Policy paper

Local authority financial reporting and external audit: government response to the independent review

Published 17 December 2020

This was published under the 2019 to 2022 Johnson Conservative government

Applies to England

The response of the Ministry of Housing, Communities and Local Government to Sir Tony Redmond’s Independent review into the oversight of local audit and the transparency of local authority financial reporting.

This response to the Redmond Review, prepared by the Ministry of Housing, Communities and Local Government, forms part of the department’s post-legislative scrutiny assessment of parts 1 to 5 of the Local Audit and Accountability Act 2014 which received Royal Assent on 30 January 2014. The department’s review of the non-audit related elements of the 2014 Act will be published separately.

The importance of local audit

1. A robust local audit system and transparent local authority financial reporting are key to delivering value for money for taxpayers, and for sustaining public confidence in our systems of local democracy.

2. Statutory accounts are the only information provided by local authorities that are independently verified through external audit. For users of the accounts to trust and rely on this information, they must both have confidence the audit process is robust and be able to understand what the financial reports are telling them.

3. External auditors also have a duty to inform stakeholders of matters of importance. The recent public interest reports (PIRs) issued in relation to Nottingham City Council and Croydon Council demonstrate the crucial role of external audit in bringing concerns into the public domain. It is equally important that robust governance mechanisms are in place within local authorities to review and, if necessary, act on audit findings.

4. Audit ensures transparency and accountability and, when done well, encourages audited bodies to have strong governance and financial records. It also strongly encourages organisations to follow the relevant financial and regulatory frameworks.

5. Effective, high quality audit is becoming increasingly important as local authorities’ accounting practices become more complex and the sector comes under financial pressure. In recent years more councils have been borrowing to fund schemes to generate commercial income. This has changed the risks that councils are facing, so it is essential that the financial reporting and audit process is able to make these risks clear.

6. Finally, external audit is a key assurance mechanism. A local authority’s audited accounts allow the Ministry for Housing, Communities and Local Government (MHCLG), in its role as the steward of the local government accountability framework, to be assured that the authority has been acting with regularity, propriety and value for money in the use of their resources.

Context

7. The current local audit framework was established by the Local Audit and Accountability Act 2014. It abolished the Audit Commission, which had become unnecessarily centralised and bureaucratic, creating a locally led audit regime to help local taxpayers, councillors, MPs and the media better hold their council to account, both for their spending and whether they had delivered effective value for money, through enhanced transparency arrangements.

8. Key benefits of the 2014 Act were the reduction in the cost to local authorities and government of local audit, delivering estimated savings of £1.35 billion over 10 years, and that it gave councils the freedom to procure their own audit services and required principal councils to publish certain information set out in transparency codes which, for the very smallest authorities, replaced external audit in most cases.

9. This department remains committed to the principles of a locally-led audit regime, as embodied in the 2014 Act. Robust local scrutiny and accountability by the press and public, underpinned by genuine transparency, must be fundamental to the local audit framework.

10. However, we recognise there are improvements to be made in how the framework operates, to ensure it is sufficiently robust and sustainable. The effectiveness of the 2014 framework was questioned by Sir John Kingman in his 2018 Review of the Financial Reporting Council (FRC).. His report recommended that the local audit regime be fundamentally rethought to improve scrutiny, quality and leadership. Further criticisms around audit quality, transparency and departmental oversight in terms of system assurance were made in the March 2019 Public Accounts Committee Inquiry Auditing Local Government which was based on an earlier report issued by the National Audit Office (NAO).

11. The delays in the completion of over 200 of the 487 local public body accounts for 2018/19 also contributed to a concern by this department that the effectiveness of the local audit regime needed to be reviewed. In July 2019, this department asked Sir Tony Redmond to undertake an independent review into the arrangements in place to support the transparency and quality of local authority financial reporting and external audit in England.

12. The objectives of the Review were to examine the existing purpose, scope and quality of external audits of local authorities in England and the supporting regulatory framework to:

• Determine whether the audit and related regulatory framework for local authorities in England is operating in line with the policy intent set out in the Act and the related impact assessment,

• Determine whether the reforms have improved the effectiveness of the control and governance framework along with the transparency of financial information presented by local authorities,

• Determine whether the current statutory framework for local authority financial reporting supports the transparent disclosure of financial performance and enables users of the accounts to hold local authorities to account, and

• Make recommendations on how far the process, products and framework may need to improve and evolve to meet the needs of local residents and local taxpayers, and the wider public interest.

