#localaudit – Martin Wheatcroft

Setting a new direction for local authority accounts

The Levelling Up, Housing and Communities Committee has delivered a landmark report that will transform local authority financial statements, says ICAEW’s Alison Ring.

While the focus for many of us at the moment is on a rather depressing English roulette game of guessing which local authority will be the next to issue a section 114 ‘bankruptcy’ notice, you may be forgiven for having missed the landmark nature of the House of Commons Levelling Up, Housing and Communities Committee report ‘Financial Reporting and Audit in Local Authorities’.

Admirably concise (for such reports) at 45 pages, the report has quite rightly attracted headlines for the elements focused on the local audit crisis in England – and the increasingly urgent actions that are needed to resolve it. We at ICAEW are equally frustrated at the slow pace of the response and continue to urge the government to prioritise getting local authority audits back on track as quickly as possible.

So far, so expected. The Committee adds to the chorus of voices already calling for the government to address and reduce the backlog of audited accounts, as well as to take action in the longer term to prevent backlogs from happening again. The report highlights delays in putting the new system leader for local audit onto a statutory basis and calls for enabling legislation to be brought forward as soon as possible.

What makes this report so important is that it has not stopped there, instead going under the hood of the local authority financial reporting and audit system to come up with transformational recommendations on how local authority accounts can be improved to properly support democracy and accountability in a way that they aren’t doing now.

Fundamental weaknesses

The principal focus of the report is on addressing: “… fundamental weaknesses in the accounts themselves that are hampering the efforts of members of the public and other stakeholders to use them in holding local authorities to account”.

The Committee highlights the impenetrability of local authority financial statements as being a core issue, commenting that stakeholders who might want to use the information in the accounts encounter significant challenges in finding and understanding the information they need. As a result, many stakeholders do not use the accounts at all. Local authority accounts and audit are therefore not adequately fulfilling their role in supporting local democracy and accountability.

The Committee also quotes Rob Whiteman, Chief Executive of the Chartered Institute of Public Finance and Accountancy (CIPFA), who commented in his evidence to the inquiry that if people do not understand the accounts, they may also believe the accounts to be opaque and untrustworthy. My boss Iain Wright, Managing Director for Reputation and Influence at ICAEW, also gave evidence to the inquiry in which he stated that council taxpayers want to know how their money is being spent, and ultimately local authority accounts are the best way of being able to distil that.

Five purposes of accounts

One of the key issues identified by the Committee is a lack of clarity around the purpose of accounts, with the report quoting evidence from Alison Scott, Shared Director of Finance for Three Rivers District Council and Watford Borough Council, who stated: “At the moment, the statement of accounts tries to be all things to all people and, in doing that, gains lots of complexity. It almost loses its focus as to who it is supposed to be being produced for and who its focus is on.”

The Committee answers that by setting out five purposes that it believes accounts should fulfil to adequately support local democracy and accountability:

To be a credible public record.
Provide accountability for spending.
Enable conclusions to be reached on value for money.
Provide information to run local authorities.
Alert stakeholders of actual and potential issues.

The Committee believes these purposes will ultimately focus local authority accounts on their role as vital tools for upholding local democracy and accountability.

ICAEW concurs in the need for clarity around the purposes of the accounts and believes these proposals will provide much needed clarity to government, standard setters, preparers and regulators in how financial statements should be designed and presented. A new foundation that will be critical in helping users understand what is going on so that stakeholders can read and use the accounts to hold local authorities to account.

The Committee makes some specific recommendations to align local authority accounts with the five purposes, including introducing a standardised statement of service information and costs (as recommended by the Redmond Review); decoupling pension statements from the accounts; ensuring that auditors consider and conclude on the value for money achieved by local authorities; and encouraging more consistent use of auditors’ existing powers to sound early warnings. It also called for the government to work with CIPFA to make the Accounting Code freely available to all possible users.

A much more significant recommendation is the Committee’s call for the Department of Levelling Up, Housing and Communities to undertake an immediate review into existing legislation that places requirements on the contents and format of local authority accounts (including statutory overrides), with a view to ensuring they align with the five purposes as set out above.

