Memorandum submitted by ICAEW
INTRODUCTION
- 1. We
are writing to provide evidence in response to the Communities
and Local Government Committee's inquiry. ICAEW would be pleased
to provide oral evidence on any aspect of its submission.
WHO WE ARE
- 2. As
the largest Recognised Supervisory Body (RSB) in the UK, ICAEW
registers all the firms for Companies Act audit work that are
currently also carrying out work for the Audit Commission and
those firms likely to carry out this work in the future. ICAEW
operates under a Royal Charter, working in the public interest.
Its regulation of its members, in particular its responsibilities
in respect of auditors, is overseen by the Financial Reporting
Council. As a world leading professional accountancy body, we
provide leadership and practical support to over 134,000 members
in more than 160 countries, working with governments, regulators
and industry in order to ensure the highest standards are maintained.
We are a founding member of the Global Accounting Alliance with
over 775,000 members worldwide.
- 3. Our members
provide financial knowledge and guidance based on the highest
technical and ethical standards. They are trained to challenge
people and organisations to think and act differently, to provide
clarity and rigour, and so help create and sustain prosperity.
We ensure these skills are constantly developed, recognised and
valued
EXECUTIVE SUMMARY
- 4. Devising
a new local audit regime to replace the Audit Commission presents
an opportunity to review the public audit and accounting regime
across the public sector in England, making it more transparent
and consistent with other sectors of the economy.
- 5. The new local
audit regime should aim to avoid duplication of activity, provide
economies of scale, improve accountability, strengthen financial
management within local authorities and improve value for tax-payers'
money.
- 6. The
new regime will need to consider whether the Principles of Public
Audit remain relevant and if so how they will be reflected in
the new arrangements.
- 7. One option
for overseeing the new regime would be to give new responsibilities
to the National Audit Office (for example in relation to the
Code of Audit Practice, technical support and guidance, assessing
audit firms' eligibility to carry out the work).
- 8. Another option
would be to create a small residuary body (for example as part
of the DCLG or another suitable public body) to continue some
of the key functions of the Commission.
- 9. An increase
in the number of audit firms in the public sector audit market
should not be at the expense of audit quality and the safeguarding
of public money.
- 10. The framework
for the appointment of auditors should be in line with the principles
already established by independent oversight bodies and consistent
with other sectors, including protection for local public bodies
and audit firms.
- 11. Standardising
the requirement for local authorities to issue annual reports
and harmonising financial reporting with the private and central
government sectors would improve transparency and accountability
for the public and encourage other audit firms to enter the market.
- 12. Revising and
strengthening the role of local authority audit committees would
provide an independent basis for the appointment of the audit
firm and the monitoring of its performance.
DETAILED EVIDENCE
THE PRINCIPLES OF PUBLIC AUDIT
- 13. The
Principles of Public Audit are published by the Public Audit Forum
(comprising the National Audit Office, the Northern Ireland Audit
Office, the Audit Commission for Local Authorities and the National
Health Service in England, the Wales Audit Office and Audit Scotland).
The Principles are summarised as:
- the independence of public sector auditors from
the organisations being audited;
- the wide scope of public audit, that is covering
the audit of financial statements, regularity (or legality), propriety
(or probity) and value for money; and
- the ability of public auditors to make the results
of their audits available to the public, to democratically elected
representatives and other key stakeholders.
- The Principles take as their starting point the
assumption that the audit of public (taxpayers') money demands
safeguards that might not necessarily apply to the same extent
in other sectors. In designing the local public audit regime post
the Commission, consideration needs to be given to whether the
Principles are still relevant and if so how they will be upheld
by the new arrangements.
CONSISTENCY ACROSS THE PUBLIC SECTOR
- 14. The
focus for the new arrangements post the Commission appears to
be on the new audit arrangements for local government; however
the Commission's current responsibilities also cover the National
Health Service in England. Thought needs given as to how audit
responsibilities in relation to the NHS in England will be discharged
in future.
- 15. In particular,
the Government should recognise that the demise of the Commission
presents an opportunity to review the public audit and financial
reporting regime across the wider public sector in England. This
opportunity to create consistency across local government, health
and central government audit should be considered carefully rather
than the new regime being treated as a local government issue
in isolation.
