First Report - Financial Reporting and Audit in Local Authorities

The publication of local authority accounts and local authority audit have a vital role to play in supporting local democracy and accountability. However, their capability to fulfil this vital role is limited because 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.

There is currently no shared view of the purposes of local authority accounts and who should be using them. This has made it difficult to decide what the format and contents of the accounts, and their accompanying audit outputs, should be so that accounts fulfil their role in supporting local democracy and accountability.

We believe that the first purpose of local authority accounts is: To provide a credible public financial record that can be relied upon, and which can be used as a point of comparison for other financial information to assess its credibility and accuracy.

We believe that the second purpose of local authority accounts is: To enable council taxpayers, businesses, central government, and other sources of funding to understand what money the local authority has received (including council tax, government grants and borrowing) and how the authority has used its resources, so they can hold the authority to account for its spending decisions.

We believe that the third purpose of local authority accounts is: To enable residents, service users, and councillors to understand the value for money offered by the authority’s spending, so that they can scrutinise the economy, efficiency, effectiveness, and equity of services or programmes.

We believe that the fourth purpose of local authority accounts is: To enable councillors and officers inside the authority to understand the financial activity, financial position, financial sustainability, and resilience of the authority, so that they can make informed decisions and run that authority efficiently and effectively. (Paragraph 42) Financial Reporting and Audit in Local Authorities 35

We believe that the fifth purpose of local authority accounts is: To enable the public, oversight bodies and central government to understand the financial situation and any actual or potential financial issues affecting the authority, so that they can make informed decisions about what actions to take.

The Government must ensure that the purposes of local authority accounts are clearly set out in government policy and accessible to all relevant stakeholders. This should be done before the next accounts production cycle for the year ended 31 March 2024.

The Government must also coordinate with key stakeholders in the sector, including the Chartered Institute for Public Finance and Accountancy and the local audit system leader, to ensure that the production, content and format of local authority accounts are aligned with the agreed purposes of local authority accounts; and it must report back to us at least annually on its progress in this area.

The Code of Practice on Local Authority Accounting (the Accounting Code) is a statutorily recommended guidance document for preparing and understanding local authority accounts, but it is too expensive to be accessed by all possible users of the accounts. If made accessible, it could also serve to keep the agreed purposes of the accounts visible to the whole sector.

Through coordination with the Chartered Institute of Public Finance and Accountancy, the Department for Levelling Up, Housing and Communities must make the Accounting Code freely available to all possible users of local authority accounts before the next accounts production cycle for the year ended 31 March 2024. Once this has been achieved, the Department should set out its assessment of what else it can do to encourage the use of the Accounting Code as a central, authoritative, and accessible document that meets the needs of all possible users of local authority accounts.

Within the broader rationale for the local authority accounting and audit systems, the purposes of local audit specifically are: • to establish the credibility of the local authority accounts, so that they can fulfil their purposes in supporting local accountability; and • to supplement the local authority accounts with relevant information and conclusions that are needed to fulfil the purposes of the audited accounts, but that are not part of the disclosures in the accounts. (Paragraph 60) The current audit crisis

The local audit system is currently in an unacceptable crisis which requires significant and urgent attention. The most significant symptom of the crisis is an extensive backlog of incomplete audits and unaudited accounts, some of them many years out of date. This has led to a deleterious cycle in which delays create further delays, and which can only be resolved by a potentially painful reset to the whole system. (Paragraph 69) 36 Financial Reporting and Audit in Local Authorities

The Department has proposed a series of actions to clear the audit backlog, which include resetting the system through a limited series of statutory deadlines for the delivery of outstanding audits from previous financial years. These proposals represent a necessary first step towards overcoming the audit crisis. However, more work is needed to implement them and to resolve the issues in the local audit system to achieve meaningful and much needed change in the sector.

The Department must move quickly to clear the audit backlog and implement its proposed actions by the end of the calendar year 2023. Until the actions have been fully implemented, the Department should provide us with updates on its progress every four months. In addition, the Department should ensure that, when auditors qualify or disclaim the audit opinions on delayed audits, the accompanying commentary should be clear whether the local authorities are at fault and whether the audit has given any indication of financial failings or distress at those authorities.

We welcome the commitment of the then-Parliamentary Under-Secretary of State for Local Government and Building Safety to address the causes of delays in the local audit system. While the lack of an annual statutory deadline is not itself a cause of delays, the lack of any consequences for local authorities and auditors for delayed delivery may have contributed to the current backlog of delayed audits. Annual deadlines with suitable consequences for failure to deliver might have prevented the accumulation of the backlog and the destructive cycle of delay that has led to this current crisis.

The Department must introduce backstop dates for publishing audited local authority accounts on an annual basis going forwards. The Department must also ensure that, if an authority and its auditors do not collectively produce audited accounts by the backstop date in a given year, then the Section 151 Officer of the authority (and other responsible individuals such as the auditor’s Key Audit Partner) must immediately write to the Secretary of State for Levelling Up, Housing and Communities, to us, and to the authority’s council to explain why the audit could not be completed. The relevant recipients of the correspondence from the Section 151 Officer should then pursue any follow-up action as is necessary. The introduction of these backstop dates should be done alongside the Department’s implementation of its statement of proposals to clear the backlog, with a suitable annual backstop date chosen by the end of the calendar year.

