As local government prepares for the end of the Audit Commission and a new private market, there are warning signs from the NHS experience
For more than 170 years, local public audit has been predominantly the domain of specialist auditors. But May’s Queen’s Speech included plans for a draft Local Audit Bill formalising the abolition of the Audit Commission and its in-house auditors (District Audit). From next year, local government and health audits will be undertaken exclusively by private firms.
So what are the implications of this stark change? The NHS provides a useful starting point to investigate what local public audit might be like in the aftermath of the commission’s abolition.
In NHS trusts (as opposed to foundation trusts), the commission appoints all the auditors. It carries out two-thirds of the audits itself, with the remainder allocated to a small number of firms considered to have the necessary expertise.
Foundation trusts operate differently. Each trust’s board of governors is responsible for appointing an auditor. Audit committees must then make annual assessments to ensure high standards, reasonable fees and that the auditor meets broad criteria set by the regulator Monitor.
Here, the commission carries out a minority of the audits. It does not make auditor appointments or oversee the fees or the work of the audit firms.
As foundation trusts become more established – with three or more complete financial years – they are less likely to appoint the commission than newer trusts – 34% compared with 44%.
Sixty-one per cent of older foundation trusts opt for ‘Big Four’ auditors – 14 percentage points more than the newer models. Other audit firms also lose out, with their share of the work falling from 9% to 5%.
It seems that, given the choice of appointing their own auditor, FTs employ the services of Big Four firms.
We analysed data from the annual reports and financial statements of 117 foundation trusts and discovered that, in 2009/10, audit fees varied from £37,000 to £210,000.
Controlling for trust size, location and risk, we found that private firms charged more than District Audit. Big Four firms charged the highest fees.
Private firms factored risk into their fees. It is particularly important in public audit to be able to report in the public interest, for example, on misappropriation or inappropriate use of funds. For NHS trusts, the Audit Commission indemnifies the firms with which it contracts against costs arising from their statutory audit functions and public interest reports. But there have been remarkably few public interest reports on foundation trusts.
Some have argued that although audit fees might be higher in Big Four firms, their work is of better quality because of their ‘deep pockets’ should they be sued. However, we found that frequently Big Four firms restrict their liability when auditing foundation trusts, usually to £500,000 or £1m.
In addition to controlling fees, the commission monitors the work of the auditor, provides specialist auditors and a forum for discussion of issues. All these factors enhance quality. However, for foundation trusts, Monitor commissions the Quality Assurance Directorate of the Institute of Chartered Accountants in England and Wales to report on audit quality.
The process of outsourcing the work of the commission’s in-house audit practice began in September 2011. In March 2012, the award of five-year audit contracts to four private firms starting from 2012/13 was announced.
Two Big Four firms, KPMG and Ernst & Young, gained annual contracts of £23.1m and £20m respectively. Ernst & Young had not previously undertaken NHS audit work.
The majority of the business, £41.3m, was awarded to Grant Thornton (UK), while DA Partnership (formed by former District Audit staff but now a wholly owned subsidiary of Mazars) was awarded only £5m.
These contracts were publicised as showing the extent of the Audit Commission’s unique purchasing power. It was claimed they would contribute to a 40% cut in audit fees paid by local bodies.
Such huge savings and the introduction of two new audit firms (Ernst & Young and DA Partnership) might seem to validate the decision to abolish the commission. But the commission exerted its power to achieve the savings, which are not repeatable unless a similar body acts as a bulk purchaser of NHS and local government audits.
In addition, the audit firms might also have been prepared to reduce their margins for regular audit work to enter a potentially lucrative market.
The future choice of auditor and contract negotiations will be at local level and the commission will no longer be there to curb other auditor remuneration.
Specialist expertise from former commission staff will be subsumed within the successful firms. Thus, there is likely to be considerable audit concentration without the alternative of a public sector or mutual organisation.
Simply stopping performance assessment would have answered some of the criticisms of the commission without it having to disband its audit practice. Throwing out the bathwater of performance auditing reduced the commission’s costs and stature. But losing the baby of specialist government auditors (and Audit Commission oversight) is likely to have adverse financial and other consequences in the long term.
The independence of the auditor is seen as the cornerstone of auditing theory. An oversight appointing body ensures clear audit independence from management.
Communities Secretary Eric Pickles claimed local bodies would be ‘free to choose their own independent external auditors’, but this is a contradiction – the ability to choose an auditor reduces independence and hence quality.
It is a basic principle of public audit, emphasised by Lord Sharman in 2001, that public service organisations should not appoint their own auditors. This principle was contravened by foundation trusts and could now be across all local public audit.
Without the commission’s responsibility to appoint auditors, control fees and monitor quality, the cost of audit is destined to rise, quality might fall and the promised ‘open, competitive market’ is unlikely to materialise.
Sheila Ellwood is professor of accounting at the University of Bristol and Javier Garcia-Lacalle is lecturer at Universidad de Zaragoza. A longer version of this article appeared in Public Money & Management
This article first appeared in the June issue of Public Finance