13. The Redmond Review took place against the backdrop of wider concerns about audit, including those highlighted in reviews of the Financial Reporting Council, competition in the audit of FTSE350 companies, and the quality and effectiveness of audit. The government will respond to those reviews in due course, taking account of local audit perspectives through consultation

14. This department published the Redmond Review report on 8 September 2020; we are grateful to Sir Tony Redmond and his team for their work.

The Redmond Review

15. The Redmond Review highlighted 3 key problems:

a. Current local audit arrangements do not meet the policy objectives underpinning the Local Audit and Accountability Act 2014. In particular, Sir Tony identified weaknesses in the functioning and value of local audit, the timeliness of its findings and how these are considered and managed by local authorities;

b. Market fragility. Sir Tony highlighted how local audit is an unattractive market for audit firms and individual auditors to operate within. He indicated that “without prompt action… there is a significant risk that the firms currently holding local audit contracts will withdraw from the market” (‘Redmond Review’ (2020), p.1).

c. Absence of system leadership. The introduction of the localised audit framework in the 2014 Act spread roles and responsibilities for local audit across multiple organisations. Sir Tony argues this has contributed to a lack of coherency and makes resolving the weaknesses in the system challenging.

16. In addition, the Redmond Review highlighted that the statutory accounts prepared by local authorities are widely agreed to be ‘impenetrable to the public’ (‘Redmond Review’ (2020), p.4), limiting how effectively taxpayers can judge the performance of their authority.

17. it is also important to highlight that, since the Review was published, further evidence has underlined some of the challenges which Sir Tony Redmond identified:

a. In October 2020, the Financial Reporting Council (FRC) issued its first inspection findings into the quality of major local audits. The FRC reviewed 15 audits across the seven largest audit firms, covering both the financial statement opinion and value for money conclusion, and found that 60% required improvement.

b. Recognising the significant pressure on local authorities because of Covid-19, the department extended the deadline for the publication of audited 2019/20 accounts to 30 November. Despite this extended deadline, 265 audits remained outstanding for 2019/20 accounts.

c. The recent Public Interest Reports for Nottingham (published in August) and for Croydon (October) provide evidence of poor engagement with local audit and suggest that these councils did not fully grip issues raised by auditors.

18. These are deeply concerning findings which the Department has closely considered. As noted above, we are committed to ensuring a robust locally-led audit regime and will look to act swiftly to address the problems Sir Tony has highlighted, particularly regarding the fragility of the local audit market. The Department sets out its response to the Redmond Review below.

The department’s response to the Redmond Review

19. Sir Tony made 23 recommendations relating to the quality, timeliness and sustainability of local audit, and the transparency of local authority accounts. The department has grouped its response into 5 themes, which is summarised in Annex A:

a. Action to support immediate market stability (recommendations 5, 6, 8, 10, 11) b. Consideration of system leadership options (recommendations 1, 2, 3, 7, 13, 17) c. Enhancing the functioning of local audit, and the governance for responding to its findings (recommendations 4, 9, 12, 18) d. Improving transparency of local authorities’ accounts to the public (recommendations 19, 20, 21, 22) e. Action to further consider the functioning of local audit for smaller bodies (recommendations 14, 15, 16, 23)

20. To support the implementation of the above, the department will provide relevant local authorities with £15 million in additional funding in 2021/22. This is intended to support affected local bodies to meet the anticipated rise in audit fees in 2021/22, driven by new requirements on auditors including the 2020 Code of Audit Practice, and to enable local authorities to develop standardised statements of service information and costs, as recommended by Sir Tony. We will confirm allocations in the new year.

21. This department has engaged key stakeholders from across the local audit sector, including audit firms, councils, regulators and other interested bodies. We thank all the individuals and organisations who have given their time over the past few months.

22. To deliver the recommendations will require a collaborative effort across public and private sectors, nationally and locally. Government has an important role to play, as do regulators and professional bodies (including the FRC, the Institute of Chartered Accountants in England and Wales (ICAEW), the NAO and the Chartered Institute of Public Finance and Accountancy (CIPFA)). There are other bodies with important roles in the local audit framework (including Public Sector Audit Appointments Ltd (PSAA) and Smaller Authorities’ Audit Appointments Ltd (SAAA)) and of course audit firms and local authorities (including their representative bodies the Local Government Association (LGA) and National Association of Local Councils (NALC)). We look forward to working with them and other stakeholders over the coming weeks and months.

