Local Authority Internal Audit Virtual Forum

23 September  

Please note:

• All Institute responses are boxed and highlighted blue
• Where the CEO comments in that capacity, the box is blank but outlined
• Where the Chair comments in that capacity, the box is highlighted in yellow
• For confidentiality, the identities of all delegates/attendees are anonymised 

Sir Tony Redmond

Thank you for the opportunity to talk to your forum.

I will take you through the key findings of the report and the recommendations and then spend a few minutes on the interface between internal and external audit.

Key findings

1. The audit performance and outcomes and the general state of the audit market

There are serious concerns about the way in which the audit market is currently operating and the pricing of the market. Through discussions with a number of participants (not just audit firms) the fact that the fees are too low and figures of 25% or so have been cited.

The quality of external audits and the fact that 40% of audits were not completed on time in 2019 for the accounts 2018/19 are issues. Quality is also an issue that I addressed.

Comments from a number of people indicated that the teams of auditors on the ground actually doing the work haven’t always had all the knowledge and experience of local government finance and accounting necessary to fulfil their roles effectively.

I have concerns about the general lack of coordination of local audit: there is no oversight and regulation of the local audit process from beginning to end which is something that is certainly important.

The fee variations are quite a strong feature of local audit, in that many local authorities encounter requests for fee variation during the audit. That may not be unconnected with the fact that the fee structure may need review.

2. Governance and the interface between internal and external audit

In governance terms, I have looked at the way in which the key audit partner relates to the statutory officers. I have reviewed the capacity of audit committee members to fulfil their roles, whether they are given the proper support and training to enable them to effect the challenge they might need to in audit committee meetings when receiving external audit reports.

There is the question of the transparency of audits and whether their work is reaching those who have a stake in it like local taxpayers and, indeed, services users generally.

There is very limited use of internal audit by the external auditors and of course that is underpinned in part, in terms of responses received from external audit, by the fact that the current Code of Audit Practice does not see assurance being derived from internal audit work.

There is very limited contact and engagement between audit work and inspectorates, not like there used to be with CQC (Care Quality Commission) and HMICFRS (Her Majesty's Inspectorate of Constabulary and Fire & Rescue Services) and OFSTED (The Office for Standards in Education, Children's Services and Skills).

There is no clear accountability for local audit performance despite the fact that there is a role to be played by FRC (Financial Reporting Council) and ICAEW (The Institute of Chartered Accountants in England and Wales) which is effective in its limited way but does not extend sufficiently to say this is a true accountability arrangement.

3. Financial reporting

There is a problem because clearly statutory accounts are impenetrable from a public perspective, and there is a need to think about that.

Chief Financial Officers (CFOs) have expressed concerns about the fact that there is a good deal of work used to engage in the valuations of things like pension funds and property, when they have little or no relevance in terms of overall value and benefit to the balance sheet.

There are considerable variations in use of the narrative statement currently in place in support of the accounts.

Key recommendations

1. Audit performance, price, quality, and regulation – I am now proposing a single overarching body. I do not believe that any of the existing bodies can fulfil that role, because of conflict of interest but also because it is just not appropriate to put those bodies in place. The Office of Local Audit and Regulation (OLAR) is proposed, and that would oversee the whole process from beginning to end, from procurement, the Code of Audit Practice, performance assessment, through to accountability and regulation.

2. A new fee structure – The current fee structure for local audit should be revised to ensure that adequate resources are deployed to meet the full extent of local audit requirements, which is realistic and would make sure that the local audit function is not under resourced. Training of all audit teams in local government finance and accounting is critical, so that there is a capacity, knowledge and understanding to be able to do the job effectively. Audit performance will be monitored, assessed and regulated by the new OLAR operation. There will be sanctions imposed on auditors for any significant under performance and I am also proposing that the NAO Code of Practice, as revised (currently subject to consultation) be supported in the sense that it actually deals with some of the issues around value for money and resilience.

3. Changes to the Code of Practice - The changes implemented in the 2020 Audit Code of Practice are endorsed; OLAR to undertake a post implementation review to assess whether these changes have led to more effective external audit consideration of financial resilience and value for money matters. But I recognise that it does not actually give quite the attention it should to the interface between internal and external audit. I am also proposing that there should be a formal arrangement for engagement with inspectorates whereby auditors meet with inspectors during the audit. I am suggesting that, to oversee all of this, a liaison committee of key stakeholders, chaired by the Minister for Housing and Local Government.