SUCCESSOR BODIES
- 16. In
addition to its duties around appointing auditors of all local
public bodies, the Commission has other specific statutory responsibilities.
The Commission drafts the Code of Audit Practice, provides guidance
and technical support to auditors, monitors audit quality, sets
the grant reporting framework, is responsible for the national
fraud initiative and is the public body responsible for providing
information under the freedom of information legislation in relation
to local public bodies.
- 17. All of these
duties are significant and the Department for Communities and
Local Government (DCLG) will need to consider carefully what happens
to these responsibilities and who will take them on. This may
require the transfer of some Commission costs to whichever body
or bodies inherit these responsibilities. It will therefore be
necessary for DCLG to consider how these bodies will be funded
to enable them to take on these responsibilities.
- 18. Whatever new
arrangements are put in place, DCLG will need to ensure successor
bodies should have the following attributes:
- · public
sector knowledge;
- · public
sector audit experience;
- · technical
competence;
- · the
right infrastructure; and
- · adequate
resources and capacity.
- 19. One option
would be for the National Audit Office to take on the majority
of the Commission's role (in particular in relation to the Code
of Audit Practice, technical support and guidance, monitoring
audit firms eligibility and independence, auditor appointments
and audit quality). This would be similar to the arrangements
which already exist within Wales (by the Wales Audit Office) and
Scotland (by Audit Scotland). The NAO contracts some of its work
to audit firms already in the local public audit market. This
arrangement would avoid duplication; provide economies of scale
and would be cost-effective as the NAO already has the necessary
public sector audit experience and expertise in place.
- 20. Where there
are specific skill gaps with respect to local audit, the NAO could
recruit or receive by transfer key Commission staff with relevant
expertise. Another factor which makes this a viable option is
that the NAO will be the body responsible for auditing the Whole
of Government Accounts (WGA). Local government accounts will be
consolidated into the WGA of which the NAO is the external auditor.
WGA will be published for the first time for the financial year
ending 31 March 2010.
- 21. Another option
would be to create a small residuary body (either as part of the
DCLG or another suitable public body) to continue some of the
key functions of the Commission. Key aspects of the public audit
regime such as audit appointments, independence, audit fees, public
interest reports etc. could be discharged by this small central
body. This would avoid the possibility of several successor bodies
sharing the Commission's different responsibilities, avoiding
potential duplication and increased costs.
AUDIT QUALITY AND INCREASED MARKET PARTICIPATION
- 22. ICAEW
is in favour of increasing market participation in the public
sector audit market. However, any policy objective to increase
market participation should not be at the expense of audit quality
and the safeguarding of public money. While potential new entrant
firms to the public audit market will already have quality control
systems in place for audit work in other sectors, not all audit
firms will have the necessary public sector experience and building
up such experience will take time.
POWER AND DUTIES AND IMPACT ON AUDIT FEES
- 23. The
current powers and duties of auditors in the public sector are
included in a framework document published by the Commission,
which plays a key role in keeping audit fees at a controlled level
across the local public audit market. There is no evidence to
suggest that under the new regime, giving local bodies the power
to appoint their own auditors will necessarily result in a reduction
in audit fees paid by individual bodies.
- 24. If the government
is seeking to reduce the overall level of audit fees, it could
take the opportunity to consider the current powers and duties
of auditors and bring about some consistency in the audit framework
between central government, health and local government. It would
not, in our view, be sensible to introduce new duties (see paragraph
26) or retain existing powers or duties within local audit (such
as public interest reports and inspection of accounts by electors,
see paragraphs 28 and 29), which are not mirrored in central government
or NHS audit. The more consistency there is between the different
parts of the public sector in England, the easier it will be for
audit firms to transfer their expertise between the different
sectors and achieve economies of scale for the tax-payer.
- 25. Currently
the Commission provides support, in specific circumstances, in
terms of guidance, legal advice and indemnity cover for all its
appointed auditors. A new framework will need to consider whether
such support will remain available to auditors and who will provide
it. There will also need to be a minimum amount of support available
to auditors new to the market under the new arrangements.