23. It is important to note that, as well as principal local authorities, the Redmond Review included within its scope police and crime commissioners, fire and rescue authorities, national parks and a range of smaller bodies such as parish councils and internal drainage boards. The department will continue to work closely with relevant other departments on the implications for these bodies of implementing the Review’s recommendations. The remit of the Review excluded consideration of health bodies but as noted below, there are close links in our response to the audit of health bodies, on which we will continue to engage with the Department for Health and Social Care (DHSC).

24. The department will monitor and review the impact of both its actions and those of other bodies on strengthening the local audit framework and the transparency of local authorities’ financial reporting, with a view to taking further action if necessary.

Action to support immediate market stability

25. The department recognises the Redmond Review’s findings regarding the fragility of the local audit market and agrees that urgent action is required. We accept that the actions to support immediate market stability, set out in the following section, will not by themselves solve these problems, but they will help to alleviate some of the immediate funding and timing pressures facing audit firms and local authorities.

Rec 6. The current fee structure for local audit be revised to ensure that adequate resources are deployed to meet the full extent of local audit requirements.

26. The Redmond Review particularly focussed on the fee structure of the audit contracts administered by PSAA, which is the appointing body for 98% of local authority audits. (S.I. 2015/192) Sir Tony found that:

a. No assessment of the amount it would cost to audit each local authority based on their level of audit risk has been made in the past ten years, despite significant changes to the major powers and duties of local authorities and to the business environment in which they operate, (‘Redmond Review’ (2020), p.22)

b. The fee variation process is insufficiently flexible to allow amendments to the fee scale that reflect changes to the regulatory requirements for auditors, that were not known or foreseen at the time the fees were set. (Redmond Review’ (2020), p.23)

c. Local audit fees have reduced by 40% since 2015 when compared against a 20% rise in central government and FTSE100 audit fees, ( ‘Redmond Review’ (2020), p. 22)

d. 88% of local authorities who responded to the Review’s Call for Views thought the current procurement process does not drive the right balance between cost reduction, quality of work, volume of external auditors and mix of staff undertaking the work (‘Redmond Review’ (2020), p.22), and

e. Without action, there is a risk firms may withdraw from the market. (‘Redmond Review’ (2020), p.1) As only 3 firms cover over 80% of local audit, a withdrawal by one could create a very challenging gap to fill – and in the meantime would present significant risks to the timely completion of audit for local authorities.

27. The department recognises that securing an appropriate balance between cost and quality will be critical to ensuring continued market viability when the next audit contracts are procured. Whilst achieving efficiency continues to be important, so too is ensuring there is sufficient funding to ensure high-quality audits.

28. We welcome PSAA’s ambition to strike an appropriate balance between cost and quality. As part of its consideration regarding options for the establishment of a strong systems leader for local audit (see below), MHCLG will decide:

a. The appropriate body to act as to the future appointing person for local authority audit, and b. How the appointing body for local authority audit can most effectively carry out its functions. This will include consideration of what support the appointing body may need to carry out its procurement role.

29. PSAA intends to begin work on future contracts in summer 2021. The department will seek to confirm its decisions on the above by spring 2021.

30. However, we can act now to improve the process which firms need to follow when the cost of audit work is greater than that allowed for the contract fee. Sir Tony found that the current fee variation request process, which has significantly increased in use since 2016/17, is unsatisfactory to both audit firms and the majority of local authorities who contributed a view. In particular, audit firms feel that the scope to claim fee variations is insufficient to meet their additional costs. And some local authorities are unsure as to what additional work fee variations are being claimed for. (‘Redmond Review’ (2020), p.23)

31. Existing regulations mean PSAA must set scale fees before the start of the financial year to which the fees relate; PSAA is then unable to amend these after the financial year has begun. We recognise PSAA’s difficulty in accurately setting fees so far in advance, particularly when there is uncertainty (e.g. impact of Covid-19) and change (e.g. impact of new auditing requirements). When additional work is identified, this can then force audit firms and local authorities down a cumbersome case-by-case fee variation request process.