4. On the governance front - The governance arrangements within local authorities be reviewed by local councils with the purpose of:

• Consideration being given to the appointment of at least one independent member, suitably qualified, to the audit committee; and
• Formalising the facility for the CEO, Monitoring Officer and Chief Financial Officer (CFO) to meet with the Key Audit Partner at least annually.

I am suggesting that all audit committees be provided with requisite training; an independent member be appointed to each audit committee.

5. Formal engagement between external and internal audit - We really need to get external auditors to recognise the importance of the work that internal audit carries out and is undoubtedly relevant to external audit, in terms of looking at the overall financial arrangements, soundness and the appropriateness of everything that is going on in the local authority including governance.

6. Training - I am also suggesting that there are opportunities for the CFO’s, particularly new CFOs just moving into the role, to be given an induction, some training and support wherever appropriate.

7. On the financial reporting front - A standardised statement of service information and costs be prepared by each authority and be compared with the budget agreed to support the council tax/precept/levy and presented alongside the statutory accounts, so that there is the opportunity for the local authority to be held to account by its local taxpayers and service users. This statement would be subject to consideration by local authorities between now and the end of December. I propose that the draft in the annex to my report, is to be subject to consultation with local authorities to ensure that all is included that should be. I am also suggesting that the statement be adopted for the 2020/21 accounts although not audited, only 2021/22 would be subject to audit once it is properly settled down.

8. That CIPFA/LASAAC be required to review the statutory accounts - In the light of the new requirement to prepare the standardised statement, to determine whether there is scope to simplify the presentation of local authority accounts, by removing disclosures that may no longer be considered necessary, and to explore the opportunity to ensure things like property and pension fund valuation proposals are really appropriate, and they are not in any way duplicated, which has been suggested.

9. The relationship between internal and external audit - External audit recognises that internal audit work can be a key support in appropriate circumstances where consistent with the Code of Audit Practice. The argument that has advanced is that the Code of Practice says that external audit does not take assurance from internal audit work. I have pressed that case as it cannot be as simple as that. Internal audit work that has been undertaken must be relevant to what the external auditor does. I have proposed in my recommendations that dialogue and engagement be re-established and hopefully reinforced where it is already in place. Areas where internal audit could look at, things like complementing external audit work in terms of planning, the VFM audit interface, certainly the sharing of draft reports as appropriate and also maybe conversations prior to audit committee meetings, so that there is a clear understanding of what each might be doing or saying in those meetings. Maybe in time, the NAO Code of Practice might better reflect some of the things that I am suggesting here. I have not made those specific proposals in the report, but I have made them known both to the NAO and the audit firms.

10. Governance (as mentioned earlier) - Is an important feature here, about the way in which audit committees operate. The audit committee has to have all the resources, capacity and understanding to be able to perform its role. I am strongly suggesting that that be undertaken within each local authority, and I am sure that the internal audit function is equally appropriate in trying to strengthen that governance.

11. Risk - I believe that risk is something that must be looked at by internal and external audit together. That is something that each party does quite significantly, and there must be an overlap. I strongly advocate that as part of the dialogue that you will be undertaking in the future.

Questions and answers session

Question 1

Your report mentions that the external auditor will need to present a report to full council annually. Could you provide a little bit more information about what the content of that report is likely to be?

Response

The auditor’s report isn’t simply a report that says the accounts are fine and everything is in order and there no problems at all. It is about trying to encourage the external auditor to give wider assurance to the council that the situation pertaining to a particular council is sound, that may well embrace not just value for money but it will also look at financial resilience and sustainability.

It will say that there has been a financial health check undertaken and whether the auditors are content with the outcome, or not. The report, therefore, to some degree is not going to be dictated by me in terms of its content, but more to say that the underlying principle is to give assurance to the council that the local authorities finances are sound.

The annual audit report would be submitted, to the first Full Council meeting after 30 September each year, irrespective of whether the accounts have been certified; OLAR to decide the framework for this report. I think it is important to stress here, it is the key audit partner that attends the Council, this has got to be given profile, presence, and transparency.

Question 2

I totally welcome the recommendation around engagement between internal and external, while valuable, is one of the key barriers to this likely to be time?

Response

I recognise that the external auditor may well feel that there is so much to do that there will be little opportunity to engage with internal audit. It is a matter of individual local circumstances and I cannot specify and prescribe how each auditor should work. But I believe that it is strongly advocated that there be a regular dialogue between the two. It isn’t a matter of saying in June; we had better have a conversation. I am suggesting that this is a continuous dialogue between the two on key issues. I think the second point is: that given that there is now a change to the deadline from 31^st July to 30^th September, hopefully some of the issues around the inability to meet such a timetable might also enable a better conversation to happen with the internal auditors.

