Overview of the year
PSAA is an appointing person for principal local government and police bodies for audits from 2018/19, specified by the Secretary of State in July 2016 under the provisions of the Local Audit and Accountability Act 2014 and the Local Audit (Appointing Person Regulations 2015. PSAA is responsible for appointing auditors and setting scales of fees for relevant principal authorities that have chosen to opt into its national scheme, overseeing issues of auditor independence and monitoring compliance by the auditor with the contracts we enter into with the audit firms.
2020/21 was the second year of the current appointing period during which PSAA was responsible for audits carried out in 478 opted-in bodies (98% of eligible bodies). During this financial year, the audits in respect of 2019/20 were performed in a challenging context which included the COVID-19 pandemic.
Local audit market landscape
A number of high-profile corporate failures in the private sector have led to significant government and public concern about the role of the auditor and have created instability in the wider audit market. As a result, the government commissioned reviews into different aspects of audit, led by Sir John Kingman, the Competition & Markets Authority and Sir Donald Brydon. This has led to consequences for local audit, with a change in emphasis of audit work and a significant increase in audit quality requirements set by regulators. As a result, audits are taking longer, auditors are applying greater scepticism and audits are requiring more resource and a different mix of skills. These factors were not envisaged when audit firms submitted tenders during the 2017 procurement, and this is leading to a significant level of additional audit fees being proposed as managed through our fee variations process.
The global pandemic has had wide reaching implications for the delivery of the 2019/20 audits, impacting both finance and audit teams. Remote working brings practical challenges in terms of the efficiency and effectiveness of interaction between auditors and opted-in body staff, training/coaching members of the audit team and audit completion tasks. In terms of the financial statements, the Financial Reporting Council (FRC) has highlighted that the timing of the pandemic results in auditors needing to consider the potential impact on matters such as asset valuation, debt recoverability and going concern (financial resilience being particularly relevant to local audit). Auditors have also needed to assess the requirement for additional Post Balance Sheet Event disclosures and amendments to the audit opinion. A further factor is the personal toll on both finance and audit teams – through sickness as well as shielding and personal responses to lockdown – which reduce the resilience and capacity of the financial reporting supply chain.
We will continue to monitor the repercussions of the COVID-19 pandemic including its impact on fees and signing of audit opinions.
Review of Local Authority Financial Reporting and Audit
In September 2020 Sir Tony Redmond’s review of local authority financial reporting and external audit was published. The report highlighted the significant challenges and turbulence within the new system of local audit, emphasising that at present local government audit is under-resourced, undervalued and is not having impact in the right areas. The report made a number of recommendations in relation to external audit regulation, smaller authorities audit regulation, financial resilience of local authorities and transparency of financial reporting.
In December 2020, the Ministry of Housing, Communities and Local Government – MHCLG delivered its response to the Redmond Review setting out proposed actions to implement the majority of the recommendations made in the report. This was followed by a further announcement in May 2021 which responded to the options for systems leadership with the proposal to strengthen the Audit, Reporting and Governance Authority (ARGA) -– the new regulator being established to replace the FRC – with new powers in relation to local government audit, protecting public funds and ensuring councils are best serving taxpayers. Furthermore, it is proposed that the new regulator will contain a dedicated local audit unit which will bring all regulatory functions into one place, to better coordinate a new, simplified local audit framework.
MHCLG confirmed that PSAA would remain responsible and accountable for the appointment of auditors and setting scales of fees for relevant principal authorities that have chosen to opt into its national scheme, as specified by the Secretary of State for Housing Communities and Local Government under the provisions of the Local Audit and Accountability Act 2014 and the Local Audit (Appointing Person) Regulations 2015. This is based on MHCLG’s view that PSAA is the organisation best placed to act as the appointing body, including overseeing the next procurement, due to its strong technical expertise and the proactive work that has been performed to help identify improvements that can be made to the process. This will also help to provide continuity, given the proximity of the next procurement exercise.
As MHCLG takes forward and refines its proposals in response to the Redmond Review, the next few years are likely to continue to be significantly challenging for the world of local audit and for stakeholders, PSAA included, in the system.
