on an accruals basis, enabling consistency between in-year budgets and end year Accounts and discouraging the use of cash movements to distort in year spending patterns. Accruals accounting has allowed Parliament and the public to gain a better understanding of how the Government uses its resources and manages its assets and liabilities. Accruals accounting is therefore a good basis for the further work we believe the accounts also need to do (described in other parts of this report).
124.Currently Government Accounts are prepared according to International Financial Reporting Standards (IFRS), as interpreted for the public sector by the Treasury, on the advice of the FRAB (Financial Reporting Advisory Board) (discussed in Chapter 4). 41% of OECD members use international accounting standards.176 The Treasury, under the Government Resources and Accounts Act 2000 is charged with consulting with FRAB about how it implements the accounting standards in the UK .
125.The use of IFRS permits comparison between Government and other bodies. David Kilpin, in his evidence, said that “the use of International Financial Reporting Standards (IFRS) permits accountants and economists inside and outside Government, and across the world to understand what basis the Accounts have been prepared under”.177 The NAO have described IFRS as the “global language” of finance.178 The C&AG argued that using the same basis as the private sector gave public sector Accounts “more credibility”.179 The NAO also told us that the UK are leading in this area and that “other national Governments are adopting similar accounting frameworks”.180
126.Much of the effect of IFRS is benign. Craig Mackinlay MP said that often IFRS are introduced to ensure that liabilities are accurately reported. He said
There has been for years and years and years the tendency to try to hide liabilities, and that is what a lot of the new IFRSs are trying to get into Accounts.181
Mr Mackinlay told us about one important example: the Private Finance Initiative (PFI). PFI is effectively a loan from the private sector to the public sector to construct an asset, often paid back over many years. IFRS forced the UK Government to disclose more about the debt that the Government had acquired through constructing buildings using PFI.182
127.While IFRS offers consistency and high standards of reporting, it is not always necessarily ideally suited to the particular circumstances of the public sector. Professor Ellwood told us that IFRS Accounts were not designed for the normal users of Government information but “for investors in the capital markets. Those are defined as the primary users of IFRS statements”.183 Professor Prowle said that
What I have observed in the last 30, 35 years in this country is that with the Accounts for public bodies, Government bodies, we have basically followed practice in the private sector blindly. We have ended up with a set of Accounts that are mirroring what happens in the private sector and we are talking about very different things.184
128.International standards can assist transparency, by ensuring that Government accounts reflect all the results of Government policy. However, it is important that the Treasury recognises that Accounts in the public sector do very different things to Accounts in the private sector and their design should reflect the different group of people that use them. Given that, it is important that although the accounts currently meet the international standards, the Government makes additional disclosures (discussed in Chapter 3 and 4 for example about spend on particular policies) above and beyond standard corporate accounting. Otherwise both Parliament and citizens will be unable to use these documents to hold the government to account.
129.Professor Heald, in his evidence, told us that Annual Reports and Accounts were useful even if there were limited numbers of users. He pointed to the fact that auditors of the Accounts check whether monies have been spent in line with Parliamentary, Treasury and Departmental approvals as a key control.
Even if there were no actual external user, knowledge that Government entities have delivered Accounts and secured clean audit certificates is highly relevant to public confidence in the management of public finances.185
Professor Heald told us that it was impossible for a member of the public to find out how many Government Departments had secured clean audit certificates. He argued that the NAO should resume publishing a report (which ceased publication in 2004) that showed the public and Parliament how many Accounts it had qualified in each year and why. Such a report would give the public and Parliament useful insights into the quality of Government’s financial management. The C&AG told us that he “will give some thought” to how “this information could be made available”.186
130.Professor Heald argues that Accounts give us assurance that the Government knows what it spends money on, and can measure it accurately. At the moment, we do not have summarised data that enables us to check how many of the Government’s published Accounts are either accurate or properly compiled. The National Audit Office should publish an annual report which identifies how many Accounts are qualified, why they were qualified and what that tells us about the Government’s ability to manage its finances effectively.
131.This next section explains the arrangements in place to ensure that the Annual Reports and Accounts are accurate and makes recommendations to improve the accuracy of the documents.
132.The Comptroller and Auditor General (C&AG), assisted by the NAO, audits the financial information in Annual Reports and Accounts.187 In their evidence, the NAO said that “a key measure of the robustness of a set of Accounts is the opinion provided by the external auditor”, as they note
For the 2014–15 year of account the C&AG qualified his audit opinion for 15 Accounts out of almost 400 Accounts he audited.188
The 400 Accounts include Accounts from Departments but also other Government bodies. The NAO note that they found inaccuracy in only 6 of the 15 qualifications.189 We understand that the number of qualifications is similar in 2015–16.