AUDIT SCOPE, RISK AND IMPACT ON FEES
26. IT HAS BEEN SUGGESTED THAT THE SCOPE OF LOCAL
PUBLIC AUDIT COULD IN FUTURE REQUIRE A SEPARATE AUDIT OPINION
FOR EACH OF THE FOUR CATEGORIES OF AUDIT WORK MENTIONED IN THE
PRINCIPLES OF PUBLIC AUDIT (SEE PARAGRAPH 13). NOT ONLY WOULD
THIS IMPOSE ON LOCAL AUTHORITY AUDIT A REQUIREMENT NOT PRESENT
IN OTHER PARTS OF THE PUBLIC SECTOR IN ENGLAND, BUT ANY INCREASE
IN AUDIT SCOPE WILL RESULT IN AUDIT FIRMS TAKING ON ADDITIONAL
RISKS WHICH WOULD BE REFLECTED IN THE FEES CHARGED.
27. THE HIGHER THE AUDIT RISK OF A CLIENT, THE
HIGHER THE AUDIT FIRM'S POTENTIAL LIABILITIES IN RELATION TO THAT
AUDIT CLIENT. IN ORDER TO MITIGATE THE HIGHER RISKS AND INCREASED
POTENTIAL LIABILITIES, THE AUDIT FIRM IS LIKELY TO NEED TO INCREASE
ITS INSURANCE COVER (AS INSURANCE COMPANIES WILL NOT PROVIDE COVER
AT THE SAME LEVEL WITHOUT THE BENEFIT OF THE COMMISSION PROVIDING
SUPPORT). THIS WILL LIKELY LEAD TO AN INCREASE IN AUDIT FEES,
AS AUDITORS WILL NEED TO RECOVER THEIR COSTS IN SOME WAY FOR AGREEING
TO TAKE ON AN INCREASED SCOPE OF AUDIT.
PUBLIC INTEREST REPORTS AND INSPECTION OF ACCOUNTS
- 28. Public
interest reports are unique to local authority audit in the English
public sector. They are produced by the auditor where there are
grounds for believing, for example, that an authority has wasted
significant amounts of public money through mismanagement or worse.
The publication of such reports inevitably brings the auditor
into conflict with the audited body. We are concerned that without
the protection of the Commission (which currently reinforces the
auditor's independence, meets the costs, provides the guidance
and support and indemnifies the legal costs that may arise) or
a similar residuary body, auditors may be put under pressure not
to report in the public interest. There is potential that an auditor's
independence could be compromised through the contractual relationship,
perhaps with the audited body being unwilling to pay the fees
or threatening termination of the contract.
- 29. Local authorities
are again unique in the English public sector for by law allowing
local electors to inspect the annual accounts and to raise questions
and objections with the auditor. The ability of the auditor to
decline to receive such questions and objections is very limited.
The result is that much audit time and cost can be expended researching
and answering issues raised by electors. Given the greater transparency
of spending now available through publication on line of significant
local authority expenditure items, a review of whether this unique
situation should continue is advisable.
INDEPENDENT APPOINTMENT OF AUDITORS
- 30. There
are a number of aspects to the independent appointment of auditors
in the public sector, which ICAEW has concerns about.
ELIGIBILITY CRITERIA
- 31. The
eligibility criteria for firms wishing to conduct public audit
need to ensure that only competent auditors with the appropriate
knowledge, skills and experience are appointed. However, there
needs to be a mechanism in place to enable new firms wishing to
enter the market the opportunity to gain the appropriate knowledge,
skills and experience.
POWER OF ELECTORATE TO VETO APPOINTMENT
- 32. ICAEW
is not in favour of the power of the electorate to veto the appointment
of auditors, which would be unique to local authority audit across
the public sector in England. In our view, this could be counter-productive
and expensive to the whole appointment process and could result
in an authority wasting valuable time and resources going through
a re-tender process. In our view, the audit appointment should
be made by the full council on recommendation from the audit committee.
-
MANDATORY ROTATION OF AUDITORS
- 33. The
Commission, under the current regime, appoints auditors (to local
and health bodies) for a fixed period and upon re-appointment
may appoint the same firm with a change of lead partner. This
is in line with the Auditing Practices Board's ethical standards.