32. Subject to consultation, the Department will review and reform regulations to provide the appointing person with greater flexibility to ensure the costs to audit firms of additional work are met. This could include enabling the appointing person to allow a fee scale to be set or changed in-year (subject to consultation with the auditor and the audited body), and/or enabling the appointing person (subject to appropriate consultation) to set additional fees across groupings of audited bodies in-year where there is clear evidence of additional work that affects those groupings.

33. We expect that the above options would also help to address the difficulties local authorities have reported, whereby they can sometimes struggle to understand what fee variation requests are for. Removing the need for case-by-case consideration, where appropriate, would help to take a potential source of tension out of the system, contribute to improved fairness within the current fee structure, and provide much greater certainty to all parties.

34. We recognise that the above changes would likely place greater pressure on local authorities’ budgets. However, we note that in-year fee variation requests are already increasing, and that Sir Tony found audit fees formed only 0.04% of local authority expenditure in 2018/19 (down from 0.05% in 2014/15). (‘Redmond Review’ (2020), p. 21)

35. We will provide the sector with £15 million of additional funding in the 2021/22 financial year to support affected local bodies to meet the anticipated increase in auditor fees and to meet new burdens on councils as a result of new reporting requirements. We will confirm individual authority allocations once PSAA has set out its fee scales for the audit of 2021/22 accounts. The department will continue to monitor the financial impact of auditor fees on local government in future years.

36. We will consult in the new year on how best to amend the existing regulations, with a view to having revised regulations in place before the 2021 summer recess.

37. The department also notes PSAA’s recent consultation on proposed changes to its in-year fee variation process and will work with them to consider how that proposal can best be taken forward given our intention to amend the regulations.

Rec 10: The deadline for publishing audited local authority accounts be revisited with a view to extending it to 30 September from 31 July each year

Rec 11. The revised deadline for publication of audited local authority accounts be considered in consultation with NHSI(E) and DHSC, given that audit firms use the same auditors on both local government and health final accounts work.

38. The Redmond Review highlighted the significant increase in delayed audit opinions since the target date was brought forward in 2017/18 from 30 September to 31 July. Over 200 audits did not meet the 31 July deadline in 2018/19. Reasons included:

• poor quality accounts/working papers submitted by the local authority,
• potential qualification issues,
• outstanding objections on the accounts, and
• for the first time in 2019/20, having insufficient qualified individuals to deliver all audits at the appropriate time was included as a reason for some of the delays (‘Redmond Review’ (2020), p.35).

39. Since then PSAA has stated that 265 audits did not meet the extended 30 November deadline (implemented in recognition of one-off Covid-19 pressures) for 2019/20.

40. In addition, PSAA research from March 2020 highlighted that the 31 July target date creates a summer peak in workload for auditors. Audit firms stated this contributes to making local audit an unattractive place to work, making it more difficult for firms to attract and retain high quality staff (‘Redmond Review’ (2020), p.31).

41. In his Review Sir Tony concluded that 40% of audits failing to meet the required deadline for publication in 2018/19 ‘signalled a serious weakness in the ability of auditors to comply with their contractual obligations’ (‘Redmond Review’ (2020), p.3) and recommended that the current deadline should be reviewed, with a view to extending it to 30 September.

42. The department agrees with this recommendation. The existing deadline is currently challenging to meet, presents risks to market viability and puts audit firms in a difficult position of having to weigh up meeting contractual audit completion requirements with the need to ensure a robust auditing process. It is important to note that all the audit firms which the Department has engaged with have highlighted how their priority is to ensure a good quality audit, even if that has meant missing the publication deadline.

43. In addition, we recognise that next year will be particularly challenging as audit firms seek to catch-up after the significant Covid-19 related delays this year. Trying to return to a 31 July deadline to audit the 2020/21 accounting period would be unrealistic.

44. However, we also note there is a balance to be struck with ensuring that potential accounting risks can be surfaced and shared promptly so that appropriate and timely mitigating action can be undertaken. A prolonged audit also impacts on local authorities’ finance teams’ capacity, as they will need to work with auditors for longer and are therefore less able to focus on other matters.

45. Furthermore, permanently extending the deadline does not in and of itself address the reasons why it is taking longer for auditors to agree local authorities’ accounts. Extending the deadline mitigates the impact of these issues but does not resolve them.

