Memorandum from the Chartered Institute of Public Finance and Accountancy
CIPFA is one of the leading professional accountancy bodies in the UK and the only one which specialises in the public sector. It is responsible for the education and training of professional accountants and for their regulation through the setting and monitoring of professional standards. Uniquely among the professional accountancy bodies in the UK, CIPFA has responsibility for setting accounting standards for a significant part of the economy, namely local government. CIPFA's members work (often at the most senior level) in public service bodies, in the national audit agencies and major accountancy firms. They are respected throughout for their high technical and ethical standards, and professional integrity. CIPFA also provides a range of high quality advisory, information and training and consultancy services to public service organisations. As such, CIPFA is the leading independent commentator on managing and accounting for public money.
1.1. The Chartered Institute of Public Finance and Accountancy (CIPFA) is pleased to respond to the Treasury Committee's request for submissions to the inquiry into the financial regulation of public limited companies in the light of the collapse of Enron. Whilst CIPFA does not have a significant number of members operating in this environment, CIPFA is a member of the Consultative Committee of Accountancy Bodies (CCAB) and is regulated by the Accountancy Foundation. CIPFA's Standard of Professional Practice on Ethics is based on the "International Federation of Accountants (IFAC) Code of Ethics for Professional Accountants", and therefore covers the audit of public limited companies. CIPFA is also well advanced in its application to the Department of Trade and Industry for Recognised Qualifying Body status which will enable Chartered Public Finance Accountants (CPFAs) who meet the Companies Act requirements to audit public limited companies. Approximately 1,000 CPFAs are engaged in the external audit of public service organisations.
1.2 The events and issues surrounding the Enron collapse are complex and the apportionment of liability remains to be determined. It is therefore arguably too early to draw definite conclusions for the regulation of UK public limited companies. CIPFA would however like to draw the attention of the Committee to aspects of the "public audit model" that may have relevance in the context of the inquiry in the event that evidence shows that changes to the external audit arrangements of UK public limited companies are desirable.
1.3 Many aspects of this debate are not new. In the 1980s and early 1990s there were a number of significant corporate failures in the UK such as Polly Peck, Maxwell and BCCI. The resulting debate considered issues such as auditor rotation, provision of non-audit services and stakeholder reporting. In 1994 CIPFA published Auditing the Public ServicesA Contribution to the Debate on the Future of Auditing which was followed up by the 1997 publication What is the Proper Scope of Public Audit?. The Public Audit Forum, of which CIPFA is a member of the consultative group, issued a statement on "The Principles of Public Audit" in 1998. This submission draws on the principles laid down in these publications, updated for more recent developments in aspects of public sector audit arrangements.
1.4 There have been significant developments in corporate management and reporting over the past decade, including:
The Cadbury Reportbringing to prominence the concept of corporate governance, a focus on internal controls and the need for effective audit committees.
The Greenbury Reportrequiring increased transparency and consistency of disclosure for directors' remuneration.
The Turnbull Reportbuilding on corporate governance and turning it into a positive management vehicle for risk management and corporate reporting.
These developments focus on the role and activity of the directors of public limited companies. The principles laid down in the reports have either been adopted or are in the process of being adopted across the public sector.
1.5 In this submission we highlight aspects of the public audit model in its various forms which have relevance to current concerns. Some audit firms work directly or on a subcontracted basis for the statutory audit agencies within the requirements of the public audit model outlined below. Approximately 40 per cent of UK GDP is subject to the audit arrangements described in this model.
1.6 In summary the issues covered are:
Audit Quality and Regulation.
Provision of Non-Audit Services.
1.7 In considering this submission the Committee should bear in mind that the model was developed for a different sector which requires a wider scope of audit, does not directly address the audit of multinational entities and that the number of appointments made under the model is significantly lower than for the private sector.
2. AUDITOR INDEPENDENCE
2.1 The key feature of public service auditing by the National Audit Office (NAO), the Northern Ireland Audit Office (NIAO), the Audit Commission and Audit Scotland is the independence of auditors from the organisations they audit. Most public service bodies do not appoint their own auditors.
2.2 In the central government sector the auditors are appointed either by Parliament or by the Secretary of State of the sponsoring government department. Whilst the exact arrangements are to change following the government's response to the Sharman report "Holding to AccountThe Review of Audit and Accountability for Central Government" the general principle of independent appointment is retained and remains a key feature of the public audit model.
2.3 In the local government and NHS sectors, the Audit Commission appoint auditors under the terms of the Audit Commission Act 1998. These appointed auditors must comply with the Audit Commission Code of Audit Practice which requires auditors to ". . . carry out their work with independence and objectivity" and ensure opinions, conclusions and recommendations are both impartial and seen to be impartial. This Code is approved by both Houses of Parliament every five years and changes made in the intervening years are laid before Parliament. Audit Scotland appoint auditors under the Local Government (Scotland) Act 1973 and the Public Finance and Accountability (Scotland) Act 2000 to central government bodies, the NHS and local government, on behalf of the Auditor General and the Accounts Commission.
2.4 These methods of auditor appointment ensure that the appointed auditor is, and is seen to be, independent of the audited body and can report without fear or favour. This independence is underpinned by a series of other mechanisms.
Security of tenure and rotation of auditors
2.5 Auditors of most public service bodies have security of tenure and internally have arrangements for the rotation of audit personnel. For example, the Audit Commission requires a review of appointments every five years, although this will not necessarily lead to a change in auditor. A similar mechanism is operated by Audit Scotland and in this case there is an expectation that different auditors will be appointed every five years.
