Audit Quality Monitoring Report 2018/19

Public Sector Audit Appointments Limited (PSAA) is an independent company limited by guarantee incorporated by the Local Government Association in August 2014.

The Secretary of State specified PSAA as an appointing person for principal local government bodies from 2018/19, under the provisions of the Local Audit and Accountability Act 2014 and the Local Audit (Appointing Person) Regulations 2015.


Adherence to Professional Standards and guidance

Information on the firms’ adherence to professional standards and guidance comes from the results of professional regulatory reviews completed by the Audit Quality Review team (AQR) for the Financial Reporting Council (FRC) and the Quality Assurance Department (QAD) for the Institute of Chartered Accountants in England and Wales (ICAEW), the principal Recognised Supervisory Body (RSB) for local audits in England.

The AQR reviews a sample of the largest local government and NHS audits. These are known as ‘major local audits’ and are those bodies with income or expenditure above £500 million. The QAD reviews a sample of local audits that fall below this threshold. The regulatory reviews covered both financial statement and VFM arrangements work. The publicly reported results cover local government and police bodies which have not opted-in to the PSAA appointing person arrangements as well as NHS bodies. However, our judgement is that we are able to use the findings as reported to inform and support our contract monitoring arrangements.

The professional reviews focus on identifying areas where improvements are required and individual ratings will reflect a wide range of factors, which may include size, complexity and risk of the individual audits selected for review. The FRC notes that because of this and the small non-statistically valid nature of the review sample, the inspection findings may not be representative of audit quality across a firm’s entire major local audit portfolio. Nonetheless, any inspection cycle which identifies audits requiring more than limited improvements is a cause for concern and indicates the need for a firm to take action to achieve the necessary improvements.

The FRC issued its audit quality inspection report on 30 October 2020. This contained the results of its reviews, those of the ICAEW regarding non-major Local Audits, and also the firms’ own internal quality monitoring. This provided the results of 56 audit file reviews, although VFM arrangements work was not reviewed in every case.

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Financial Statements

Auditors are required to give an opinion on whether the financial statements of an audited body give a true and fair view of its financial position and of its income and expenditure for the period then ended. They have other reporting responsibilities with respect to the preparation of the financial statements, the remuneration report and other information published with the financial statements.

The FRC reported that not all firms were consistently achieving the necessary level of audit quality and that urgent action is required from auditors to respond to their findings and improve audit quality. They also reported that the results at some individual firms have been encouraging with no more than limited improvements identified.

The FRC report commented specifically on three firms where it reviewed more than one engagement, those with the largest share of major local audits. The FRC reviewed six GT financial statement audits: one was assessed as meeting the required standard, and five as 2B (improvements required). The FRC reviewed two Mazars financial statements audits which they assessed as 3 (significant improvements required). All EY’s audits reviewed by the FRC were assessed as meeting the required standard (no more than limited improvement). Two of the remaining four firms inspected (BDO, Deloitte, KPMG and PwC)   had audits that required more than limited improvement although these were not named by the FRC.

Those firms with audits requiring limited improvement are required to complete and submit a root cause analysis to the FRC and put in place an audit quality action plan across local audits.

The most significant quality findings related to challenge and corroboration of the valuation of properties (council dwellings, specialised properties and investment properties), improvements required in the audit of amounts receivable (sample sizes and the assumptions used for expected credit loss provisions), and improved audit responses required to the risk of fraud arising from management override of controls and fraud in expenditure recognition. Given the findings on higher risk areas the FRC have challenged the effectiveness of the ‘second partner review’ process or Engagement Quality Control Review (EQCR). In the report the areas for improvement are detailed as:

  • significantly strengthen audit procedures and challenge of management and their own valuation experts in the testing of property revalued in the year;
  • improve the level of evidence obtained over amounts receivable, particularly sample sizes and the assumptions used to value credit losses for financial receivables;
  • strengthen the audit response to the risk of fraud arising from management override of controls;
  • improve the consideration of the risk of fraud in expenditure recognition and the extent of testing around the completeness and occurrence of expenditure;
  • design and execute appropriate audit procedures to assess the estimates to determine liability provisions; and
  • enhance the procedures over defined benefit pension arrangements, with improvements in the sufficiency of audit work performed over pension fund assets.

We note that the current statutory environment following International Financial Reporting Standards requires a valuations basis on which auditors express a true and fair opinion. The views of local government practitioners expressed in the Redmond Review were that the extent and nature of asset valuations, very relevant in a commercial setting, undertaken by auditors, have limited significance in local government where assets are more often than not critical to service delivery and “market value” is not a consideration’. The Redmond Review also noted the FRC’s view that if the sector considers the focus on asset and pension valuations is inappropriate, then this can be resolved through modifications to the Accounting Code. Accordingly, Sir Tony has recommended that CIPFA/LASSAC review the format and content of local authority accounts.

The FRC also highlighted the proportion of the audits they inspected (48%) that contained a prior period adjustment. Whilst these adjustments can be the result of changes in accounting policies or management reporting configurations, they can also be the result of errors which are a concern for both preparers and auditors of accounts.

There is a clear message in the FRC report for firms to provide stronger challenge management in these areas of complexity and forward-looking judgement. Until this matter is resolved the audit of these areas will continue to be a point of contention between auditors and those that they audit, but auditors must strive to meet the requirements of the statutorily appointed regulator.

Table 3 shows the results of this year’s inspection reviews together with those from earlier years completed under the post-Audit Commission transitional arrangements which included firm’s internal quality monitoring results moderated by PSAA.

Table 3: Financial statements – inspection review gradings 

Results of the reviews completed by engagement year.

