We present our Annual Quality Monitoring Report for 2021. This covers the work of local auditors appointed by PSAA for the 2019/20 financial year, which was undertaken during a difficult time for all concerned. The systemic issues that were highlighted in Sir Tony Redmond’s Review continued and were compounded by the pandemic.
PSAA is committed to working with all parties so that quality audit services are provided to its opted-in bodies. PSAA has adopted the International Auditing and Assurance Standards Board’s Framework for Audit Quality (IAASB framework) as the model for its appointing person audit service quality monitoring arrangements. This is widely regarded as a definitive statement on overall audit quality. The IAASB framework recognises there is a complex interplay of many factors in audit quality and notes the need for a rounded approach. We have taken the attributes that IAASB Framework expects to be present within a quality audit and distilled them into three tests which we use to monitor the quality of audit services provided by auditors under our contracts:
- Adherence to professional standards and guidance;
- Compliance with contractual requirements; and
- Effective relationship management.
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, the financial resilience of local authorities and the transparency of financial reporting.
In December 2020 the Ministry of Housing, Communities and Local Government (MHCLG) delivered its initial 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 proposed that the Audit, Reporting and Governance Authority (ARGA) would carry out the hugely important role of the local audit systems leader. ARGA is the new regulator being established to replace the FRC and will contain a dedicated local audit unit which will play a key leadership and coordination role in the local audit framework. MHCLG consulted in Summer 2021 on how the new arrangements would function.
The next year is likely to continue to be very challenging for all involved in local audit, but DLUHC (formerly MHCLG) will take forward and refine its proposals in its role as interim systems leader until ARGA is created, and the FRC will create a local audit unit in shadow form.
The problems that Sir Tony Redmond reported on continue to impact significantly on the timely completion of local government audits. Only 45% of audit opinions were completed by the publishing date of 30 November 2020, compared with 58% in the previous year. This has now fallen even further with only 9% for 2020/21 audits of financial statement opinions completed (noting the reversion to a 30 September publishing date). Delayed audit opinions have a real public-facing impact, undermining the ability of local bodies to account effectively for their stewardship of public money to taxpayers. It is imperative that the whole system works together to restore timely completion of audits in order to rebuild public confidence and trust, especially as the lack of a statutory deadline for the audit opinion means that co-operation is essential to make the system work as the public has the right to expect it to.
Adherence to professional standards and guidance
Information on the quality of local audit work in this report comes from the reports provided by the audit regulators, the Financial Reporting Council (FRC) and the Institute of Chartered Accountants of England and Wales (ICAEW). The FRC issued its audit quality inspection News I Financial Reporting Council (frc.org.uk) (FRC report) containing the results of its audit quality inspections of 2019/20 engagements on 29 October 2021. It also included the results of reviews undertaken by the Quality Assurance Department (QAD) team of the ICAEW, and firms’ own internal quality monitoring arrangements. The scope of the report covers the whole of local audit, including those not opted-in to the PSAA appointing person arrangements and NHS bodies, but we are able to use the findings to inform our contract monitoring arrangements.
The FRC is the primary regulator, and it reviewed the audits of 20 of the 299 bodies that meet the major local audit definition (Expenditure in excess of £500 million). This sample comprised of 11 local authorities, five local authority pension funds and four health bodies, focusing in particular on audits with ‘higher risk attributes’. The report sets out that six financial statements audits (across four of the seven firms reviewed) did not meet the required standard (which is being assessed as ‘good or limited improvements required’). In the previous report the FRC judged nine audits as not meeting the required standard. The improvement in the number of audits requiring no more than limited improvement was seen as encouraging whilst too soon to confirm as a trend. The FRC identified that they had seen tangible actions taken by the firms to respond to quality issues previously identified, but further work was needed to ensure that the observed improvement is both permanent and continuous.
The FRC’s reviews found that the quality of VFM arrangements conclusion work across all firms remains high, with all 15 reviews meeting the standard (auditors do not carry out this work at pension funds). The new Code of Audit Practice changes the reporting of the VFM arrangements work from 2020/21 onwards to be a commentary rather than a binary conclusion.
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 nine Grant Thornton (GT) financial statement audits: six were assessed as meeting the required standard, and three as improvements required. This is an improvement on the previous year when only one of the six GT audits reviewed met the required standard. The FRC reviewed four EY audits, one of which was assessed as improvements required compared to the previous year where all three EY audits reviewed met the required standard. Four Mazars financial statements audits were reviewed and all were assessed as meeting the required standard. This is an improvement on the previous year where the two Mazars audits reviewed were assessed as ‘significant improvements required’. Two of the remaining three firms inspected (BDO, Deloitte and KPMG) had individual audits that required more than limited improvement, but the FRC did not indicate which firms they were.
The FRC report highlights that the key areas requiring action by audit firms include improving the evaluation and challenge of assumptions used in valuing operational and investment property. The testing of expenditure also needs to be strengthened.
The FRC report cited some good practice examples such as the increased use of experts to help audit highly specialised property assets and the challenge of management’s property valuers. Responding to revenue recognition risks was also highlighted.