The report comments that not a single stakeholder, witness or piece of written evidence expressed to the inquiry that one of the purposes of the accounts was to provide a baseline for the council tax calculation. The Committee did not consider council tax setting to be one of the main purposes of the accounts, questioning whether this could be better done outside of the accounts as part of a separate process.

A landmark report

I believe this report marks a decisive turn in what local authority annual financial reports should look like and how they can be used much more effectively to hold local authorities to account, improve decision-making and governance, and ensure value for money provided by local and national taxpayers.

We can only hope that it will be as effective as the Public Administration and Constitutional Affairs Committee’s report ‘Accounting for Democracy’ was to making central government accounts much more accessible to parliamentarians and other users.

If I have one (or is that two?) quibble(s) it is that the report does not sufficiently emphasise the role of councillors in holding local authorities to account and the role of finance teams in helping them to do so effectively.

Despite that small caveat, this is a landmark report that sets a new direction for local authority accounts and audit to support local democracy and accountability. By establishing clarity around the purpose of accounts the Committee has provided a foundation on which the whole system can be rebuilt.

Alison Ring is Director Public Sector and Taxation, ICAEW.

This article was written by Martin Wheatcroft (on behalf of ICAEW) together with Alison Ring, and was originally published in Room 151 and subsequently by ICAEW.

Spotlight on local audit also shines on the accounts

Alison Ring, ICAEW Director Public Sector and Taxation, says we must take a once-in-a-generation opportunity to fix long-standing underlying problems with the way local government financial statements are used.

There is a crisis in local government financial reporting and audit in England that urgently needs resolving. Some 74% of 2021/22 local authority financial statements were still not signed off after a year, 31% after two years, and some audited accounts are still not published from 2018/19 or earlier. These delays are not just a compliance issue – they are fundamental to how our local democratic institutions operate at a time when many authorities are struggling amid difficult economic conditions.

Getting local audits back on track must be the immediate priority, even if it will mean accepting some unpalatable measures, such as temporary relaxations in some audit requirements, or the postponement of new accounting standards. All parts of the system will need to compromise a little to unlock audit sign-offs, clear the backlog, and get the system up and running and sustainable again.

However, the spotlight focused on local audit illuminates some uncomfortable truths about the underlying effectiveness of audited financial statements in ensuring that councils are well managed and public money is spent wisely. They are often not understood, not read by enough people, and not used by councillors and other stakeholders in holding local authorities to account, as part of governance processes or when approving major financial decisions.

Many of these problems were identified by the Redmond Review, but progress in addressing its recommendations is, perhaps inevitably, much slower than anyone would like. In the meantime, there have been several well-publicised disasters as the financial tide has swept out to expose the naked vulnerability of some local authorities.

Much more than an informative read

Done well, financial statements are much more than an informative read that sets out the story of the most recent financial year. They are a multi-purpose tool for accountability, governance, risk management, strategic decision-making, regulatory and system oversight. They are also the apex of the system of internal financial control and the vehicle through which external assurance is delivered.

The trouble is that financial statements can only serve these purposes if they are read, understood, and actively utilised in each of these roles. When I hear that “nobody reads the accounts” I start to worry. Even though I know this is an exaggeration and that many people do of course read the annual financial report, the implication is that accounts are not being used to their full extent.

This poses some big questions. Are councillors able to properly hold their local authority and its management team to account if they aren’t actively using the principal tool designed to help them do so?

Are governance committees able to ensure their local authority is well run if they aren’t using the official document that brings together the effects of thousands of financial decisions made every year into a single assured report that summarises financial performance as well as the end-of-year financial position?

Are they able to assess the effectiveness of risk management if they aren’t looking at the balance sheet and the financial exposures disclosed in the notes to the financial statements?

Where decisions are being made, are council leaders, cabinets, officers, and management teams able to make effective strategic choices, potentially transforming their balance sheets, if they aren’t starting from the foundation provided by the audited financial statements?

Are DLUHC and other government departments, including HM Treasury, able to make good funding decisions, or assess the effectiveness of the overall system of local government in England, if they aren’t reading the accounts in some detail?

Finally, how can the preparation of financial statements be a key factor in promoting financial control if they lack the challenge of having an interested readership?

Of course, this is not the whole story. Unlike in the private sector where internal financial reports are confidential, a whole swathe of financial documents are in the public domain.

