Conrad Hall returns to the classics to discuss why there is a disconnect between the expectations of local government and the Financial Reporting Council over audit quality.
I have recently developed something of an interest in the classics, inspired by a rather marvellous radio stand-up comedy show and my youngest daughter’s growing interest and study. I rather regret now not having studied classics sooner, but am learning to be stoical about that.
Many quotes from those ancient Greek and Roman texts have entered our language to such an extent that they are used and, I now know, often misused in everyday speech. ‘Quis custodiet ipsos custodes’ might be the most striking example of that. Even with no Latin at all, the sense of its meaning – who guards the guardians? – can easily be deciphered, and the quote is often rolled out in discussions about audit and regulation, even though Juvenal actually intended his words in a very different context indeed.
What then should we make of the recent statement from the Financial Reporting Council (FRC) about the quality of local audit? Well, no less an authority than Aristotle tells us that:
“Inasmuch as some of the magistracies, if not all, handle large sums of public money, there must be another office to receive an account and subject it to audit, which must itself handle no other business.”
No one would argue with that principle, which has endured with only minor refinements to the detail for around two and a half millennia. I would be astonished if any of my budget reports were being read a mere 25 years after publication, but Aristotle’s view on the matter has survived 100 times longer and is still only a minor footnote compared to his better known texts.
Aristotelian audit
Aristotle didn’t develop his principle to consider the regulation of those auditors. To be fair, he chose instead to write the Nicomachean Ethics, still a foundational text in the study of moral philosophy, the Dramatics, which today’s TV script writers would do well to remind themselves of, and many other seminal texts. Nonetheless, it’s a shame as I think we could do with some of his insights on the matter today.
It is beyond doubt that the principle of having a regulator of auditors must be a good one. I can remember early in my career the way that the Audit Commission’s Quality Control Review process drove the standards of local audit teams higher, even though one knew that only a small proportion of audits would ever be reviewed.
Reading the FRC’s recent findings on local audit, I was struck that they had found that “changes had been made to an audit file provided to FRC inspectors after the FRC had notified the firm of its inspection”. Hopefully that sort of thing is very rare indeed. Local authorities pay for their audits and will be paying much more shortly, so there must be a mechanism to root out unacceptable practice.
To make audit regulation sufficient to the task you need to ask if the defined service is actually the one we need. That is a harder question to answer, but the more important one.
Rationale of regulation
However, the point of regulation is not just to root out such poor practice, vital though that is. It must go beyond that, to ensure we get what we pay for, to the proper standard and indeed to drive up those standards.
Getting what you pay for, and having a regulator making sure that you receive the defined service to the proper professional standard, is only a necessary condition to whatever goal you are striving for – in this case governance, transparency and accountability, at the right price. It is a necessary condition, but not a sufficient one, which sounds like the sort of proposition that would be better expressed as an Aristotelian syllogism. It’s probably beyond me to do it as neatly as that, but let me have a try.
To make audit regulation sufficient to the task you need to ask if the defined service is actually the one we need. That is a harder question to answer, but therefore the more important one.
So what do we – the local government sector – want from our regulator, the FRC, which oversees the vital external audit service?
To be honest, I can’t say anyone has ever tried very hard to ask me. There are always lots of consultations out there and although I am usually fairly diligent at looking at those that relate to audit, I may have missed one. I think I even responded to one not so very long ago.
Too many audits, the FRC says, are not good enough and improvement is needed. Well, perhaps, but I rather think if the regulator asked the local government sector on that, it would hear a different conclusion.
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A distant regulator
Now, to be fair, my experience as chair of CIPFA/LASAAC has taught me that it is hard to consult in technical areas where there are competing and sometimes entrenched views and to provide feedback on the results. I like to think we’ve made progress in improving that, but doubtless with much more to do. But the FRC, as our auditors’ regulator, feels very distant from the sector.
Surely it has its moment now. Too many audits, it says, are not good enough and improvement is therefore needed. Well, perhaps, but I rather think if the regulator asked the local government sector on that, it would hear a different conclusion. Yes, improvement is needed, but not, I expect, in the way the FRC would suggest.
Are our experts’ reports on operational property and pension valuations really so important in the way the FRC seems to think they are? If, as I suspect, these are examples where the FRC considers audits to have not been conducted to the proper standard, then this signal to the firms to up their game means that there will be less time to audit other areas, or more cost, or both. Is that what we want as a sector?
Where poor quality audits have been identified, has the FRC shown that the local authorities that suffered them had to go back and review their decision making. Isn’t that a cue for another syllogism?
If (A) the audit wasn’t good enough, then (B) the accounts cannot be relied upon in the way that was thought, so therefore (C) the local authority in question went back and reviewed, for example, its property or pension funding strategy. Quo erat demonstrandum? No, thought not. Surely that’s the best test of the relevance of audit regulation there could be. If the link hasn’t been made, as I suspect it hasn’t, it feels more like evidence of a disconnect between the sector and the FRC as the audit regulator.
As you might have guessed by now, I have concerns that the FRC’s report still suggests that its concerns are rather far removed from the sector’s. Healthy consultation and dialogue must be the way to resolve that, and we should all welcome the appointment of the first director of local audit as, hopefully, the first step towards building a much stronger consensus on the purpose of the local audit regime and how best to regulate it.
I would also argue that the local government sector must be much more engaged on some of the accounting issues and perhaps less dismissive of some of the complexities they can throw up. If we want the regulator to hear our voice more strongly, we must meet them at least part-way and show that we are equally uncompromising when it comes to upholding high accounting standards.
Conrad Hall is the corporate director of resources at the London Borough of Newham and chairs the CIPFA/LASAAC Code Board.
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