The Financial Reporting Council has delivered its verdict on council audits but, writes Stephen Sheen, it falls short of recognising the “unique nature of local authority accounts”.
Although the Financial Reporting Council (FRC) has previously had a role in reviewing local government audit work, the 2018-19 round was the first that came with statutory responsibility for monitoring the quality of the audits of larger bodies (total income or expenditure of at least £500m).
Last week, the FRC published its first report under these new responsibilities (here).
The report is based on a total of 12 reviews of 2018-19 audits across local government (plus three from the NHS), covering each of the seven firms involved in local audit. The sample size is therefore low, but was risk-based, and the reviews did cover the firms’ overall policies and procedures as they applied at each audit.
The report is, though, something of a dead duck. The findings were communicated to the firms some time ago, and the report includes their humble statements that lessons have been learnt.
Only six of the 15 reviews concluded that the audit was good or required limited improvement. Nine failed to reach an acceptable level.
Grant Thornton and Mazars were identified for particular criticism. They had respectively five out of six audits requiring improvements and two out of two requiring significant improvements. Both firms must perform a “root cause analysis” of the issues identified and put in place an audit quality action plan. EY reached an acceptable level on all three of their audits.
Work on the VFM conclusion was graded good or requiring limited improvement at all 15 audits.
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‘Dead duck’
The report is, though, something of a dead duck. The findings were communicated to the firms some time ago, and the report includes their humble statements that lessons have been learnt. Most of you will have noted the impact of recommendations on your 2019-20 audits (or will do, if they have not started yet).
So, what is there to get excited about in the report?
The first thing to note is the confirmation of the FRC’s role in skewing the focus of local government auditors. The report is clear that quality of audit work over property valuations continues to be the area of greatest concern. The only justification provided for this concern is that the CIPFA/LASAAC Accounting Code requires property valuation and that this involves judgement.
There is no analysis of the context in which the code requires properties to be valued, which has always featured a relatively high margin for accuracy in recognition of the limited purposes to which these valuations are put by users of the accounts, and the absence of any pressure for experts to bias their opinions.
What was really required was an examination of how auditors have made their materiality judgements in the unique context of local government, appreciating how even though property, plant and equipment represent a huge number on balance sheets it is at low risk of a truly material misstatement (ie, one that would make a difference to users).
It’s like dumping someone out of Strictly because their sequins weren’t sparkly enough.
The increased audit effort that we have seen so far in 2019-20 has confirmed that the capital accounting framework developed under the code is designed to be fit for its minimum purpose but, if you expect more, it will not sustain the undue pressure.
The FRC also appears to regard it as inherently admirable for auditors to engage their own specialists, without consideration as to whether the reliability of the authority’s experts justifies challenge under auditing standards. Misery for many valuers who are now being assumed to have done a duff job until proven otherwise.
This must be especially galling for Grant Thornton, as much of their marking down appears to be due to their property audit work. It’s like dumping someone out of Strictly because their sequins weren’t sparkly enough.
The same encouragement of over-auditing because of a failure to appreciate the use to which the figures are put and the impartiality of the experts preparing them applies to pensions figures. Does anybody use IAS 19 numbers in assessing an authority’s financial standing? Similarly to capital accounting, perhaps they ought to, but the fact that nobody does is more important to assessing audit risk.
The other particular areas of the FRC’s concern are more apposite: occurrence and completeness of expenditure, first year audit procedures, the impairment of receivables and the fraud risk assessment.
Watch out for auditors with greater interest in:
- wanting more evidence for amounts receivable, particularly setting larger sample sizes and challenging the assumptions used to value expected credit losses;
- responding to the risk of fraud arising from management override of controls, particularly in relation to journal entry testing;
- considering the risk of fraud in expenditure recognition and extending testing around the completeness and occurrence of expenditure;
- tougher audit procedures to assess the estimates used to determine liability provisions
- evidencing judgements taken in the exercise of special reporting powers (statutory recommendations and public interest reports).
The big thing that is missing? In fact, the huge thing that is missing? Consideration of laws and regulations in an audit of financial statements.
The big thing that is missing? In fact, the huge thing that is missing? Consideration of laws and regulations in an audit of financial statements. While the whole world moans about the complexity of local authority financial statements, there is not a word on the source of this complexity in the capital financing arrangements and other statutory adjustments, where there is the greatest potential for material misstatement through misunderstanding or manipulation.
Capitalisation, MRP policies, flexible use of capital receipts, exercise of borrowing powers? Nothing to see here.
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Unique nature
If, as seems likely, an early impact of the Redmond Review will be that audit fees are raised, authorities must be assured that they are getting value for money.
The FRC should be providing that assurance but they will fail to do so for as long as they are unable to recognise the unique nature of local authority accounts, the limited uses to which they are put and how this requires the particular application of auditing standards.
Top of the list should be a rigorous analysis of what is properly material in local government, so that risk can be assessed effectively and scepticism applied appropriately, resulting in audit resources being devoted to what might really matter to users of the financial statements.
Followed closely by assurance that whilst you are diligently trying to apply all the complicated rules and regulations your council tax payers can appreciate that you have done a good job (whilst your neighbours are not getting away with a less robust application that might threaten the Prudential Framework).
The Report suggests that the FRC has been part of a network of stakeholders in the form of the MHCLG Local Audit Delivery Board. Are there none of these stakeholders that has an interest in sorting this mess out?
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.
Photo by Wesley Tingey on Unsplash
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