The FRC report also includes the findings of both the ICAEW reviews of audits of bodies that do not meet the major local audit definition, and the firms’ Internal Quality Monitoring (IQM) reviews of audits.
The ICAEW reported that 15 of the 17 financial statement audits that they reviewed met the required standard across all firms, along with all of the associated VFM arrangements work. One audit required improvement and one required significant improvement.
Internal Quality Monitoring Reviews
The IQM results covered 24 individual audits including 12 major local audits. Of these 22 were considered to be of a good or limited improvements standard (11 for major local audits). There were two audits assessed as requiring improvement and no audits needed significant improvements.
We will follow up the results and resulting action plans of all firms to get assurance that the reported concerns are being actively addressed.
Effective relationship management
We surveyed all of our 2019/20 Section 151 officers and Audit Committee chairs to judge the effectiveness of relationships between bodies and their auditors. We received responses from 198 (40%) Section 151 officers and 116 (24%) Audit Committee chairs. Respondents highlighted the local impact of delayed audit opinions, the shortage of auditor resources, the level of scale fee variations, and the extent of the audit work now required on property and pension valuations.
Disappointingly only 20% of responses said that the audit committee had met privately with the auditors. These private sessions are widely acknowledged to contribute positively to the organisation’s governance arrangements.
Overall communication remains an area for improvement. We were pleased to note that 80% of respondents had had frequent communication with their auditors on matters relating to the ongoing pandemic (remote working and the increased audit procedures covering going concern/financial resilience, valuations and accounts disclosures). However, this fell to 60% for communications on the timeliness of audit work.
We have provided firms with details of the anonymised analysis of survey responses to enable them to develop tailored improvement plans where appropriate. Communication is the area where most improvement can be made with delays in reporting the need for an audit deferral or a fee variation highlighted in responses.
Compliance with contractual requirements
Our biggest concern is the timeliness of audit completion. For the year covered by this report the number of audit opinions completed by the publishing date set out in the Accounts and Audit Regulations 2015 (or equivalent) of 30 November 2020 was 214 (45%) compared with 279 (58%) in the previous year (31 July 2019). In 2017/18 87% of opinions were issued by the publishing date, the first time it had been 31 July.
The NAO’s report Timeliness of local auditor reporting on local government in England examined the factors causing the delays seeking views from audit firms and stakeholders. This corroborated the information provided to us by firms as part of our contract management processes, highlighting a number of contributory factors including:
- Competing resource and workload pressures for both auditors and audited bodies;
- Increasing audit risks such as investment in commercial enterprises;
- Meeting heightened quality expectations of the professional regulators;
- Local bodies preparedness for the audit process;
- The impact of the pandemic involving both additional audit procedures; and
- The delaying impact of remote working and increased sickness absence.
The instances where firms did not have sufficient staff to undertake particular audits is symptomatic of the vulnerability that has developed in the local audit market, and the lack of trainees and qualified staff with the appropriate knowledge to undertake this work.
It is clear that firms are responding to the challenge from the FRC to improve inspection results by prioritising audit quality, ensuring that they have obtained and evaluated all of the evidence necessary for their opinion.
Whilst the Accounts and Audit Regulations specify a date for publishing financial statements (draft or otherwise) there is no statutory deadline for an auditor to provide an opinion on those financial statements. Consequently given the fundamental importance of the work of auditors complying with auditing and ethical standards, we have no means to enforce a contractual requirement for an audit opinion to be provided by the publishing date.
In summary, the results of the professional regulatory reviews of financial statement work showed improvement with 78% (2018/19 62%) of financial statements audits reviewed assessed as requiring no more than limited improvements. This reflects the efforts that all firms have made to address the concerns of the FRC and ICAEW. The outcome is consistent with the reviews of corporate audits, but continued improvement is still required, as further improvement across all audit sectors is expected. We have discussed with the firms their plans to address the matters raised by the professional regulators.
In the last year of the current VFM arrangements audit requirements all work inspected was assessed as meeting the required standard.
However, the fact that only 9% of 2020/21 audits were completed by the expected publishing date of 30 September is extremely concerning for all with an interest in local government. As concluded by the NAO in their report on local government audit timeliness in 2019/20:
‘Given the increasing financial challenge and service pressures on local authorities since 2010, local councils need strong arrangements to manage finances and secure value for money. External auditors have a key role in providing independent assurance on whether these arrangements are strong enough and recommending any action. The late delivery of 2019-20 audit opinions is concerning, given the important part that external audit plays in assurance over taxpayers’ money both centrally and locally’.
The IAASB framework notes that all parts of the financial reporting supply chain have a role in contributing to and encouraging an audit environment that supports high quality audits. The role of systems leader will be critical for the sector as a whole to deliver the required improvements. As a member of the newly established Local Audit Liaison Committee and more widely we will continue to work with regulators, auditors, finance staff and those charged with governance to improve audit quality and the timeliness of audit delivery.
We have started the procurement process for the Next Appointing Period. Our strategy includes encouraging more audit firms to provide local audit services, one of the factors that will contribute to the return of timely completion of local audits and the sustainability of the market.