Martin quoted in ICAEW article on councils at risk of failure

Martin was quoted in an article published on ICAEW Insights titled: One fifth of councils risk financial failure this year.

The section in which Martin was quoted reads as follows:

Martin Wheatcroft FCA, an external adviser on public finances to ICAEW, says it is not just badly run councils – that either speculated and lost or mismanaged funds – that now face the distinct possibility of financial failure: “Many ‘normal’ local authorities are now looking vulnerable too, as they struggle to balance their budgets in the face of rising demand, rising costs and constrained funding.”

In particular, Wheatcroft says adult social care is a significant challenge for many local authorities, as an ageing population sees demand increasing each year as the number of pensioners grows. Meanwhile, the knock-on impact of the minimum wage increase of 9.8% from April will further add to the challenges facing councils in the coming financial year.

“With local authority core funding only going up 6.5% in the coming financial year, local authorities are having to look for further cuts in other already ‘cut to the bone’ public services to try and balance their books,” Wheatcroft adds.

Last month, the Department for Levelling Up, Housing and Communities released a call for views on greater capital flexibilities that would allow councils to either use capital receipts to fund operational expenditure or to treat some operational expenditure as if it were capital, without the requirement to approach the government.

The intention is to encourage local authorities to invest in ways that reduce the cost of service delivery and provide more local levers to manage financial resources. The consultation is open until the end of January.

Under the current rules, councils are restricted from using money received from asset sales or from borrowing to fund operating costs due to capital receipts being considered a ‘one-off‘, while borrowing creates a liability that has to be repaid.

Wheatcroft adds: “The government’s announcement of greater capital flexibilities may help stave off some of the problems for a while but is likely to further weaken local authority balance sheets in doing so.” 

To read the full article, click here.

Councils should ‘comply or explain’ on governance code

ICAEW welcomes proposed statutory guidance that establishes a corporate governance code for local authorities in England, but says councillors need better training and support if they are to be able to hold leaders to account.

Financial collapses and major stresses in local government finances have led the government to undertake a major rewrite of the applicable statutory guidance, in effect establishing a corporate governance code for local authorities in England.

ICAEW has formally responded to welcome the proposed new guidance, while also making some recommendations for improvements.

The government is introducing the new guidance in response to a series of high-profile collapses of local authorities in England in which governance failures were identified as a common feature, as well as an increasing number of local authorities reporting that they are in financial difficulty or at risk of being so.

Local authorities in Thurrock, Woking and Croydon are together estimated to have lost local and national taxpayers in excess of £1bn, with their communities adversely affected by significant cuts to local public services and higher council tax bills. Central government has also stepped in to provide additional funding and loans, some of which are unlikely ever to be repaid.

The proposed guidance technically relates to the ‘best value duty’, a legal obligation placed on specified public sector bodies, including local authorities, to have arrangements in place to secure continual improvement in how they carry out their work. Relevant public bodies are required to have regard to any statutory guidance issued by the government in deciding how they comply with this duty.

As the proposed guidance acknowledges, meeting the best value duty will only be possible if councils have adequate governance arrangements in place. It goes on to set out a series of characteristics of well-functioning authorities, as well as indicators of potential failure, covering continuous improvement, leadership, governance arrangements, culture, use of resources, service delivery, and partnerships and community engagement.

Accountability is not accidental

ICAEW has suggested a need for accountability events. These should include a formal presentation on financial performance and position each year by leaders and officers to councillors within four months of the end of the financial year, and proper consideration and adoption by full council of the annual financial report once the external audit is completed. The latter should cover the financial statements and accompanying narrative reports on financial performance and position, audit reports, and statements on governance arrangements; regard for the statutory guidance on best value duty; and responsibilities for the preparation of the financial statements and internal financial control.

ICAEW has recommended a ‘comply or explain’ approach when local authorities report on how they have had regard to the guidance. This would provide clarity on how local authorities have set about applying the guidance, where they have chosen to diverge, and where they have been unable to comply.

