A recent FRC report exposed serious faults in the audit process, but will a system reset help or hinder some of the more nuanced problems, asks Stephen Sheen, managing director of consultancy Ichabod’s Industries.
The recent FRC audit quality inspection report on major local audits made for interesting reading whilst we await news of the proposals for the ‘Great Reset’.
It shows up one big fault in the overall accounts and audit process – that scrutiny can be avoided through inaction. Whether it’s authorities not producing accounts to be audited, or auditors not completing audits to be inspected, there are few consequences for non-performance.
Authorities have a statutory requirement to post a notice if the audited statement of accounts hasn’t been published by 30 September. Reasons need to be provided, but these can be as simple as “because the audit has yet to be completed”. There is no requirement for the notice to be kept up to date about progress being made.
Despite there undoubtedly being circumstances amongst the almost 1,000 audits awaiting sign-off that would justify it, it doesn’t appear that any auditor has yet issued a public interest report to reassure or alarm an expectant local population.
Apart from the headline numbers, we therefore have very little useful information on what the underlying state of local audit is. The FRC report makes a valuable plea for more granular data to be publicly available in the future to explain the reasons for audits that are delayed or incomplete after the system ‘reset’.
All this means that the report is very thin in its findings. Not only was the overall population of inspectable audits small, but it was impossible for the FRC to place its customary focus on higher profile and higher risk audits.
As a result, the FRC inspection team is suspending its work. That there will be no more routine audit quality inspections of major local audits for any financial years up to and including 2022/2023 – i.e., no inspections before the system has been reset by government – suggests that the reset itself is intended to proceed unpoliced.
The report does say that exceptions might be made where there is a clear case in the public interest to do so, but does not indicate when such cases might arise.
Does this mean that auditors will be able to get on with clearing the backlog without having to second guess the expectations of the FRC?
If so, then we are perhaps in for an easier ride. The FRC underplays the role that it has had in influencing the audit agenda away from the issues that should really matter to users of the accounts. A considerable part of the report is dedicated to refuting any claims of responsibility for the disproportionate focus on the valuation of non-investment property that has caused so many problems between authorities and their auditors.
The refutation has three elements:
- the valuation of operational property is not an area for focus for the FRC (forgetting that as recently as the equivalent report for 2020 the quality of audit work over property valuations was the FRC’s area of greatest concern);
- the FRC would not look at operational property if individual local auditors were not regularly identifying it as a significant audit risk (not acknowledging that this was not a regular feature of risk assessments until the FRC made it a key area of focus and imposed a fine on Mazars for reasons that don’t appear to have been fully explained to the public); and,
- CIPFA LASAAC has imposed on authorities a valuation basis that is complex and has a high degree of estimation uncertainty and must simplify the arrangements (despite these arrangements having been specifically designed for the needs of the users of the financial statements, giving proper consideration to proportionality and understandability).
It is undeniable that a cost-based balance sheet would be easier to audit than one including valuations. But the objective of property valuations was not primarily to stock up the balance sheet but to provide a basis for charging services for their use of property that would reflect the value of resources consumed.
If the primary focus is on depreciation, the potential for misstatements in the balance sheet amounts to be truly material (i.e., to have an adverse impact on the decisions that might be taken by a user of the accounts) is much reduced as they are divided through by useful lives. And once the depreciation charges have helped towards the important objective of recording the real cost of services, they are reversed out of council tax calculations.
Over the past 30 years, the Accounting Code and accounts preparers’ application of it have reflected this sophistication by making sure that in each circumstance users are given information of sufficient (but not excessive) precision.
The fault is that in this and other areas (such as pensions accounting and group accounts), the audit framework is claimed not to be able to deal with these nuances, with the result that auditors have been significantly more sensitive to potential misstatements than users of the accounts would be.
It is clear that this an audit problem, and it is curious that the FRC are arguing that it should be solved by weakening the accounting arrangements.
Stephen Sheen is a director of Ichabod’s Industries, a consultancy providing a technical accounting support service to subscribing local authorities. He was previously the senior technical manager for local government audit at PricewaterhouseCoopers.
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