There have been discussions on the benefits of mandatory rotation
of local authority auditors with the suggestion that (to further
reinforce independence) the audit appointment should be limited
to two, three or five year appointments with a change of audit
firm after a fixed period.
34. In
our view, the looked for benefits of mandatory rotation need to
be weighed against the disbenefits. Mandatory rotation of the
whole audit firm has been tried in other jurisdictions but has
not been a success. We are only aware of one G20 economy which
requires mandatory firm rotation on a continuing basis. The key
problems of mandatory rotation are:
· rotation
of auditor firms for short periods may decrease audit quality,
because although the appearance of independence is very important,
knowledge of the organisation is critical to quality;
· it erases
the cumulative knowledge of an audit firm and thereby reduces
audit effectiveness and efficiency and increases costs to organisations;
and
· it can
be used as an excuse to undermine audit quality by allowing issues
to be hidden after a rotation.
- 35. The risk of
over-familiarity is a valid concern, as is the threat of complacency
if a competitive tendering process is not on the horizon. However,
the value of experience and transfer of knowledge must also be
acknowledged. If a good audit committee is in place, it will keep
the choice of auditor, and the performance and objectivity of
the incumbent, under constant review and should be willing, when
it sees fit, to conduct a fresh tender. In the private sector,
ICAEW has stated that there should be mandatory rotation of audit
partner at least every seven years for public interest entities,
as required by the Statutory Audit Directive. We believe that
this achieves an appropriate balance in the regulatory framework
between the necessity of renewal and the benefits of continuity.
- 36. The
Statutory Audit Directive requirement mirrors the Code of Ethics
issued by the International Ethics Standards Board for Accountants
(IESBA) under the oversight of the independent Public Interest
Oversight Board (PIOB). The Code mandates the rotation of key
audit partners on public interest audits at least every seven
years to protect against over-familiarity and requires potential
threats due to over-familiarity to be considered for all other
audits. We are not aware of a jurisdiction in which a partner
rotation period of less than five years has been deemed appropriate.
- 37. ICAEW's
view, therefore, is that we should be consistent with the framework
promulgated by independent international oversight bodies and
should not introduce a different framework solely for local public
audit. It would be inconsistent if mandatory rotation was brought
into local government in England, but there was nothing similar
in health, central government or indeed the private sector.
- 38. In
considering all of the above, both parties should have the right
to terminate the relationship if it is felt to be unsatisfactory
with appropriate safeguards.
MONITORING AUDIT QUALITY AND LICENSING OF AUDIT FIRMS
- 39. Currently
the Commission reviews the quality of audits of local public bodies
by contracting with the Audit Inspection Unit (AIU) of the Financial
Reporting Council. A similar arrangement could be envisaged post
the Commission, however in the private sector the remit of the
AIU is restricted to public interest entities (basically companies
with a market listing). A review of whether the AIU should be
responsible for monitoring the quality of all local public audits
would be appropriate.
40. Giving
a new responsibility to Recognised Supervisory Bodies (RSBs) to
register audit firms for public audit should be considered. Currently,
the Audit Registration Committees of the RSBs only register auditors
and responsible individuals for the purpose of Companies Act audits.
There is no equivalent provision for public sector audits. Thus,
the RSBs do not recognise public sector audit work under the registration
and therefore do not license auditors separately for public sector
audit work. There would need to be a legislative provision for
the Audit Registration Committees of the RSBs to take on this
additional role. However, it would seem inconsistent for there
to be a requirement for audit firms to be registered for the audit
of local public bodies without there being an equivalent requirement
for the audit of National Health Service bodies, central government
bodies and agencies.
AUDITED BODIES' RESPONSIBILITIES
- 41. There
are a number of aspects in relation to the possible new framework
that need to be thought through carefully before decisions about
the new audit framework are made.
CURRENT ACCOUNTING AND REPORTING FRAMEWORK
- 42. Local
government is in the process of implementing International Financial
Reporting Standards (IFRS), which should help to bring local government
accounting more in line with financial reporting in other sectors.
However, there is further opportunity brought about by the proposal
to abolish the Commission for DCLG to review the overall accounting
and reporting framework within local government and simplify it.
