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Audit improves but problems and uncertainties remain

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  • by Guest
  • in Blogs · Stephen Sheen · Technical
  • — 4 Nov, 2021

Photo by Cathryn Lavery on Unsplash

The regulator has reported revealing improvements in local government audit but key issues remain unresolved, writes Stephen Sheen.

At the end of October, the Financial Reporting Council (FRC) released its second annual report into the quality of local audits (here). The report is somewhat hampered by the fact that inspections were restricted to the audits of 2019-20 statement of accounts. With only 45% of audit opinions issued by the statutory target date of 30 November 2020, the FRC had to replace half of the audits originally selected on the basis of risk. The fuller facts will therefore not be known until catch-up work in 2022 on some of these “missing” riskier audits.

The headline news is that the quality of local audits has improved so that the inspection results are now comparable with those for Companies Act audits. Unfortunately, this does mean that local auditors still fall short of FRC expectations.



Six out of 20 audits reviewed for 2019-20 required improvements, compared with nine out of 15 for 2018/19. None required significant improvements, whereas two did for 2018-19.

For the individual firms, Grant Thornton and Mazars both improved their scores substantially and EY slipped back a measure.

There are therefore some encouraging signs that the quality of audits is improving (if you actually get round to having one).

Particularly encouraging, though, is the evidence in the report that the FRC has put the effort in to improve the quality of its own work, unlike previous years where the agenda appeared little different from that applied to the commercial sector, where going concern, revenue recognition, related parties and group accounts headed the list. These were the matters considered significant:

  • the exercise of auditor’s additional powers or duties;
  • the disclosure of senior officer remuneration;
  • the appropriateness of capital expenditure;
  • investment property valuation;
  • adjustments between the accounting basis and the funding basis such as minimum revenue provision.

There was also increased concentration on the testing of the accuracy and completeness of expenditure.

A well-focused list that now shows a proper appreciation that public sector financial reporting has a very different purpose and peculiar set of users that auditors need to reflect upon.

References to the use of experts are nuanced, so that the encouragement that auditors were previously given to earn bonus points simply by engaging experts to dismantle the work of an authority’s own experts is removed. A proper recognition of the absence of any incentives to bias in valuations for property (excepting investment property) and estimates for IAS 19 figures should mean a greater respect for the professional work carried out for the authority.


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Good practice recommendations are restricted to calling in expert support for specialist valuations and for assistance with ensuring that the audit team has the appropriate level of scepticism about the assumptions used by an authority’s experts.

This should go someone way to restoring the balance by which the statement of accounts reflects the authority’s judgements and the auditor gives an opinion on those judgements. There has been too much recent experience of auditors looking to impose their own judgements on authorities where the only distinction is that they are different, not better.

Scope

There are two remaining substantial issues. The first is the one acknowledged by the FRC: The scope of their inspection was restricted to completed 2019-20 audits.

One of the first reactions to an authority getting into financial difficulties or being suspected of questionable activities is normally to suspend the accounts and audit process. Accounts can remain open for several years while loose ends remain untied.

Without audit sign-off, the impression is given that regulator scrutiny can be avoided. There must be a mechanism for examining the extent to which the work of auditors might have contributed to the situation.

We need a framework in which processes are accelerated in these circumstances. It should be a priority of a failing authority that the statement of accounts is prepared and signed off as soon as possible, once the possibility of a disclaimer of opinion has been removed.

Uncertainties and contingencies can be reflected in appropriate disclosures in the statement and qualifications in the audit opinion.

Materiality

The second issue is that the materiality problems have still not been resolved. The report notes that auditors’ materiality levels (usually based on a percentage of gross expenditure) are typically low relative to the value of their property assets. Rather than take this as evidence that levels are not being set effectively, the FRC accepts that this justifies auditors’ identification of property valuations as a significant risk.

 


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In local government, with the clear split between valuations provided for the balance sheet and the figures that establish an authority’s spending power, a materiality measure based on expenditure is going to overstate the importance of figures provided as an indicator of the breadth of the stewardship exercised by elected members.

Several of the authorities that I work with have been met with claims that their property, plant and equipment balance will be materially misstated if it is more than 1% “wrong”. Even without consideration of whether the accounting framework ever conceived that such accuracy would be possible, where are the users that would be the slightest bit interested in its achievement?

In the commercial sector, everything can be judged equally, because every pound counts equally against the investor’s focus on net assets and profitability. For local government, we need a framework that bases the initial assessment of materiality on what users are actually least interested in, and then works down to smaller levels for the items that are most concerning, until we are counting every penny of senior officers’ remuneration.

Until all elements of the financial statements are properly assessed for their risk of truly material misstatement, then there will be a lot of wasted audit work.

More critical work on materiality, please, key stakeholders.

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.

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1 Comment

  1. Ichabod’s at Room 151 – Ichabod’s Industries says:
    2021/11/05 at 09:21

    […] Audit improves but problems and uncertainties remain […]

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