Question 3

You mentioned that about 40% of audits are not completed on time, were any causes identified for this?

Response

There are three things that emerged in my findings, and they do not apply everywhere.

1. The timescale set at 31^st July has not worked. This is in part due to the auditors that undertake the audit in local government are the same auditors that undertake health audits. When one considers the time afforded to auditors to complete their audit of both health and local government in that space of time, it is perhaps not surprising that it has not worked as it should.
   
   
2. Do all of the auditors that are engaged in local audit have a full appreciation and understanding of local authority finance and accounting. I am not trying to lay blame or criticism, I am simply stating that it is quite a complex area and somewhat different from the private sector. Given those differences it is important that training be provided to the people who engage in local authority audits so that they can do it efficiently.
   
   
3. The way in which the local authority itself sometimes doesn’t always provide the information in a timely way to the auditors, is a factor. That again is not criticising every local authority, but I have had quite a bit of push back from the external auditors where sometimes the information is not being presented in a clear fashion, or where the accounting officers are struggling to produce the information in the way they should in a timely fashion.

Question 4

I wanted to raise the issue of audit committees again. I think it is helpful to highlight that in the report. You highlighted some of the issues and problems that some audit committees have – some are quite a large size or structure and reporting arrangements are not always as robust as they should be. I wondered whether there was any consideration given to perhaps introducing some statutory guidance on that, or whether you felt that it was best to focus on the membership?

Response

I first asked myself a question: how much should I actually seek to direct and prescribe the way in which local authorities should manage their audit committees? I am very conscious of the democratic process and the way that local authorities should be left to individually determine how they conduct their audit committee matters. I didn’t go as far as saying there should be any statutory or prescribed regulations for each local authority.

What I’ve said, is that I think that there is opportunity for every audit committee, first of all to appoint an independent member, and secondly in the interests of audit committee members on the council itself, that the people who sit on the audit committee, must have the capacity, knowledge and understanding of the issues in order to challenge effectively. I believe I can say that I can leave it to each local authority to decide how they affect that.

Question 5

Have you had an indication from government about whether they are minded whether to do anything about the recommendations made in your report?

Response

Implementation is obviously not straightforward. The situation is that the government is currently considering the report. Clearly it will want to look very critically and carefully at many of the recommendations made.

The principal recommendation, the creation of a regulatory body would require primary legislation. Therefore, I cannot say which way the government will move on that one. But there are several recommendations that I have made that do not require primary or secondary legislation. So, one would hope, that there will be in time, opportunity to sit down with the department and work through how these might be developed and implemented, sooner rather than later.

Question 6

You made a comment about pricing, in the context of the reality that the pricing comment has probably been made by the external auditor themselves. To what extent would you consider that as being a self-serving observation?

Response

I looked very critically at that, as obviously I could see that there was a vested interested in that group of auditors saying that. I looked more critically at that, and the timescale for the audit, and the work that was undertaken. I also took advice from quite a lot of local authority treasurers and other participants in local government. The pricing topic was coming from a number of areas, who were saying that the current arrangements are not sustainable.

If I could just mention, even though this might be seen as a plea from the firms themselves, there is increasing evidence that fewer and fewer auditors are specialising in local government financial accounting. That is partly to do with the reduction and slow demise of district auditors who move to the audit firms post Audit Commission. Therefore, it is inevitable, I think, that there is a decline in the level of knowledge, expertise, and experience, so I do not believe that this is simply the fee structure. The fee structure needs to be reviewed, and it also needs to have the right level of investment to enable the quality of audit to improve, and the career opportunity for any would be accountant, wanting to pursue that particular course in that sector. At the moment I am afraid that is a serious issue, which as I say, has not been said to me only by the audit firms.

Comment

One of the things that we do with external audit is that, when we are preparing our annual plan, we engage with them to determine what audits they would like to work with us on. We also meet with them on a quarterly basis, to catch up on their thoughts, our thoughts, delivery of the audit plan and some of the outcomes.

We also deliver joint training with them to the elected members on our audit committee, and that is helpful because it helps the elected members and the audit committee understand the relationship between internal and external audit, and how that should work in practice.

Response

That is a perfect illustration of good practice. I did encounter some examples of what you said but the majority do not have that arrangement in place.