Completion of 2018/19 and 2019/20 audits
Last year, we reported that for 2018/19, audit opinions had not been given at 40% (208 of our opted-in bodies) at the target publishing date of 31 July 2019. The comparable position in relation to the 2017/18 accounts was 13%. Increased regulatory pressure, including the need to demonstrate scepticism at every step of the audit process, requires auditors to do more and different testing before a confident, safe opinion can be issued. Subsequent sign-off has been gradual rather than rapid and as at 31 March 2021 there were still 19 opinions outstanding from 2018/19.
Disappointingly, the position has deteriorated in relation to 2019/20 audits as audit teams have struggled with the lack of capacity to address the previous year’s backlog as well as dealing with the impact of COVID-19 on the audit work required. In respect of the 2019/20 audits, 55% (264 out of 478) of the audit opinions were not issued by the revised target date of 30 November 2020. By 31 March 2021, this total had reduced to 116 outstanding audit opinions (24%).
This increase in delayed opinions is a significant concern and we recognise the inconvenience and disruption it causes. The COVID-19 pandemic has added a further layer of difficulty to these challenges and has impacted the speed with which some delayed 2018/19 audits can be completed. It has also had implications for the conduct of 2019/20 audits as local authority resources are reduced through enforced absence or prioritised to support delivery of frontline services.
Audit market sustainability
It is critically important that the market remains competitive and sustainable for the long term. Throughout the year we have maintained a strong focus on planning for the future including striving to strengthen the resilience and sustainability of local audit arrangements. We welcome the fact that the Redmond Review has served to raise awareness of these challenges.
Much of our work, including commissioning independent research and working collaboratively with other stakeholders including the Redmond Review, has been directed to support market sustainability. At the beginning of 2020, we commissioned a particularly important project exploring the sustainability of the local audit market to gain a more in-depth understanding of potential challenges. This included capturing the views of actual and potential audit providers concerning the attractiveness of the market relative to auditing in other sectors of the economy and the possible features of a future procurement which would influence decision making about future participation in the market.
The report PSAA Future Procurement and Market Supply Options Review highlighted that sustainability of audit supply is likely to be a major challenge and identified a number of distinctive challenges in the local audit market. In particular it highlighted the unprecedented scrutiny and significant regulatory pressure on the auditing profession; the challenges of a demanding timetable which (prior to recent adjustments) expected publication of audited accounts by 31 July each year; and the impact of austerity on local public bodies and its effect on both the complexity of the issues auditors face and the capacity of local finance teams. The report was shared widely as this is an area where we need to work with key stakeholders to address issues which are not within our singular control.
The findings have helped to inform our work around developing our procurement strategy and our consideration of a further procurement exercise designed to access additional auditor resources. In the event we decided not to proceed because of the continuing uncertainties facing audit firms following Redmond and the other government commissioned reports from the CMA, Kingman and Brydon.
The report is also mentioned in the Public Accounts Committee Report entitled “Local auditor reporting on local government in England” published on 14 July where a full section is devoted to stabilising the local authority audit market.
Linked to our work on market sustainability, we commissioned a review of scale fees focusing on gathering and analysing data on audit risks and costs to gain a more in-depth understanding about the current level of scale fees and to explore the changes in audit requirements over the past two years. The results will inform our approach to the next procurement and have provided the Board with invaluable insights into the current position.
Setting audit fees
All of the pressures and challenges outlined have added significant complexity and practical difficulty for PSAA in setting audit fee scales. The regulations currently require that the fee scale must be set before the start of the financial year. A significant proportion of audit work is undertaken after the end of the relevant financial year, making it impossible for PSAA to set a realistic fee scale with the benefit of up-to-date information on the outcome of the audits for the preceding year. Increased regulatory scrutiny and new audit requirements have meant that additional audit work, the extent of which is not known at the time the fee scale must be set, has ultimately been necessary at most audits. The regulations require that such additional audit fees are approved retrospectively once the work has been undertaken. Helpfully, MHCLG is consulting on a number of proposed changes to the regulations, to allow for updating of audit fee scales in a more timely way.
We consulted in November 2020 on changes to our fee variations arrangements, with the aim of reducing, if possible, the volume of local discussions about fee variations. We proposed a new approach to apply in the case of national fee variations, where changes in audit requirements relate to the conduct of all or most audits and where a standard additional fee could reasonably be estimated across groupings of bodies. The consultation also set out a proposed increase in the fee rates for additional work.
