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Local government audit failed to reach optimum performance levels this year: Deadlines were missed and key staff lost. Things will need to improve in 2020, says Stephen Sheen

The headline news of the first year of the new audit contracts awarded by Public Sector Audit Appointments (PSAA) was that 40% of authorities did not have their statement of accounts signed off by the statutory date of 31 July.

But behind the headlines, the issues for authorities were not just about timeliness but with the quality of audit work and the experience and expertise of those that carry it out.

Not all of the problems have been the fault of the audit firms. The 31 July date has collapsed audit work into an unfeasibly short period, making team building and continuity of team members very difficult. The time has effectively been halved over which junior auditors can gain experience of local government final audit, leading to the under-development of those who have traditionally been relied upon to understand how accounting works.

Security

The firms might seek to lay some blame at the feet of PSAA. The contract award process can result in firms losing all their audit appointments at the flick of a switch (as happened to KPMG this summer). The absence of any security gives no incentive for firms to invest for the long term in staff and other capabilities.

PSAA has also given the public perception of being devoted, primarily, to reducing the cost of audit. 2018-19 fees were set at a 23% discount on those for 2017-18. But remember these fees were set after a competitive tender which the firms participated in voluntarily. Many authorities have been surprised this year to have been approached by their auditors with an Oliver Twisty plea for “more”.

This surprise was exacerbated by the real decline in quality that authorities have noted in their audit teams.

Whether by accident or design, the firms have lost a significant number of the staff that were transferred to them when the Audit Commission was dissolved. The decline in fees is matched by a perceived decline in the service they receive.

McCloud

This is also evident in the approach to technical matters. I have written previously about the willingness of the firms to be driven by the FRC’s views of what constitutes a standards-compliant audit, making no allowances for the big differences between the commercial and municipal worlds. This is likely to get worse with the FRC’s request that at least one of the firms becomes more sceptical in its work, particularly in relation to valuations.

There have been many examples this audit round of valuers having their professionalism challenged by auditors, with no understanding that possible imprecisions in valuations have less importance for readers and that there are not the incentives in local government to inflate valuations that there might be in the commercial world.

The firms also seem less capable of dealing with issues that arise. The model appears to be to agree a position (hopefully with all the other firms) and then seek to impose this position on authorities. Audit teams appear to have no discretion to see what their authorities have done and decide whether this was reasonable.

The McCloud judgement was an excellent case in point. It was clear from half an hour’s study of the situation that the best that an individual authority could do was to report a contingent liability. The Supreme Court case confirmed age discrimination in pension payments in circumstances that were paralleled in the local government scheme. Individuals in the scheme will therefore be entitled to redress.

However, it was far from clear whether, and to what extent, this would result in authorities having liabilities. Under threat of qualification, authorities were told to recognise these unrecognisable liabilities and then asked to pay auditors for the costs incurred in the telling.

A similar situation arose in relation to the wholly uncontentious area of negative earmarked reserves for Dedicated Schools Grant, but there is not enough space here to chase that particular fox.

Getting better

Are things going to get better after the dip in 2018-19? In theory, the auditors are locked into their PSAA contracts for the next four years, but work on the local audit regime is underway that might make those contracts unsustainable.

The NAO is rewriting its Code of Audit Practice, but this will not be effective until 2020-21. The proposals include a commitment for auditors to ensure that teams have the necessary skills and knowledge of the local authority financial reporting and regulatory frameworks to enable them to deliver their audit work.

There will be a clear expectation that auditors will complete their work in time to allow authorities to meet the 31 July target for publication of the audited statement of accounts.

Firms will also need open and transparent arrangements for engaging with the public effectively and to ensure that their reporting to audited bodies is as effective and transparent as possible and promotes improvement.

It might be imagined that all of these would be good practice without having to be stated in the Code. The Code is also not being amended to introduce any amendments or extensions to auditing standards, so that there should be little impact on the audit of the financial statements.

However, a new approach to value for money auditing is proposed. Auditors will be required to make judgements in three areas:

Procedures will be specified for work in each of these areas, and auditors will be required to give a commentary on their findings, not just express a “did or did not” opinion.

My own particular bugbear is also given a reassuring hug: The non-existent/inconsistent application of auditors’ statutory powers, such as public interest reports and advisory notices. If exercised effectively and equitably, these powers can boost the good that audit does, in comparison with their current perception as apocalyptically bad news.

There is therefore intended to be an increased burden of audit in 2020-21, even before any changes consequent on the Redmond Review. The Review is currently at the stage of calling for evidence. The material currently made available therefore only gives a hint of what might be to come.