2.6 In the private sector audit model, whilst in theory shareholders approve and dismiss auditors, in reality it is the directors who make the decisions, requiring shareholder approval only at the AGM. This ability to reappoint or replace auditors after a term of office which may only extend to one set of financial statements precludes security of tenure. We understand that a seven yearly partner rotation is recommended best practice amongst audit firms. The Audit Commission also stipulate such a rotation for their appointed auditors and additionally require that the audit manager also be rotated on this basis.
2.7 Public service auditors and audit bodies are publicly accountable. The NAO reports to Parliament and the National Assembly for Wales and the NIAO reports to the Northern Ireland Assembly. Audit Scotland report to the Scottish Parliament. The relevant Committees of these legislatures consider public interest and value for money reports from the auditors. The Audit Commission is subject to a five yearly fundamental review by its sponsoring government departments. Annual reports and accounts are published by the audit agencies and reviewed by the relevant Committee or, in the case of Scotland, by the Scottish Commission for Public Audit.
2.8 All public service statutory audit agencies are required to have independently appointed external auditors. The NAO, NIAO and Audit Scotland are audited by a private sector firm appointed by the relevant Public Accounts Committee and Scottish Commission for Public Audit respectively. The Comptroller and Auditor General is the statutory auditor for the Audit Commission. These auditors may also carry out economy, efficiency and effectiveness examinations as well as the audit of the financial statements, providing additional assurance to stakeholders.
3. AUDIT QUALITY AND REGULATION
3.1 There has been a view expressed by commentators that the intense level of price competition for audits of public limited companies may force audit fees down to a level where the quality of the audit is prejudiced. Whether or not there is substance to this view, it is not the case in most public service bodies. For example, while there is scope for Audit Commission appointed auditors to negotiate fees, the Audit Commission is able to review the range of fees across audited bodies in England and Wales. The Commission pays close attention to fees at the high and low ends of the range to ensure they are appropriate in the context of the work being undertaken. A similar mechanism operates in Scotland.
3.2 Auditors appointed by the NAO, the Audit Commission and Audit Scotland are subject to stringent quality control. The NAO has an established and robust internal quality control regime, which is backed up by external quality review undertaken by the Joint Monitoring Unit along similar lines to quality control procedures to which private sector auditors are subject. The NIAO operates similar quality control procedures. The Audit Commission operates a Quality Review Process, which encompasses feedback on the audit from local authorities and NHS bodies, a review of the audit product and assessments of auditors' own quality assurance systems. These are carried out on an independent rather than "peer review" basis. Audit Scotland operates a similar mechanism.
3.3 The public audit model recognises the importance of auditing standards issued by the Auditing Practices Board (APB). Auditors are required to follow APB Practice Note 10 (Revised) "Audit of financial statements of public sector entities in the United Kingdom" and this provides the benchmark for the various quality control procedures.
4. PROVISION OF NON AUDIT SERVICES
4.1 The overriding principle for auditors carrying out non-audit work in the public sector is that this should in no way run the risk of either impairing auditor independence or giving a public perception that independence has been impaired. In the case of the Audit Commission appointed auditors, once this condition is satisfied, all non-audit work over a £25,000 annual threshold (or 20 per cent of the audit fee if greater) must in addition be approved by the Audit Commission. Similarly, appointed auditors and subcontractors must obtain approval from the NAO or Audit Scotland as appropriate for any non-audit work. Whilst private sector auditors are required to consider issues of independence and objectivity when contracting for non audit services they do not have to obtain approval from an independent body to carry out non-audit work. A suggestion has however been made that audit committees should report the reasons where non-audit fees exceed the audit fee.
4.2 It has often been suggested that auditors are best placed to provide other services because of their detailed knowledge of the client systems and processes. It follows however that knowledge gained at one organisation can be applied at other similar organisations, and this is what happens in the public sector because of the restrictions on non-audit work. Appointed auditors are free to offer (and do so) non-audit services to public service bodies other than those they directly audit.
5. STAKEHOLDER REPORTING
5.1 Because of the different statutory framework public sector audits tend to be wider in scope and result in greater disclosures relating to regularity (or legality), propriety, use of resources in accordance with concepts of "value for money" and "best value", and the financial aspects of corporate governance. This stems from the public interest in the proper stewardship of public funds. Public sector auditors have the ability to append long form reports to accounts to expand on matters of interest and concern and disclose how the audited body proposes to address the relevant issues.
5.2 The NAO, the Audit Commission, Audit Scotland and the NIAO all publish reports which are widely available to the general public. Where auditors discover issues of public interest they have powers to issue reports to bring this to public and Parliamentary attention. Audit Commission audit letters are also published and placed in the public domain.
6.1 The public audit model has many strengths and provides a high degree of confidence to users of public service financial statements. The audit agencies that operate under the model are held in high regard both in the UK and internationally. The model is widely acknowledged as a key component of the openness and integrity that characterise the UK public services.
6.2 The model includes most, if not all, of the features that critics of audit arrangements in the private sector would like to see implemented. Importantly it removes, to a significant extent, the perception that there may be a problem with auditor independence.
6.3 Should the Committee conclude that changes in the regulation of public limited companies are required then the UK public audit model is, despite differences between the public and private sectors, worthy of more detailed consideration.