By Nigel Johnson & Martin Evans | 1 June 2011
The Commons inquiry into the audit and inspection of local authorities predictably heard mixed views about the wisdom of abolishing the Audit Commission and the arrangements that should follow its demise. But on one issue the evidence before the inquiry was unanimous. Witness after witness to the communities and local government select committee testified that the best way to drive down the cost of local authority audit would be to simplify the accounts.
Moreover, the committee was told that the accounts are now so complex that few people read them and even those who attempt to do so often find them unintelligible.
For example, Essex County Council said its financial statements require ‘some six months of preparation and audit but result in a set of accounts that is practically meaningless to the local community’.
Staffordshire County Council argued that ‘the current approach aims to adopt standard accounting practice but compromises this by including a range of adjustments which make the accounts very difficult to understand’.
And Westminster City Council took a similar view: ‘The future regime should be supported by the publication of accounts that are more transparent and accessible for the public.’
Of course, simplifying local authority accounts is easier said than done. There are good reasons for the current complexity, one of which is that local authorities themselves are complex organisations. They provide many different services, some of which they are required to account for in separate funds. They receive ring-fenced grants that must also be accounted for separately. They collect taxes both on their own account and on behalf of the government. They also have trading activities; raise money on capital markets; and form partnerships and joint ventures. So they have multiple stakeholders and it is right that the accounting standards applicable to similarly significant economic entities in the private sector should also apply in local government.
But the fact that the current form of accounts seeks to serve the different interests of the multiple stakeholders is part of the problem.
As David Heald, professor of accountancy at the University of Aberdeen Business School, put it to the select committee: ‘It is not just that they have become more complex as accounting has become more complex with the move to International Financial Reporting Standards, but there is also a dichotomy between the bottom line of the IFRS accounts and the council tax numbers.
‘That is something that Parliament should think about. There are lots of adjustments and add-backs to make sure that things such as depreciation do not come through and hit the council tax bill.’
His point is perhaps best illustrated in the most recent accounts published by the country’s largest local authority, Birmingham City Council. These show a deficit for 2009/10 of £525m on net expenditure of £1.4bn. So residents looking at these accounts might feel entitled to conclude that their elected representatives mismanaged the city’s finances last year. But they would be wrong, because the Statement of Movement on the General Fund balance shows a credit of £515m, resulting in a restated deficit for the year of only £9.7m and a resultant carry forward balance of £21m on the General Fund.
Like all local authorities, Birmingham is required to prepare and present its accounts in a form that makes them opaque, and possibly highly misleading, even to the most interested and informed of stakeholders. The case for redefining the true purpose of the statutory annual accounts of local authorities is therefore strong.
At a time when councils are cutting services but ministers are asserting that cuts could be avoided if local authorities were more efficient and did not hold excessive reserves, the public is entitled to know who is right. Voters and taxpayers are entitled to clear and simple measures of the financial standing and performance of local authorities.
In the private sector, the financial health of a company can easily be gleaned from a glance at its accounts. The bottom line of the profit and loss account provides a clear measure of the outturn for the year and some simple ratios derived from the balance sheet reveal its underlying strength.
And in local government, the idea that there is value in publishing indicators of financial resilience is not new. A financial ratios analysis tool has been available on the Audit Commission website for some years. This enables basic financial ratios for each authority in the country to be compared with those of other authorities.
They include such measures as useable reserves as a proportion of expenditure and the ratio of long-term borrowing to tax revenue. But when the Audit Commission is no longer with us, even this useful but limited tool will become unavailable.
The review of the local authority audit framework in anticipation of the commission’s abolition should address these financial reporting concerns. Other changes, such as the proposed abolition of the housing revenue account, also support the need for a fresh, fundamental review of the objectives of local authority accounts. If accounts can be made simpler, significant costs could be saved in finance staff and audit fees.
CIPFA is alert to this issue. It has published guidance to senior local government finance staff, councillors and other stakeholders on how to present and interpret the 2010/11 financial statements, the first to be prepared fully in accordance with IFRS. And it recognises that with the imminent completion of the IFRS project, there is now capacity within the system to look at simplification and increased transparency.
The need to do so is nevertheless urgent. The government has summoned forth an army of armchair auditors to hold public bodies to account. Transparency as the key to accountability is likely to remain central to public policy for some time. But for local authorities, the armchair auditors will need some help. They will want clear pointers to know what to look for and they will need much more accessible annual financial information.
Without these, the reputation of local government, and of the accounting profession itself, might be at risk.
Nigel Johnson is senior public sector audit partner at Deloitte
Dispelling the myths
There is a broad consensus that councils’ accounts are long and incomprehensible to the lay person. There is also concern that the introduction of International Financial Reporting Standards is making matters worse.
Council accounts are indeed long and complex – but so are those of any other large, complex organisation, whether a FTSE 100 company or a central government department. Even the smallest local authority has to account for complex financial transactions, such as financial instruments, leases and service concessions.
Having said that, council accounts are too complicated and this needs to change. But first a number of myths need to be dispelled. It is said that CIPFA is to blame for the complexity; that the accounting standards developed to meet the needs of the private sector are not appropriate for the public sector; that the accounts include meaningless numbers; and that the accounting framework could be simplified if it were aligned with the rest of the public sector.
None of these is true, as the panel opposite explains, but nevertheless something has to be done. A council’s accounts are the members’ accounts, by which they discharge their accountability for the stewardship of public money. The majority of members are lay people, without expertise in financial reporting. They cannot discharge their accountability meaningfully if they do not understand what the accounts are saying.
So what can be done? Potential solutions are thin on the ground. It is too simplistic to argue that the control framework should be aligned with Generally Accepted Accounting Practice or GAAP. That would add billions of pounds to council tax bills, for example, to finance the depreciation of property, plant and equipment.
The alternative would be to produce non-GAAP compliant accounts that align directly with the control framework. But this would be a backwards step and undermine accountability for public money. Compliance with GAAP imposes a proper discipline and helps to ensure comparability between different parts of the public sector, and between the public and private sectors. On a practical level, councils would still need to produce GAAP-based consolidation schedules for Whole of Government Accounts.
A third option is to continue with full accounts prepared in accordance with GAAP but not use these as the primary means of communicating information about the council’s stewardship and use of resources for accountability purposes. For this, some form of summarised accounts is needed, which would be aimed at members of the council, external stakeholders and interested citizens.
In the private sector, such summarised accounts are increasingly used to communicate with private shareholders with the full accounts more the preserve of the specialist analysts.
The form and content of summarised accounts are set out in statute. They are drawn directly from the audited accounts and are subject to annual audit review, for consistency with the full accounts.
Published as a standalone document, they serve to signpost the full accounts for those who wish to drill down into them. Clearly, however, such a new requirement would be an additional task for already hard-pressed council finance teams.
The Audit Commission will address these issues in a think-piece on the future of local authority accounting, alongside our annual Auditing the accounts publication, which will give the ‘final verdict’ on IFRS in local government.
Martin Evans is managing director, audit policy, at the Audit Commission