Why would anyone need to read a long and complicated set of accounts when they have access to this other “more useful” stuff?

The answer is that in many cases councillors and other stakeholders can’t properly understand the budget or other financial information provided to them if they haven’t first read and understood the annual report and accounts, and the financial context in which decisions are being made.

“The accounts are impenetrable”

This brings us on to another point that I have also heard frequently, which is that a reluctance to read the accounts is forgivable given how long and complicated many local authority annual financial reports are – “impenetrable”, in the words of some. Given my own attempts to grapple with some local authority annual accounts, I have sympathy for this claim.

To get this system working better, financial statements and accompanying narrative reports need to be much more understandable, so more people read them and use them as the multi-purpose tool they should be.

These concerns about whether accounts are being used effectively is one of the reasons I am so pleased that the Levelling Up, Housing and Communities Commons Select Committee is conducting an inquiry into the purpose and use of local authority financial statements and external audit in England, to which ICAEW and others have given evidence.

The committee is focusing on both the overall financial reporting and audit framework for local authorities in England as well as the immediate challenges of clearing the backlog of unaudited accounts.

A vision for local financial reporting and audit

To make the system work better we need everyone to agree on a clear vision for local financial reporting and audit, which is why ICAEW developed its own.

ICAEW’s vision is to bring confidence to the finances of local public bodies through a valued and thriving profession, high-quality understandable financial reports, high-quality timely local audits, strong financial management, good governance, value for money, and protecting the public interest.

When we started this project, it reminded us that everything starts with the financial statements. Not because they are more important than high-quality timely external audits, strong financial management, good governance, or a proper system of accountability, but because they are the rock on which everything else stands.

We need financial statements to be as understandable as they can be. We need them to be read. And – most importantly – we need them to be used.

This article was written by Martin Wheatcroft on behalf of ICAEW and was originally published in Room 151, an online news, opinion and resource service for local authority finance officers covering treasury, pensions, strategic finance, funding, resources and risk, and subsequently published by ICAEW.

ICAEW publishes its vision for local audit

In response to the crisis in financial reporting and audit in local authorities in England, ICAEW argues that urgent action is needed to bring confidence to the finances of local public bodies.

ICAEW’s vision for local audit sets out its support for understandable financial reports, timely high-quality local audits, strong financial management and good governance, value for money and protecting the public interest, and the critical role accountants and auditors play in enhancing transparency and accountability in the public sector.

The proportion of local authorities in England publishing their audited financial statements on time has fallen from more than 95% in 2017 to less than 12% in 2022, with knock-on effects for the audits of other local public bodies such as in the NHS. High-profile governance failures have led to significant financial losses. Unnecessarily impenetrable financial statements are not well understood and are not being used effectively to hold local public bodies to account. There is insufficient capacity in the local audit market, while auditors, finance teams and regulators are not aligned in their view of audit risks. Under-resourced finance teams struggle to produce good quality working papers. Local authority finance teams and audit firms struggle to retain staff in the profession.

ICAEW is publishing its vision for local audit to accompany the recent publication of a Memorandum of Understanding (MoU) between the Department of Levelling Up, Housing and Communities (DLUHC) and the Financial Reporting Council (FRC). The Institute welcomes the MoU, which covers the role of the ‘shadow’ system leader for local audit pending the establishment of the Audit, Reporting and Governance Authority (ARGA).

ICAEW also believes more needs to be done urgently if the local financial reporting and audit crisis is to be resolved.

Designed to prompt discussion about the need for urgent action, the vision identifies a series of challenges we believe need to be overcome, and actions we support to address those challenges. The vision in draft form has provided ICAEW with a focus for engagement with local authorities, auditors, government, and regulators, provoking debate and encouraging everyone involved to take action.

Alison Ring OBE FCA, Director of Taxation and Public Sector at ICAEW, commented: “Urgent action is needed to address the crisis in local financial reporting and audit in England. Local authority finances are under extreme pressure and the need for high quality financial statements, with the assurance that timely audit provides, is more important than ever.

“We want to see a robust financial reporting and audit system, underpinned by strong financial management, good governance and value for money, to protect the public interest. The vision highlights the critical role accountants and auditors play in enhancing transparency and accountability in the public sector.”

This article was originally published by ICAEW.