46. We are optimistic that the wider action being taken by this department on Sir Tony’s recommendations, and set out elsewhere in this response, will help to address these fundamental issues and ensure a right and sustainable balance between capacity, quality and timeliness can be achieved. We will want to re-visit in the future whether returning the audited account publication deadline to 31 July is a viable and sustainable option.

47. Subject to consultation in the new year, the department intends to amend regulations to extend the deadline for publishing audited local authority accounts from 31 July to 30 September, for a period of two years (i.e. covering the audit of the 2020/21 and 2021/22 accounting years). At the end of this period we will review whether there is a continued need to have an extended deadline.

48. It is also important to highlight the interdependency between the accounts publication timetable for local authorities, and those of other sectors. The same group of audit firms work on a rolling timetable of public sector accounts; any changes to publication deadlines will have knock-on impacts on the capacity of firms to deliver against their next cycle.

49. As Sir Tony highlighted, the relationship is particularly close between final accounts work on local authorities and health bodies. We welcome Sir Tony’s recommendation that the DHSC and this department consult each other on any changes to these deadlines. We are committed to working closely with the DHSC and the NHS on audit deadlines for health and local authority bodies.

50. Finally, elements of multiple central government departments’ and arms-length bodies’ accounts are subject to local audit (e.g. because they employ staff on local government pension schemes); an extension to the deadline may put at risk the timely completion of those bodies’ accounts. Government is actively considering with appropriate bodies, including the NAO, how to best mitigate this, and if appropriate will confirm what action we intend to take following the above consultation.

Rec 5. All auditors engaged in local audit be provided with the requisite skills and training to audit a local authority irrespective of seniority.

Rec 8. Statute be revised so that audit firms with the requisite capacity, skills and experience are not excluded from bidding for local audit work.

51. A ready availability of skilled and appropriately trained auditors is crucial to ensuring both the long-term sustainability of the local audit market and good quality, timely audit. As noted above, the local audit market is currently dependent on a few big suppliers; more needs to be done to encourage other firms into the market to help ensure long-term sustainability.

52. The department recognises that audit firms active in the local audit market have expert technical teams who provide sector specific training to their staff. However, we also note the feedback from many local authorities, set out in the Review, that highlighted ‘significant concerns about the knowledge and expertise of staff working on their audit’. (‘Redmond Review’ (2020), p. 35)

53. In particular, and as noted above, the Review draws out the difficulties for firms in attracting and retaining staff at both junior and senior levels who specialise in local authority audit; audit firms attribute this to both timetabling pressures and lack of profitability.

54. The wider actions the Department is taking will create a framework whereby the timetabling and relative profitability issues can be addressed; we are optimistic this will help to make the local audit market a more attractive setting for firms to invest. However, we agree with Sir Tony that further action is needed now to ensure auditors working in local audit have the right skills and training.

55. On recommendation 5, we welcome the work by CIPFA, supported by the ICAEW and the FRC in this area, and we will seek to work with these organisations to consider whether and how the Department can help improve the uptake of local audit training.

56. In so doing we will want to consider further how to balance the tension between ensuring auditors have access to the appropriate training and qualifications, with ensuring there is sufficient time for auditors to carry out local authority audits - particularly whilst the capacity of the local audit market is fragile.

57. On recommendation 8, Sir Tony also highlighted the high entry criteria for Key Audit Partners (KAPs), exacerbating staffing supply issues and making it difficult for new firms to enter the market (‘Redmond Review’ (2020), p.19). We will seek to work with the FRC and ICAEW to review entry requirements for KAPs within the scope of the existing regulatory framework, noting that again an appropriate balance needs to be struck between ensuring quality and market sustainability. Depending on the results of this work, we will consider whether legislative change may be required.

58. The Brydon Review of the quality and effectiveness of audit, which reported in December 2019, recommended the creation of a new corporate auditing profession to tackle problems in the wider audit market. This recommendation was aimed at the audit profession as well as at government. The government is developing proposals in response to the Brydon Review alongside those derived from separate reviews of competition in the FTSE350 audit market and of the FRC, the current regulator.