In particular, it could take the opportunity to review the complex
capital accounting regime and various trading accounts that exist
within the framework which are unique to local government within
the UK. Such accounting does not exisit within other sectors.
43. If
local government accounting were brought more into line with central
government accounting and indeed more in line with a set of company
financial statements it would help to bring about consistency
in financial reporting, not just within local government but also
with other sectors. It would no doubt help the consolidation process
that will be required for the Whole of Government Accounts reporting
initiative. Reducing reporting complexities in the sector could
also help increase the audit market participation as less specialisation
would be required.
ANNUAL REPORTS
- 44. In
our view, there should first be a duty upon audited bodies themselves
to report on their own arrangements on the services they provide.
One way of achieving this would be through the publication of
an annual report. Auditors could then provide an opinion on whether
the information contained within the annual report was consistent
with the financial statements. This would be in line with auditors
responsibilities for Companies Act audits. We acknowledge that
this may not be well received by the sector and would require
some changes within local government accounting and reporting
frameworks. Other sectors, including central government, the corporate
and banking sectors and companies already publish annual reports,
therefore this would be bringing local government into line with
other sectors. This would also meet and be consistent with a wider
government policy on transparency and accountability and could
indeed result in a reduction in audit costs if auditors are only
reporting on management's assertions.
CORPORATE GOVERNANCE FRAMEWORK
- 45. Currently
having audit committees within an authority's structure is voluntary
rather than mandatory. This is inconsistent with other sectors.
Having an audit committee with independently appointed members
is, in our view, key to the success of the government's intention
of independent appointment of auditors. The audit committee, with
its independent membership, could provide some protection to the
audit firm from the threat of termination of contract by management.
GRANTS CERTIFICATION
- 46. Local
authorities currently receive more than £46 billion worth
of grants and funding from government departments. The Commission
currently makes arrangements for the certification of the claims
and returns that local authorities are required to submit to government
departments to indicate that the monies that they have received
have been spent in accordance with the terms and conditions of
the grant schemes. Under the current arrangements, the appointed
auditor provides the assurance on these claims and returns to
government departments based on certification instructions (which
are agreed in advance with government departments by the Commission).
Each separate assurance report on each grant claim that an auditor
provides at each local authority is subject to separate fees.
47. Under
a new framework, government departments would need to play more
of a role in engaging with the auditor and the grant recipient.
This, in practice, may be more difficult, because of the number
of grants and number of bodies that receive such funding. However,
there are already similar arrangements in place when funds are
allocated to private sector organisations. ICAEW has a framework
document (published in March 2010) which outlines the key issues
in this area. This could, in our view, be easily transferred to
grants received by public sector organisations. However, it would
mean that grant-paying bodies would need to review their own arrangements,
take on more responsibility for identifying their requirements
and be prepared to have discussions with auditors (or the auditors'
accountancy bodies) to ensure that there is no expectations gap.
AUDIT OF SMALL BODIES
- 48. The
audit requirements for smaller bodies (such as parish councils)
are currently the same as for larger bodies. Although, for a number
of years, the Commission has operated a 'light touch' audit for
smaller bodies with the smallest bodies not paying any fees for
their annual audit.
- 49. We note the
government's intention to consider how it treats parish and town
councils and other bodies and to ensure that a more proportionate
approach is adopted, similar to that which applies to small companies
and charities.
- 50. We are in
favour of a more proportionate approach being considered and adopted
and our suggestion would be for government to set a turnover threshold
for a full audit similar to that of small companies (currently
£6.5million). We are also in favour of an approach similar
to that adopted by the Charity Commission i.e. the independent
examination of bodies at the lower end of the scale.
- 51. We are, however,
not in favour of a regime whereby each small body will be required
to appoint its own auditor. The smaller parish councils do not
necessarily have the skills or expertise to appoint their own
auditor and it would not be appropriate to place this additional
burden on them, which would inevitably be at a cost.
- 52. For the smaller
end of the scale, our view is that the precepting authority (to
whom the parish is accountable) should take the responsibility
for carrying out some checks of how the precept is spent. The
precepting authority could use its own internal auditors or perhaps
even its external auditors for this purpose (recognising that
they were would be cost involved in using its external auditors).
ICAEW
January 2011
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