The response to the consultation was positive, with significant support for the proposal to introduce national fee variations where appropriate for some new audit requirements and a significant majority in support of the fee variation rate card increase. We have resolved to implement the proposed changes and will consider possible national fee variations when the consultation on relevant regulations, referred to above, is concluded.
A programme of research is under way to consider the likely impact on audit work and fees of some expected changes in audit requirements, such as the new NAO Code of Audit Practice and some new or revised auditing and financial reporting requirements. We will consult opted-in bodies and other stakeholders on proposals where we identify changes for which a national approach would be appropriate.
We consulted in January and February 2021 on the proposed fee scale for 2021/22 and set the fee scale in March as required under current regulations. We received a good response to the 2021/22 fee scale consultation, with support for the proposal to build into the fee scale the ongoing elements of the additional fees determined for 2018/19 audits. While there was a wide range of views reflected in consultation responses, most stakeholders accept that audit fees must rise in response to the evolving local audit environment/market.
Monitoring our contracts and the quality of audit services
We published our first Annual Quality Monitoring Report under the appointing person arrangements, covering the work of local auditors appointed by us for the 2018/19 financial year and providing a rounded, well-informed view of performance and quality for each supplier. The report included the results of our first client survey on the quality of audit services and the outcome of the regulators’ reports (FRC and ICAEW) on the quality of local audit work.
The FRC reported that only 62% of the financial statement audit reviews they completed met their expectations and were assessed as requiring no more than limited improvements. The FRC’s sample is of higher risk major local audits and included NHS and other bodies not in the PSAA contract. Nevertheless, we were disappointed by this result. In contrast, the ICAEW reported that 91% of the financial statement reviews they completed of non-major local audits met the required standard. All VFM arrangements work inspected by both regulators was assessed as meeting the required standards. We have discussed with the firms their plans to address the matters raised by the professional regulators.
Helpfully, in recognition of the unprecedented challenges on local audit, MHCLG adjusted the target date for publication of 2019/20 audited accounts to 30 November 2020. For the subsequent two audit years, 2020/21 and 2021/22, the Accounts and Audit (Amendment) Regulations 2021 have revised the target date for publication to 30 September.
The second appointing period
Following the government’s confirmation that PSAA will continue as the appointing body for local audit, we have continued preparations for the next appointing period which is due to commence on 1 April 2023. We are working on developing our procurement strategy and approach in key areas such as procurement route, lot structure, evaluation ratios, basis for bid pricing and social value. The next procurement exercise will include strong focus on audit quality and market development, to support the long-term competitiveness and sustainability of the market.
Given the current local audit landscape, the early indications are that devising a successful procurement strategy will be more complex and challenging than for the 2017 procurement.
With the government’s expected response to the various audit-related reviews and the consultation on its proposals in response to the Redmond Review, we are likely to continue to face an uncertain operating environment over the medium term. We will continue to closely monitor the local audit landscape and work hard to understand the potential implications of any change for opted-in bodies, audit suppliers, key stakeholders and ourselves. We have worked closely with MHCLG, prior to and since publication of its response to Redmond and we will fully engage with activities that support the design and development of the new arrangements. It is critically important that the market remains competitive and sustainable for the long term.
A significant focus over the next two years will be to prepare for the next appointing period. We will work closely with MHCLG and other stakeholders to determine the timing of and to develop proposals for the next main procurement, including our approach to fees and auditor appointments.
We were delighted to congratulate Caroline Gardner, a founding member of our Board, who was awarded a CBE for her services to the Scottish public sector in the 2021 New Year’s Honours List.
As a result of our process for Board succession planning and rotation, we said farewell to Clive Grace, a founding member of our Board. We thank Clive for his invaluable contribution to help establish PSAA and develop our role and arrangements as the appointing person.
In April 2021 Marta Phillips OBE was appointed as a Board member and director of PSAA to succeed Clive. We welcome Marta to the Board. We are also pleased to welcome Alan Edwards to Marta’s former role as the independent member of the PSAA audit committee.