Question 7

Do you see the report to council also including the annual internal audit opinion as an additional source of assurance?

Response

I have not specified that. I think it would be something that all external auditors might contemplate as good practice, but I did not determine that it should be a requirement.

Question 8

Internal audit is well placed to support audit committees in terms of evaluating its resources and capacity, and we provide internal audit training to our audit committees. I am aware that external audit provide training on understanding the accounts, that is usually an annual thing that they carry out.

What do you see external audits role is in supporting the audit committee, in terms of their training, development and responsibilities? Does that sit more with internal audit or do you see that being more of a shared role?

Response

I think it is a shared role for the very reason that you described, that both have value to add in the way in which audit committee members can be appraised of their responsibilities, and have sufficient knowledge to discharge them.

I agree with what you say. My take on this, in light of the evidence that has been submitted to me, is that the picture is mixed. I have heard two illustrations of good practice, but that is not being applied everywhere. The other thing that is quite important here, and I wouldn’t dwell on it in this forum. I am very concerned about whether or not external audit is genuinely testing the financial resilience and sustainability of local authorities. I do think that one of the areas in terms of training that is really important for an audit committee, is to have a familiarity with the key tests of financial resilience so that they are in a position to challenge what the audit committee will receive from the external auditor. Some simple things like debt profile, gearing of debt, reserves policy, what sort of commercial enterprise that might be undertaken by a local authority. The sorts of things that are important. It is not so much about every audit committee member being practised in understanding the technical nature of a balance sheet, but certainly the key drivers that determine whether that local authority is financially sound. This is an area that external audit should be doing more to explain to their audit committee, they should be seeking to establish whether or not the local authority is in a good position financially.

Question 9

What are your thoughts on organisational culture, which can often be a bit of a challenge in local authorities and its importance in relation to scrutiny and governance by the audit committees?

Response

Every local authority needs to establish its principles and values in terms of the overall financial planning, management, and resilience of its organisation. There must be a clear awareness of the key features that make it important for every local authority to be engaged in. In terms of the culture, there are three or four things here.

1. I think that culture can be supported by good governance arrangements: the governance Code of Audit Practice of a local authority is a really important feature and alongside that a clear understanding of risk – risk policy, risk awareness, risk adversity – the whole question about risk and how that is understood by the local authority. Sometimes I do not think it is given the attention that it deserves.
   
   
2. There is a clear illustration and demonstration from the most senior people in the organisation - statutory officers and generally directors of services in local government. That they can illustrate and demonstrate what good practice looks like, and therefore it is endemic in the culture that, that is the way one operates and behaves. If those behaviours are observed and understood, that will be a good example for others to follow.
   
   
3. I think it is about transparency, one of the hardest things sometimes to embed in a local authority is how you ensure accountability and transparency is properly established throughout the organisation from beginning to end. That is very much a feature of my report – accountability and transparency. If you can build that into the way in which the governance arrangements interfaces between different departments, and obviously the interface between the executive and non-executive, how they actually work together then you are moving into the cultural behaviours and improvements you would like to see.

Question 10

When I have seen this in the past, when external audit used to engage more with internal audit sometimes that led to increased reliance on internal audit’s work, and that had a knock on effect into what went into internal audit plans, and the likelihood for CFOs to say: I’ll get my internal auditors to do that because they are cheaper. Do you think that is likely to occur?

Response

No, I think that the opposite is the challenge. What I say in my report is that I believe very strongly that there must be much stronger engagement between internal and external audit, but I think the barrier to that greater cooperation is the NAO Code of Audit Practice, which does not see internal audit providing assurance to external audit in fulfilling its own responsibilities. It may happen in some cases, let me emphasis, I am generalising here, as there are many examples of good practice, but there are a lot more examples of not so good practice in this area. I would not see that, to paraphrase what you are saying: that they will get audit work on the cheap by asking internal audit to do it rather than external audit. I don’t think that is likely to be the outcome. I think the outcome is going to be pushing hard to get the right level of engagement between the two bodies.

Question 11

Is there anything that you wanted to recommend but held back because you did not think government would implement it or you were steered away from specifically?

No, I did not hold back on anything. Something that has been asked of me by many people is: is this the reintroduction of the Audit Commission – absolutely not. I never had any intention of this, not because of any political pressure. This body would cost around £5m – the new Office for Audit Regulation compared to what was nearly £90m, in the last couple of years of the Audit Commission. A totally different body, much narrower, much more focused. So, no I wasn’t dissuaded from doing anything that I wanted to do.