A feature of recent failures has been inadequate accountability, with councillors not being properly equipped to hold leaders and officers to account for unwise debt-leveraged investment strategies, poor individual financial decisions, and inadequate governance arrangements. In most cases councillors were not fully aware or did not fully understand the scale of the risks that were being assumed and the consequent financial implications for their local communities. ICAEW’s response stresses that councillors need sufficient training, information and support to undertake this role.

ICAEW has separately submitted evidence to the House of Commons Levelling Up, Housing and Communities Select Committee on how local authority financial statements must be understandable if they are to provide the information councillors need to hold their local authorities to account and to be used effectively in governance and risk management processes.

Good governance is critical

The proposed guidance stresses the importance of good governance and strong financial management, providing a useful framework for local authorities in how they set about ensuring they have appropriate governance arrangements in place.

However, the proposed guidance does not make it clear that performance management should include monitoring and management of the balance sheet and financial risks, a feature that was missing in recent local authority failures that saw debt-leveraged investments significantly increase balance sheet risk.

ICAEW’s response also highlights the role that internal audit can play in assuring governance arrangements are in place, while noting that local councillor codes of conduct will need to be updated to reflect the new guidance.

The role of the audit committee is extremely important to an effective system of governance, and ICAEW calls for the government to legislate, as promised, to require independent members of local authority audit committees.

Alison Ring OBE FCA, ICAEW Director for Public Sector and Taxation, commented:

“We are very pleased that the government has recognised the need for a corporate governance code for local government in the form of new statutory guidance on the best value duty. This is particularly welcome in the light of recent financial collapses at Thurrock, Woking and Croydon that together have cost local and national taxpayers in excess of £1bn, as well as increasing levels of financial stress on local authorities across England.

“We believe that accountability does not happen by accident. There is a need for regular accountability events covering financial performance and the annual financial report as well as budgets, for a ‘comply or explain’ approach to reporting on how the best value duty guidance has been implemented, and for councillors to be properly equipped with the training, information and support they need to hold leaders and officers to account.

“Good governance is essential if local authorities in the UK are to ensure they obtain value for the more than £200bn of public money they spend each year on our behalf.”

Read ICAEW’s response to the consultation here.

This article was first published by ICAEW. The article, and the consultation response it refers to, were written by Martin Wheatcroft of behalf of 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.

Alison Ring: don’t waste the huge effort you put into annual accounts

Council finance teams put a lot of time and resources into preparing financial statements each year but often the results are impenetrable. A focus on streamlining and clarity can make a huge difference, writes the ICAEW’s public sector director.

Getting the annual accounts finished and out of the way is a relief to most finance teams. It is a major undertaking to put together what can be a couple of hundred pages of detailed numerical content and getting your auditors to sign off on it all. Understandably, there is a temptation to just upload it to the website, forget about it for another year and move onto the budget, that bid for levelling up funding, or the many other priorities that are pushing up your to-do list.

But are you getting a full return on the investment you make into your annual report? The answer is almost certainly “no”. Unlike their corporate equivalents, local authority accounts are notoriously “impenetrable” and a difficult tool to use in communicating with stakeholders on the financial story of the year and how you are making progress in delivering on your strategic objectives.

The last thing you want to do is to use a long, complicated, and difficult to understand document as a tool for accountability, while for readers the challenge in trying to understand the finances of many local authorities is daunting. Ahead of them might be a 250-page document with over 150 pages of difficult-to-follow financial statements. To put it bluntly, who has the time to read all of that?

Concise and streamlined accounts

This contrasts with annual reports such as that recently published by the Government Legal Department (a non-ministerial department), where the financial statements including notes take up only 15 pages of an 80-page document. This is a much better vehicle for understanding the financial performance and position of, admittedly, a simpler organisation than most local authorities – but an example of how being concise and streamlined can make accountability that much easier to achieve.

It is almost two years since the conclusion in the Redmond Review that local authority accounts are “considered impenetrable to the public”. As finance leaders in the local government sector, this should concern us all.

Your accounts should help residents, councillors and councils understand the financial performance and position of the local authority. They should be the cornerstone of the evidence-based decision-making and strong financial management, essential for effective delivery of public services.