It will, though, consider the recommendations of the Kingman Review of the Financial Reporting Council: a single regulatory body dedicated to securing local audit quality, setting standards, inspecting work the quality of relevant audit work and oversee the relevant professional bodies. It should also have responsibility for appointing auditors and agreeing fees. Perhaps it could be called the Commission for Audit.

My view, though, having worked almost 20 years in local government audit for the private sector, is that the bigger loss for local government was not the Audit Commission but the District Audit Service. Can we have that back, please? Santa?

The government is minded to exclude councils’ commercial income from calculations on how much funding they receive from central government, according to a senior official working on the Fair Funding Review.

Stuart Hoggan, deputy director for local government finance at the Ministry of Housing Communities and Local Government (MHCLG), said that the department is cranking up technical work on the review following the general election.

He said that, although no firm decisions have been made, commercial income is likely to be excluded from the “resources adjustment” used to work out how much money councils need to provide services.

Speaking to the Local Government Association’s (LGA’s) Local Government Finance Conference last week, he said: “My guess is that what we will not take into account sales fees, charges or commercial income.

“No final decisions have been made on that yet. But my guess is we won’t take that into account.”

He said that including commercial income could reduce incentives for councils to pursue it as a source of income, and that some councils face restraints on raising or spending such income.

Richard Harbord, former chief executive of Boston Borough Council, told Room 151: “Commercial income is now quite a vital part of local authorities’ income.

“It is a bit strange if they excluded it from the resources adjustment – some councils will have low resources on paper but high commercial income and they may do better from future settlements under this scenario.

“You could say that they are being rewarded for taking commercial risks, but it is a little hard to follow the logic.”

Hoggan also told delegates that the government has yet to take a decision on whether to include deprivation as a factor in the calculation of base funding to local authorities.

Negative RSG compensation labelled ‘unfair’ by metropolitan councils

The government is proposing to compensate councils with negative revenue support grant (RSG) in 2020/21, it has announced in a consultation on the distribution of next year’s local government finance settlement.

The government caused consternation in some quarters last year when it decided to compensate authorities suffering negative revenue support grant (RSG).

But the consultation from the Ministry of Housing, Communities and Local Government, released last week, said ministers are minded to continue the current approach.

It said: “This approach would recognise the need to provide stability to local authorities with negative RSG in 2020-21 and would be consistent with the government’s previous commitment, made during the implementation of the business rate retention scheme in 2013/14, that authorities’ retained business rates baselines, which are used to determine their tariff and top-ups, would be fixed in real terms until the business rates system was reset.”

However, it acknowledged that some authorities had opposed the policy last year.

Compensation policy

The compensation policy is unfair on deprived urban authorities, according to representatives of municipal councils.

Geoff Winterbottom, principal research officer at urban council representative organisation SIGOMA, said that 145 of the 168 authorities who would have been adversely affected by the negative RSG issue in 2019 will be shire district councils.

He said: “These authorities are in a position where they are collecting more than they need to provide their services.”

Elsewhere in the consultation, the government said that it is not proposing to alter the existing mechanism for determining business rates tariff and top-up payments in 2020-21.

The department is also planning to retain the existing £900m top-slice of RSG to fund New Homes Bonus payments during 2020/21.

However, it said that it could adjust the baseline of housing provision above which the grant is paid “to reflect significant additional housing growth and spending limits”.

The government repeated its intention to examine whether NHB is the most effective mechanism for incentivising housing growth in future years.

The consultation covers the one-year spending round unveiled by chancellor Sajid Javid in September.

The government said this week that it estimates that the settlement will mean council’s “core spending power” will rise from £46.2bn this year to £49.1bn, which it says is a 4.3% real-terms increase.

It said it plans to carry out a multi-year spending review next year, which will lay the groundwork for reforms – including a full reset of business rates retention baselines in 2021/22.

The consultation will close at the end of October, with the government aiming to announce the provisional local government finance settlement in December.

How do the main party manifestos affect local government finance?

Councils borrowed just £80m through the Public Works Loan Board (PWLB) during the first full month since the Treasury’s rate rise, a mere 4% of August’s total.

Room 151 writer Colin Marrs details how just two authorities – Transport for London (£70m) and City of Edinburgh (£8.4m) – made up 98% of the month’s borrowing, with the remainder being taken in amounts of below £500,000 by parish councils.

We think this is an interesting development in lorem ipsum dolor sit amet. Read the full story on Room 151: https://www.room151.co.uk/treasury/authorities-turn-away-from-pwlb-in-favour-of-borrowing-from-peers/