Grading Total 2018/19* Total 2017/18 Total 2016/17*
1 or 2A – Good or Limited improvements required 17 20 31
2B – Improvements required 8 11 13
3 – Significant improvements required 2 4 8

*sample includes NHS and other bodies not within the PSAA contract
Source: FRC audit quality inspection report

As noted above, the sampling methodology means that changes in ratings from one year to the next are not necessarily indicative of any overall change in audit quality. Nevertheless, any inspection cycle with audits requiring more than limited improvements is a cause for concern and indicates the need for a firm or firms to take action to achieve the necessary improvements. In commenting on its findings within Appendix 2 to the FRC report the ICAEW noted that assessing an audit as needing improvement or significant improvement does not mean that the audit opinion was incorrect or that the financial statements were materially misstated.

Following each review the FRC sent a private report to each Audit Committee Chair, with a meeting to follow (at the discretion of the audited body) where the quality of the audit was assessed as requiring more than limited improvement. We are pleased that the FRC is giving greater support and attention to the role of the local government Audit Committee Chair discussing risk and concerns over the audit process.

The FRC report did highlight a number of specific examples of good practice including in some of the areas where they have raised concerns. Such examples included:

  • audit work to corroborate key property valuation assumptions and valuation movements to independent sources;
  • use of internal specialists to assist with the audit of pension liabilities and property valuations;
  • improvements in calculating an individual local audit body’s share of the overall defined benefit pension scheme;
  • bespoke approach to testing capital spending; and
  • robust challenge to the sign-off of the auditor’s report until the authority responded with additional information and reconciled balances.
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Value for money arrangements

Auditors are required to give a value for money (VFM) arrangements conclusion as to whether the audited body has made proper arrangements for securing economy, efficiency and effectiveness in its use of resources.

We are pleased that the improving trend within the assessments of VFM arrangements work has continued albeit on a limited sample. The FRC reported for their 15 reviews that the audit work to support the VFM arrangements conclusion was satisfactory in all cases as shown in Table 4. Separate information is not available on the results of the ICAEW or internal quality monitoring results, but the ICAEW reported that the work to support VFM arrangements conclusion was satisfactory on all audits that they reviewed.

Table 4:  VFM arrangements – inspection review gradings

Results of the reviews completed by engagement year.

Grading Total 2018/19* Total 2017/18 Total 2016/17*
1 or 2A – Good or Limited improvements required 15 20 31
2B – Improvements required 0 11 13
3 – Significant improvements required 0 4 8

*sample includes NHS and other bodies not within the PSAA contract
Source: FRC audit quality inspection report

We note from both the Redmond Review and the NAO’s consultation on its 2020 Code of Audit Practice that whilst the technical quality of auditors work is rated highly by regulators, the VFM arrangements conclusion is viewed by many local bodies to be an exercise of limited value to them as it is too retrospective and often states what the local body already knows. The new Code of Audit Practice operable from 2020/21 attempts to address these concerns with the introduction of a VFM arrangements commentary as part of a more tailored Auditor’s Annual Report.

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Transparency Reports

The FRC’s Local Auditors (Transparency) Instrument 2015 requires firms that conduct major public audits to report annually on information specific to their local audit responsibilities and includes inter alia:

  • a statement on the effectiveness of the functioning of internal quality monitoring arrangements in relation to local audit work;
  • a description of independence procedures and practices, including a confirmation that an internal review of independence practices has been conducted;
  • a statement on the firm’s policies and practices to ensure that Key Audit Partners continue to maintain their theoretical knowledge, professional skills and values at a sufficiently high level; and
  • confirmation that all engagement leads are competent to undertake local audit work and staff working on such assignments are suitably trained.

The Transparency Reports published by firms in December 2019 provide information on the results of regulatory reviews of 2017/18 engagements and the responses of firms to the matters raised. Some firms produce a specific ‘Local Audit’ Transparency Report, whilst others adopt the practice of publishing a firm-wide Transparency Report. Transparency Reports can be found on firms’ websites.

We found that the required disclosures were contained within each contracted firm’s Transparency Report but these were not always clear. Arguably it is more helpful for the sector’s stakeholders if a separate report is produced covering ‘Local Audit’ requirements or, if a single report is produced, the matters pertaining to Local Audit are clearly delineated.

The reports also present an opportunity for the firms to:

  • provide relevant, reliable and useful information that facilitates engagement between firms and users of financial information;
  • communicate a balanced self-assessment of the challenges the firms face in relation to audit quality and the effectiveness of their actions to overcome them, including how the independent non-executives at the firms have assessed this; and
  • promote confidence (where warranted) in their systems, processes and governance to engender public trust.

The Transparency Reports do acknowledge the commercial pressures that the firms are under, identifying both the availability of resources and client risk (corporate governance and quality of management) as well as economic returns as factors that are being used in the evaluation of audit portfolios and decisions on whether to participate in future tenders.

We note that the FRC reported on a review of the 2018 Transparency Reports (which included the local audit disclosures) in September 2019. This found that the reports tended to be too long and overly positive and not as effective as intended highlighting that ‘The reports would be more useful if they were more balanced and explained more clearly the challenges and risks the firms face in seeking to deliver consistently high-quality audits, along with their assessment of how successful they are being at meeting those challenges’. The FRC concluded that, for the full benefits of Transparency Reporting to be realised, the existing requirements need to be rethought and that it would begin work on this in 2020.

The Transparency Reports contain confirmations and information on the training and development that is provided for key audit partners and audit staff. The Redmond review reported that ‘many local authorities reported significant concerns about the knowledge and expertise of staff working on their audit’. Our client survey reported that 25% of Finance Directors did not consider that the audit team had the skills, knowledge and understanding to deliver the audit. This clearly represents a challenge for firms, especially in the context of an overall shortage of experienced local authority auditors in the market.

Firms are due to publish their next Transparency Reports by the end of 2020.

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