1.The marked decline in the timeliness of external audit undermines accountability and hampers effective decision-making. Only 45% of local authorities published audited accounts on time for 2019–20, despite the Department having extended the deadline from 31 July 2020 to 30 November 2020, due to the COVID-19 pandemic. This compares with 57% of local authorities which published their audited accounts on time for 2018–19 and 87% in 2017–18. The Department says it will set an extended deadline of end September for the next two years. Late audit completion can delay timely management action to address financial or performance issues identified; affect a local authority’s annual budget setting and decision-making processes; and impact on the production and audit of other public sector accounts, such as departmental accounts and the Whole of Government Accounts. The audits of local authorities are not of consistently good quality; more than half the audits the FRC examined in 2020 needed more than limited improvement. Delays and quality issues undermine the value and purpose of audit, reducing the assurance to taxpayers and elected representatives.
Recommendation: As a matter of urgency, the Department should write to us by September 2021 with a detailed plan and timetable for getting local audit timeliness back on track.
2.There is a pressing risk of market collapse due to an over reliance on a small number of audit firms and significant barriers to entry. Only eight audit firms have the specialist knowledge and accreditation needed to audit local authorities. Currently, the market is dominated by just two firms, which carry out around 70% of local authority audits. The current contracts for auditing local authorities cover the period up to the 2022–23 financial year but PSAA says it can unilaterally extend these contracts for two years, if needed. Existing audit firms have little financial incentive to stay in the market and there are serious and pervasive challenges to increasing audit capacity further. Audit firms that have left the market no longer have the necessary specialist teams in place. New audit firms face considerable barriers in the time and costs involved in gaining entry to the market, such as developing a sufficient sized team of staff with the specialist skills, led by key audit partners, as part of gaining accreditation. The Department and PSAA are considering how to overcome these barriers, for example, through small packages of audit work, and through consortia where an accredited firm works with an unaccredited firm to enable future entry to the market. In the meantime, any one firm deciding to exit from the market would create a fundamental capacity gap and harm accountability.
Recommendation: The Department should write to us by September 2021 explaining what contingencies it has in place should any more audit firms leave the market at the end of their contracts in 2023.
3.The commercial attractiveness to audit firms of auditing local authorities has declined. Audit firms bid for the current contracts to audit local authorities in 2017, but the work involved has increased significantly in response to well-publicised problems in the corporate sector. Fees now bear little relation to the costs audit firms incur to carry out the work. Audit firms point to the increased work required to audit pension and property valuations, and to meet increased regulatory expectations for local audit. Local authorities say the focus on these areas means less attention is paid to more meaningful areas for their themselves and their residents, such as their financial resilience, outturn against their budget, and performance outcomes. The Department is consulting on changes to the regulations that set the fees, to enable fees to be set closer to when the audit work is carried out, and so that fees can reflect any increase in audit work required. In the meantime, the Department is consulting on how to allocate an additional £15 million to help audit firms respond to the pressures in the current year.
Recommendation: The Department should ensure that PSAA’s next procurement exercise, due to begin in 2021, supports a new fee regime for local government audit, which is appropriately funded, and which brings fees into line with the costs of the work.
4.The rapidly diminishing pool of suitably qualified and experienced staff increases the risks to the timely completion of quality audits. There are serious shortfalls in the number of specialists which audit firms rely on to carry out audits of local authorities. To maintain accreditation, audit firms’ key audit partners must have at least three years’ oversight experience of auditing local authorities. Worryingly, most key audit partners are over 50 years old and audit firms are likely to find it difficult to replace experienced staff when they retire. The audit firms consider there is a missing generation of auditors with specialist experience of auditing local authorities. A lack of career prospects is a further challenge which audit firms face in recruiting trainees and ensuring they have a sufficient future supply of experienced staff to carry out audits of local authorities. This is not solely a problem for the audit firms and the Department is working with the accountancy institutes and the FRC on encouraging people into the sector, making the key audit partner accreditation process smoother, and improving skills development, but this will all take time.
Recommendation: The Department should work with the FRC and the accountancy institutions to implement accelerated training and accreditation to increase the supply of qualified auditors quickly, and to build attractive career paths in local audit.
5.We are not convinced that the recently announced new local audit arrangements will meet the pressing need for effective system leadership now. In May 2021, the Department announced that the system leader for local government audit will be the new Audit, Reporting and Governance Authority (ARGA), the new regulator replacing the FRC. However, ARGA will not be set up until 2023, at the earliest, and doing so will require legislation. Contrary to the Redmond review recommendations, ARGA will not be responsible for procurement, which will remain with PSAA, due to the Department’s concerns about potential conflicts of interest. The Department will have Accounting Officer responsibilities for just the local audit element of ARGA, while BEIS will be the sponsor department overall. There is a crisis in local government audit and a need for urgent action to tackle the increasing delays, audit quality and market fragility. The Department recognises the importance of stronger system leadership during the transition to ARGA, but we are not reassured that its proposed liaison committee, bringing together all the responsible bodies, will be enough to meet the pressing need for system leadership now. It remains to be seen whether ARGA will then be able to meet fully the ongoing priorities for effective system leadership.
Recommendation: The Department should write to us by September 2021 and outline:
6.Unless local authority accounts are useful, relevant and understandable they will not aid accountability. Changes in auditing standards, such as on auditing pensions and grant distribution, have required considerable extra audit time. Some local authorities also have increasingly complex financial arrangements. The more property investments a local authority holds, the more specialist resources the auditor needs to gain accurate estimates of their values. We are concerned that some of the additional audit work now being carried out is disproportionate to the risk to the overall financial stability of the local authority. The accountability of local authorities to stakeholders, such as residents and service users, through audited accounts is a priority. Yet, the accounts of local authorities are impenetrable to many stakeholders. There could be much greater transparency in the financial reporting of local authorities, such as through the inclusion of a simple standard statement, focused on the key issues of most use and relevance to stakeholders, presented in a readily understandable way. The Department is working with others to look at simplifying aspects of the accounts of local authorities. It intends that the new system leader will also look into reducing accounting and audit requirements for areas of less risk to local authorities.
Recommendation: The Department should write to us by September 2021 with its detailed plans for agreeing with stakeholders ways to focus local authority accounts and audits on areas of greatest risk and concern to citizens.