59. Since local auditors come from the general pool of audit-trained professionals, changes to the wider audit profession have the potential to impact significantly on the long-term sustainability of the local (and wider public sector) audit market. This is both a risk and an opportunity for local audit. The government will therefore consider whether and how a new corporate auditing profession could continue to generate auditors with skills that are transferable to public sector audit. The department will work with BEIS on the development of an appropriate framework for this new profession and ensure that local audit practitioners have a voice in its development.

60. Finally, the department notes Sir Tony’s finding that one of the barriers to the timely completion of accounts can be the capacity and capability of local authority finance teams (‘Redmond Review’ (2020), p.35). Whilst this was not an area on which the Redmond Review made a specific recommendation, we will engage local government to better understand the issue and consider how it might best be addressed.

Consideration of system leadership options

61. Sir Tony’s central proposal was the establishment of a new independent regulator for local audit – the Office of Local Audit and Regulation (OLAR). The Redmond Review made a number of recommendations relating to the creation of this body:

Rec 1: A new body, the Office of Local Audit and Regulation (OLAR), be created to manage, oversee and regulate local audit with the following key responsibilities:

• procurement of local audit contracts
• producing annual reports summarising the state of local audit
• management of local audit contracts
• monitoring and review of local audit performance
• determining the code of local audit practice
• regulating the local audit sector

Rec 2: The current roles and responsibilities relating to local audit discharged by the:

• Public Sector Audit Appointments (PSAA)
• Institute of Chartered Accountants in England and Wales (ICAEW)
• FRC/ARGA
• The Comptroller and Auditor General (C&AG) to be transferred to the OLAR

Rec 3: A Liaison Committee be established comprising key stakeholders and chaired by MHCLG, to receive reports from the new regulator on the development of local audit.

Rec 7: That quality be consistent with the highest standards of audit within the revised fee structure. In cases where there are serious or persistent breaches of expected quality standards, OLAR has the scope to apply proportionate sanctions.

Rec 13: OLAR to undertake a post implementation review of the Audit Code of Practice to assess whether it has led to more effective consideration of financial resilience and VFM matters.

Rec 17: MHCLG reviews its current framework for seeking assurance that financial sustainability in each local authority in England is maintained.

62. The department anticipates that the measures we outline elsewhere in our response will help to tackle the immediate risks in the local audit system. Early action to reform fee regulations, extend the audited account publication deadline, improve auditor training and review the KAP entry criteria are all possible within the existing local audit framework. So too is improving the transparency of local authorities’ accounts and how audit outcomes are considered by local authorities.

63. As noted above, a critical next step will be how the procurement of future local audit contracts takes into account the risks which Sir Tony has raised, to ensure an appropriate balance between the cost and quality of local audit. PSAA is currently the appointing body for local audit, and the department welcomes that organisation’s commitment to developing a resilient market. The Department will consider what, if any, further action may be necessary to support the future appointing person to ensure that the next procurement enables market sustainability.

64. The Redmond Review goes significantly further than working within the existing system, however, arguing that ‘the key challenge is the underlying weakness of the current arrangements where there is no coordination and regulation of local audit activity’ (‘Redmond Review’ (2020), p.72). Sir Tony recommended that a new Office of Local Audit and Regulation (OLAR) be created to manage, oversee and regulate local audit, noting that ‘clarity of purpose, consistency and public accountability would be essential features of this approach and the expertise and skills of those currently providing these services would be harnessed and maintained in the new body’ (‘Redmond Review’ (2020), p.73).

65. The department recognises, as Sir Tony suggests, the potential value of bringing the regulatory, procurement and leadership roles and responsibilities together under a single overarching body. If one organisation was responsible for both local audit regulation and procurement, for example, it would be significantly easier to set appropriate fee scales. It could define more detailed quality standards appropriate to local audit, and have the power, as Sir Tony recommends, to sanction firms where work did not meet these standards.