133.The Right Honourable David Gauke MP, Chief Secretary to the Treasury agreed that the role of the National Audit Office, as Government’s external auditor is important: he said that “the role of the NAO and the independence of the NAO is something that we recognise and support”.190
134.The National Audit Office will only qualify Accounts on the basis that there is an error that is material to someone’s view of the Accounts. They define three types of errors that might affect a person’s view of the Accounts.
135.Currently the National Audit Office does not disclose the level above which they would consider an error to be material by value. David Kilpin told the Committee:
Auditors are required to disclose their materiality in the private sector. As I understand it, this allows stakeholders to understand the margin of error that figures may be subject to.191
The Institute for Chartered Accountants in Scotland supported further disclosure about materiality. They argue that more discussion of materiality could aid both auditors and those who prepare Accounts in the public sector to understand which information needs to be included.192
136.In evidence to us, the C&AG and Kate Mathers, then Director of Financial Audit Practice and Quality at the NAO, said that the National Audit Office were considering publishing their materiality levels.193
137.It is crucial that Accounts are accurate, so that MPs, the public and others can take decisions on the basis of good quality information. The low numbers of qualified Accounts is an important index revealing that in the vast majority of cases the public and Parliament can and should have confidence in the accuracy of the figures reported by Government in published Accounts.
138.Materiality for Government Accounts should be disclosed. Whilst witnesses to our inquiry raised concerns about interest from the media and others pushing down materiality, this has not happened in the private sector where materiality is already disclosed. Materiality helps people understand how detailed the audit of the Accounts has been and how far they should rely upon the auditor’s assurance about the accuracy of the figures.
139.The Government’s support for the Comptroller and Auditor General and the NAO is welcome and important. The NAO’s role is constitutionally vital, both as the auditor of value for money in the public sector and as the auditor of the Accounts. As Government’s independent auditor, the NAO assures Parliament that it can rely upon the financial data published in unqualified Accounts to scrutinise the Government. Irrespective of the format or the contents of Annual Reports and Accounts, the NAO’s valuable role must be protected.
140.Whilst, as the previous section discusses, the financial accounts are subjected to a rigorous audit, this is not true of all of the rest of the annual report. The links between different parts of the Annual Reports and Accounts are not always clear. As we show in Chapter 3 however, the Annual report is a key document as it enables MPs and others to link performance information to the financial accounting data in the accounts.
141.The Annual Report has been criticised by experts in evidence to our inquiry. Professor David Heald told us that “good technical processes are marred by abusive political practices, creating distrust in official numbers”.194 The National Audit Office informed us that there is “too much “positive spin” in annual reports and Accounts.195 The Taxpayer’s Alliance agreed and pointed out, as an example, that the Home Office Annual Report and Accounts for 2014–15 did not explain the
failure to deliver the Government’s promised reduction in net immigration. There is widespread concern and dissatisfaction about this, yet the HO ARA doesn’t acknowledge the scale of the failure or provide a proper explanation.196
Craig Mackinlay MP said that “there is a tendency… within all Departmental Accounts to put a rosy gloss on things”.197 The Institute for Chartered Accountants in Scotland argued the Annual Reports were “overly focused on the [Department’s] achievements”.198
142.Will Moy, the Director of the fact checking organisation Full Fact, said that he found these comments about the positive spin on Annual Reports “striking” and said that this would be “unacceptable” in official statistics and should be unacceptable in the context of annual reports as well.199 ICAS said that the Treasury should adopt the “stronger emphasis” in the UK Corporate Governance Code, which applies to private sector companies and mandates “fair, balanced and understandable” reporting.200
143.The UK Statistics Authority (UKSA) have proposed that Annual Reports and Accounts could be bound by principles similar to those set out in the statistical Code of Practice.201 UKSA in their evidence suggested adopting principles of “impartiality and objectivity, … integrity … [and] frankness and objectivity”.202 UKSA define these values in their evidence and argue that statisticians should present figures “impartially and objectively” and prepare “commentary and analysis that aid interpretation and provide factual information about the policy of operational context”.203 In particular, UKSA say that the “public interest should prevail over organisational, personal or political interests”.204
144.UKSA are currently redrafting the code to expand its remit and cover administrative data used by Government Departments. In their exposure draft, they say that
