Stephen Sheen: Audit predictions 2021

Coping with low morale, IFRS 16, standardised statements and an audit process he describes as a “mess” are the promised highlights of the coming year.

It seems premature to look forward to the accounting and auditing issues that might predominate in local government in 2021 when the crystal balls of some many authorities are still misted up with the fog of incomplete audits for 2019-20.

My first tentative prediction is therefore that many of these audits will have been completed by the end of 2021. A safer prediction is that CFOs are going to get increasingly nervous the closer they get to having to sign off section 25 reports for 2021-22 on the robustness of budget estimates and adequacy of reserves with audit opinions outstanding.

Accounts preparers and audit teams have done some excellent work under the shadow of Covid-19 and some delay has been unavoidable. Will things improve once this shadow is lifted?

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Low morale

Not a lot. Local audit is in a desperate state that is compounded but not caused by the pandemic. The last 12 months have confirmed that even with unfeasibly low fee levels the firms are choosing to dance to the tune of the Financial Reporting Council’s (FRC) inspectors, even if that tune is as appropriate for local government foot tappers as spinning Big Fish Little Fish at the Brexit Party’s Friday night disco.

Local audit has become an opportunity for firms to demonstrate to an FRC critical of their performance on commercial audits how tough they can be. Morale amongst accounts preparers, those that assist them and junior auditors has never been lower as the firms:

• Vie with each other to demonstrate who can be the most sceptical about the information and explanations provided by an authority;
• Line experts up to challenge the views of those engaged by the authority, even before considering whether inadequate expertise or independence would make such a challenge of any value;
• Insist that the least significant parts of the accounts are the ones most deserving of their time;
• Put forward their views on technical accounting matters as obviously superior and not needing supporting arguments.

The whole mess can be summed up in the fact that one of the country’s top local auditors has been able within a single sentence to both complain about the amount of work his firm is required to carry out on property valuations and lobby for their abolition because they are of no benefit to users of the accounts.

The last 12 months have confirmed that even with unfeasibly low fee levels the firms are choosing to dance to the tune of the Financial Reporting Council’s (FRC) inspectors, even if that tune is as appropriate for local government foot tappers as spinning Big Fish Little Fish at the Brexit Party’s Friday night disco.

Co-ordination

At the same time, the immense pressure that section 151 officers are under in managing the pandemic crisis has made them far more amenable to agreeing to auditors’ demands under threat of audit qualification, even if on occasion this has meant not supporting their own staff.

My hope is that the next couple of months sees a big shake-up. The government has promised an additional £15m funding for 2021-22 partly to meet higher audit fees. This money should absolutely be conditional on it being clear what authorities are paying for. A summit should be convened of persons who actually understand the local government accounting environment and auditing standards to set out the terms for a standards-compliant audit.

Part of the problem is that there is no overarching leadership of local audit. Many organisations have a role to play, but no-one is co-ordinating any of their efforts.

The headline news from the government response to the Redmond Review was that there will not be an Office of Local Audit Regulation (OLAR). This was not quite the position.

The government said that it was unconvinced of the case but might be persuaded if more detail could be provided on how a system leader would contribute to resolving local audit weaknesses without having conflicted interests. The government might find it particularly persuasive if OLAR could feed it information on audit findings that would strengthen MHCLG’s assurance frameworks for financial sustainability.

We don’t, in any case, have time to wait for the creation of OLAR. Leadership is desperately required to hold the various participants in the local audit process to account. Not just to convene meetings of “stakeholders” to stroke each others’ virtual chins.

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Developments

Some change will take place this year. The new Code of Audit Practice will come into effect for the 2020-21 financial year. By necessity it is unambitious as it had to be approved by Parliament before the conclusion of the Redmond Review. However, it will have a substantial impact on the value for money opinion.

Part of the problem is that there is no overarching leadership of local audit. Many organisations have a role to play, but no-one is co-ordinating any of their efforts.

Instead of the simple qualified/unqualified view, auditors will now report on three criteria: financial sustainability, governance and improving economy, efficiency and effectiveness. Recommendations will be given in relation to significant weaknesses found.

Accounting developments are likely to be limited to preparations for two significant new initiatives:

• Standardised statements of service information
• IFRS 16 Leases

The standardised statement is an idea of the Redmond Review. It has been supported by the government, with a mooted implementation in 2022. However, as the illustrations accompanying the Review report were more than 10 pages but the Government is suggesting the statements should be one or two, there is clearly work to be done in finalising the required content.

Expect invitations to join working groups and to respond to consultations on the subject during 2021. If you do get a chance, vote against standardisation of service expenditure. It is only a couple of years since we finally persuaded the powers that be that it blurred accountability to reshuffle an authority’s expenditure into a standard service classification. Reporting needs to be in the same format within which promises were made and against which progress has been assessed across the course of the year.

And is the fact that the statement will be hopelessly out-of-date a price worth paying for the long wait that will be required for it to be certified by auditors? I suspect that local people will want to be told about outturns as soon as an authority is reasonably confident about their quantum and find little value in waiting for auditors to confirm they share this confidence.

Leases

With regard to IFRS 16, an end to deferment has been announced and the Accounting Code for 2022-23 will definitely bring the new lease accounting requirements into effect from 1 April 2022.

IFRS 16 does have the small potential for a nasty bite. The abolition of the concept of the operating lease for lessees means that all but the smallest leases will become capital transactions, as right-of-use assets are brought onto the Balance Sheet and lease liabilities recognised. You will as a minimum have to ensure that prudential indicators for 2022-23 are updated to reflect the new status of ex-operating leases.

For leases planned for the forthcoming years there are opportunities to use the arithmetic introduced by IFRS 16 to make better assessments of value for money and to explore the extent to which more of the cost of leases could be diverted from revenue to capital receipts. Trouble might lie in store, though, if an authority is sub-letting leased-in assets for a term that is substantially that covered by the headlease.

I will leave these suggestions hanging in the hope that they are sufficient for you to be encouraged to hurry to do the necessary homework in 2021 to determine the potential impact on your authority. I can’t guarantee that it will be fun.

Stephen Sheen is the managing director of Ichabod’s Industries, a consultancy providing a technical accounting support service to local authorities. He was previously the senior technical manager for local government audit at PricewaterhouseCoopers.