Unfortunately, impenetrable financial reports achieve none of the benefits that a well-designed annual report is capable of. Not only do they sap the resources of finance teams in preparing information that is not going to be used effectively, but they mean other ways have to be found to provide the financial transparency that councillors and others need to represent the interests of local residents effectively. Or (as many councillors tell us) not to have a full understanding of the finances at all.

Don’t wait for CIPFA/LASAAC Code improvements

While there is a real need to reform the Local Authority Accounting Code and the example financial statements in the code guidance notes – and CIPFA/LASAAC are working on that – there is no need to wait for that to happen. Yes, the complexity of the local authority finance system doesn’t help, but even so I have yet to read a set of local authority financial statements where I did not think there was something that the preparers could have done to make them more understandable and concise, while remaining compliant with the code.

Some local authorities have already been able to streamline their financial statements to good effect. Fife Council, for example, has been able to reduce the length of its annual report including the management commentary to only 68 pages, while Southwark Council worked with its auditors to reduce their document to 133 pages, which is notably short for a large London borough.

One mistake is to treat the example financial statements as currently devised as a template, rather than as a reference document covering almost every conceivable scenario. We too often see local authorities including boilerplate disclosures from the example financial statements even when not relevant. CIPFA has published helpful accounts streamlining guidance that advises moving away from the example financial statements to reduce the length of the report.

It is important though when conducting a streamlining exercise that you consider the needs of users. Shorter for the sake of it is counterproductive if it means the accounts are non-compliant or even more difficult to understand. For example, nothing useful is achieved by tiny font sizes or merging notes that don’t relate to each other.

Consider instead how you can structure your financial statements effectively. For example, in most circumstances there is no need for three separate notes to the cash flow statement when there is room in the primary statement itself. Could you move the more detailed financial instrument and pension disclosures to the back of the report so that the main balance sheet notes flow together more seamlessly? Have you “weeded” your accounting policies note as much as you can? It is surprising how many local authorities report a policy for contingent assets when there are none that (apparently) need disclosing.

Think about what users require

Streamlining should not mean losing important information – instead, it gives an opportunity to focus on what is important. Take out accounting policies that merely restate GAAP, or long expositions of credit risk on immaterial exposures that do not aid understanding, and instead provide more insightful disclosures that are specific to your local authority, perhaps such as the financial performance of council-owned businesses. Tables and charts can be used to communicate concisely, without compromising on the quality of the information provided.

Have you provided what is really needed, such as why investments have been recognised at amortised cost rather than fair value (or vice versa)? Or how you have calculated your Minimum Revenue Provision (MRP)? Despite its importance to council tax calculations, a recent review of a sample of local authority accounts by the ICAEW found that many did not disclose the MRP policy or the key judgements made in its calculation and, in the few instances where there was disclosure, the language used was often so technical as to be incomprehensible. Getting rid of jargon can help make it easier for councillors and residents to use the accounts.

A foundation for financial conversations with stakeholders

Local authorities are in theory much more transparent than their private sector comparators. Listed companies do not have to publish their budgets or internal financial reports, debate their financial decisions in meetings open to the public, nor allow their stakeholders the ability to inspect their detailed books and records.

Despite that we often hear the view that local authority finances are much more difficult to understand – a classic example of how greater quantity does not equal better quality.

Making the annual report and accounts a foundation for your financial communication is one way of addressing the deficit in understanding, and a way of getting a better return on all the effort you put into them. A good annual report should be an annually updated reference work that is actively used as the go-to place to find your strategy, how you monitor progress against your objectives, how you are managing risks, and the strength (or otherwise) of your financial position, as well as telling the story of the year in words and numbers.

Doing so may also help you get on the front foot with the new Office for Local Government, which is likely to become an avaricious consumer of your performance data once it gets up and running.

While we hope CIPFA/LASAAC’s project to improve the presentation of local authority financial statements will put understandability at its heart, that does not mean you should wait for developments. Not only can you make your annual report that much more usable through streamlining disclosures and improving clarity (potentially saving time by making it easier to prepare in the future), but you have an opportunity to use it to support better quality dialogue with your stakeholders.

If you don’t feel comfortable in presenting your annual report to your councillors as the one financial document that they need to read each year, then I would suggest that you are not doing it in the right way.

This article was originally published in Room 151.