Departments publish a wide range of other types of information, including management information and research, and in some cases the public value of this information might be enhanced if it complied more fully with the Code.205
145.Will Moy, Director of Full Fact, compared the independent oversight of Government statistics with the way that Accounts production is governed. He said that
we should recognise what the Statistics Authority offers, which is guaranteed independence, structural independence, an overview of the whole field and a set of principles that govern the whole activity that are independently published and that have a basis in statute. That is a different picture of machinery than Government accounting. The Government financial profession does not have the same professional accountability to the national statistician, and ultimately the Statistics Authority, which sits independently of Government.206
Statistics within Government must be produced in line with the statistics code of practice in order to be described as National Statistics. The Director General for Regulation at UKSA leads on “the assessment and reassessment of official statistics and their compliance with the Code of Practice for Official Statistics”.207
146.Annual Report and Accounts must impartially describe the activity of the Department during the year. Parliament can take comfort from the work of the National Audit Office and its vital constitutional role as an independent guardian of financial fact in auditing the financial statement parts of the Annual Reports and Accounts. However, there is no audit of the performance information presented in the Annual Report and Accounts, and narrative often appears to be too open to positive, rather than fully balanced, presentation. The Annual Reports should include an honest assessment of the Department’s performance to aid scrutiny. Government seeks to present itself in a favourable light, but it is missing the opportunity to present fully credible performance information. It is unacceptable that the Annual Report parts of Annual Reports and Accounts are, in the opinion of Professor Heald, the Institute for Chartered Accountants of Scotland and the NAO, often spun or subject to political bias.
147.Several of our witnesses have suggested that there is bias or spin in the Annual Report sections of Annual Reports and Accounts. The Government should move to address this by adopting the same principles to which National Statistics are subject (frankness, impartiality, objectivity and accessibility) for all the data in the Annual Report and Accounts. The new revised UKSA statistical Code of Practice should be extended to all accounting data within Departments. The National Audit Office and UKSA should work together to ensure that the code is adopted by Departments and to notify Parliament and the public where Annual Reports and Accounts are currently falling short of its requirements.
148.Whilst the financial data in the Accounts is audited by the National Audit Office, the performance information is not audited.208 The Annual Report is only audited for consistency with the Accounts rather than for accuracy. Craig Mackinlay MP told us that he was unsure “whether they [performance reports] were accurate” and thought auditors should look into this.209 The Treasury told us that it is the responsibility of the Department “to make sure that the information it is publishing [in the performance section] is true and fair and not misleading”.210
149.Departments should also subject the performance data and commentary in their Annual Report to an authoritative audit of the accuracy, completeness and objectivity of the data and statements made, to enable citizens and their representatives to obtain a full and unbiased view of the Department’s performance. This audit should go further than the NAO’s current audit of the annual report for consistency with the accounts. This audit should be conducted by an independent body, potentially the NAO, if it considers it appropriate, or UKSA. This audit should assess the accuracy of the statistics used in assessing performance, whether the Department has used a complete set of statistics in that assessment, and how true and fair the commentary provided in the report is.
169 IGA18 (Institute of Chartered Accountants in Scotland); IGA09 (Institute of Chartered Accountants in England and Wales)
172 Nigel Hawkins, UK PLC: Britain’s debt timebomb, Adam Smith Institute, April 2016; Ben Riley Smith Every Briton faces £53k debt for public sector pensions and other unfunded schemes, The Telegraph, 18 April 2016; William Turvill Successive governments accused of being “wildly reckless” as report finds public sector pensions and unpaid student loans add up to create £1.85 trillion liabilities “timebomb”, City AM, 18 April 2016.
175 Hansard, Vol. 622, 27 February 2017, col. 87.
187 The NAO audits the financial statements, remuneration report and Statement of Parliamentary Supply fully, but other sections of the Annual Report and Accounts only for consistency.
200 Financial Reporting Council, The UK Corporate Governance Code, September 2012, p.6; IGA18 (Institute for Chartered Accountants of Scotland)
201 UK Statistics Authority, Code of Practice for Official Statistics.
205 UK Statistics Authority, Stocktake of the Code of Practice for Official Statistics Exposure draft, November 2016, p.4.
206 Q235 (Will Moy)
208 The NAO audits the financial statements and some of the accountability disclosures in the annual report. They look at other data in the annual report to check its consistency with the financial statements.
26 April 2017