The Redmond and Kingman Reviews stated that a local audit system leader should be a new standalone organisation, but the Government has decided to combine it with the separate audit regulator which is currently the Financial Reporting Council (FRC) but will eventually be the Audit Reporting and Governance Authority (ARGA).

The establishment of the local audit system leader will require primary legislation. The legislation required to establish ARGA has been significantly delayed and there appears to be little or no forward momentum or urgency in the Government to introduce it. Moreover, the Department for Levelling Up, Housing and Communities, which will be responsible for the local audit system leader, informed us that only the Department for Business and Trade, as ARGA’s sponsor department, can move forward with this legislation. It is fundamentally unclear how the Government’s Financial Reporting and Audit in Local Authorities 37 departments are being coordinated to establish ARGA in a timely fashion. The Government must make it a priority to establish the local audit system leader, in a different form if necessary.

The Government must reconsider its plan to combine the local audit system leader with the new audit regulator, ARGA. Specifically, the Government must, in coordination with the FRC, which currently has shadow system leader responsibility, introduce legislation to create a new body to manage, oversee and regulate local audit in line with the recommendations put forward by the Redmond Review. The new body must be sponsored by, and directly accountable to, the Department for Levelling Up, Housing and Communities. The legislation to establish this body should be introduced as soon as possible in the 2023–24 session of Parliament.

The Department must ensure that the local audit system leader is the primary point of contact to which local auditors can escalate matters of concern that they find during an audit of a local authority. Additionally, the local audit system leader must be responsible for collecting and considering audit findings across the sector to identify and coordinate responses to systemic or widespread issues that the auditors have found. Furthermore, the Department must clearly set out which body has these responsibilities until the audit system leader is established in legislation. (Paragraph 94) Producing local authority accounts

Statutory overrides, namely requirements introduced by legislation that override standard accounting practice, are not aligned with the intended purposes of local authority accounts. Some statutory overrides can be beneficial by reducing the complexity of the accounts, but many add new requirements to the disclosures in the accounts. Additional requirements in the accounts added by statutory overrides do not contribute to the value or usefulness of those accounts, but they make the accounts more complex, less understandable, and thus less useful for supporting local democracy and accountability.

The Department for Levelling Up, Housing and Communities must immediately initiate a review into existing legislation that places requirements on the contents and format of local authority accounts. The review should refer to the intended purposes and users of the accounts (as we have set out earlier) and determine what legislation is needed to produce accounts to meet those purposes. The Government must then introduce legislation to amend existing legislation to meet that objective.

The Department should coordinate with the Chartered Institute of Public Finance and Accountancy and the CIPFA/LASAAC Local Authority Code Board to ensure that the Accounting Code does not interpret existing legislation as placing requirements on local authority accounts disclosures that are neither mandated nor intended by the existing legislation.

The Government previously accepted the Redmond Review’s recommendations to introduce a standardised statement of service information and costs for local authority accounts. Implementing these recommendations would constitute an important step to improving the clarity and content of local authority accounts. 38 Financial Reporting and Audit in Local Authorities However, the Government has delayed implementation of the new statement until the audit backlog is cleared. While we appreciate the Government’s decision to focus on addressing the backlog, it remains important in the longer term to make these necessary improvements to the local authority accounts themselves. We are concerned that the delays with the implementation of the Redmond Review’s recommendations will continue unless the Government takes immediate action.

The Department, in consultation with the Chartered Institute of Public Finance and Accountancy, must resume the introduction of a standardised statement of service information and costs for local authority accounts as soon as actions to address the audit backlog have been implemented. We expect a standardised statement could be introduced for financial years starting in 2024. At the same time, it must ensure that local authority accounts disclosures outside this statement are streamlined by removing requirements that are now covered by the new statement.

Local authority accounts are currently required by legislation to include Pension Fund statements, but this has made the accounts longer, more complicated, and less useful to users. The Government should introduce legislation to decouple local authority accounts from these Pension Fund statements, which should be published as separate documents.

Local auditors are good at establishing the credibility of the accounts under audit. However, while recent changes to the Audit Code have made improvements to the commentary around value for money, many stakeholders want an opinion from the auditors over whether their local authority has achieved value for money for its services.

The Department should work with the organisation that prepares the Audit Code (currently the National Audit Office, eventually the system leader) to ensure that local auditors’ opinions over value for money include an actual assessment of value for money achieved, not merely whether appropriate arrangements exist. Such assessments of value for money achieved should cover specific services, projects or programmes, not necessarily to the activity of the entire local authority. These services, projects or programmes would be determined by, for example, local councillors or the auditors. This would allow a greater focus on areas of risk and provide actual assurance over the performance of the authority in key areas.

The Department should work with the organisation that prepares the Audit Code (currently the National Audit Office, eventually the system leader) to assess the potential benefits (for example, to timescales and resourcing) of decoupling value for money work from financial audit work, and report the findings of the assessment to us for further consideration before the end of this Parliament.

The Department should work with the organisation that prepares the Audit Code (which is currently the National Audit Office but will be the system leader) to introduce new guidance for the auditors of local authorities in order to encourage them to make more proactive use of their existing powers to flag potential issues earlier in the audit process, both to managers internal to the authority and publicly by issuing Public Interest Reports. The Department should assess the effect of the guidance 12 months after it has been introduced and share that assessment with us. (Paragraph 135) Financial Reporting and Audit in Local Authorities 39