66. We also note the Redmond Review’s finding that a single body acting as system leader for local audit would be better placed to grip and implement wider issues relating to the value of external audit. These are areas in which the department has a close interest. They include:

a. The focus of local audit. The Redmond Review found many local authorities (and some audit firms) are concerned that auditors spend too much time on fixed asset and pension valuations, which have no immediate impact on the financial resilience of a local authority, at the expense of focussing on major areas of expenditure and level of reserves (‘Redmond Review’ (2020), p. 32).

b. Bridging what Sir Tony described as the ‘expectation gap’ between what auditors are required to do, and what local authorities and taxpayers expect, when auditors are assessing the financial resilience of local authorities. The Redmond Review suggested that expanding the scope of local audit, beyond the scope of the NAO’s 2020 Code of Audit Practice, to include a ‘substantive test’ of a local authority’s financial sustainability would help to bridge this gap, and ‘represent a genuine demonstration of public accountability’ (‘Redmond Review’ (2020), p.53-54)

67. However, the creation of a new overarching body would mark a significant departure from the 2014 Act. As noted above, this Department remains committed to a locally-led audit regime which enables genuine local accountability by residents and taxpayers. We do not wish to re-create the costly, bureaucratic and over-centralised Audit Commission.

68. Furthermore, it is government’s long-standing intention not to create new arms-length bodies. Unless there is an exceptional reason for a new body, government should look to explore other options for delivering new services or functions, and we are not currently persuaded that a new arms-length body is required.

69. Indeed, the creation of a new system leader for local audit would entail significant structural reform. Primary legislation would be required, which could take up to three years, and a new body would take time to establish itself. Noting the pressing need to address the challenges within local audit, the department is keen to explore, at pace, potential alternatives that may not require a legislative slot and/or a new body – and therefore could enable further action sooner.

70. Finally, the department is mindful that there are significant interdependencies between local and health audit: both sectors share the same regulatory framework and code of audit practice, the work is undertaken by the same audit firms, and both sectors are confronted by similar market capacity issues. This department and DHSC will need to consider how a ‘systems leader’ for local audit would interface with health bodies to ensure that, at minimum, it does not create divergence, and at best that opportunities for greater alignment and efficiency are seized.

71. Noting this, the department will commit to explore the full range of options as to how best to deliver Sir Tony’s finding that a ‘system leader’ is required. This will include close consideration of whether existing bodies could take on this function.

72. In particular, we want to understand in more detail how a system leader could grip and resolve the weaknesses in the local audit system which the Redmond Review describes, and that any consequences of its establishment, such as potential conflicts of interest within the organisation, are identified and can be mitigated. We do not want to risk re-creating an organisation similar to the Audit Commission.

73. In so doing we are mindful of the importance of close partnership working with BEIS, to ensure alignment with the Government’s response to the Brydon, Kingman and CMA reviews of audit.

74. As part of these considerations, the Department will also give thought to how government would interact with a system leader for local audit, and whether a Liaison Committee (as proposed by Sir Tony) is an appropriate method of engagement. We recognise the need to continue to engage with appropriate bodies on local audit matters in the meantime, and will consider whether the role and membership of the department’s existing Local Audit Monitoring Board needs to be strengthened, and how it relates to other local audit forums.

75. We will also consider what reporting the Department would expect to receive and how that could inform and strengthen the department’s framework for seeking assurance that financial sustainability in each local authority in England is maintained. We particularly note the potential value in the regular production of analysis highlighting trends in local audit findings across England.

76. Noting the significance of this work to the future operation of the local audit framework, the department plans to engage widely across both the local audit sector and Government on these questions. We intend to make a full response on the above recommendations by spring 2021.

Enhancing the functioning of local audit, and the governance for responding to its findings

Rec 4^{[footnote 1]}: The governance arrangements within local authorities be reviewed by local councils with the purpose of:

• an annual report being submitted to Full Council by the external auditor
• consideration being given to the appointment of at least one independent member, suitably qualified, to the Audit Committee
• formalising the facility for the CEO, Monitoring Officer and Chief Financial Officer (CFO) to meet with the Key Audit Partner at least annually

Rec 9: External Audit recognises that Internal Audit work can be a key support in appropriate circumstances where consistent with the Code of Audit Practice

Rec 12^{[footnote 2]}: The external auditor be required to present an Annual Audit Report to the first Full Council meeting after 30 September irrespective of whether the accounts have been certified; OLAR to decide the framework for this report.

Rec 18: Key concerns relating to service and financial viability be shared between Local Auditors and Inspectorates including Ofsted, Care Quality Commission and HMICFRS prior to completion of the external auditor’s Annual Report.

77. The department agrees with Sir Tony’s judgment that the effectiveness of audit is, in part, reliant on the arrangements in place to ensure that concerns are effectively considered and acted upon by local authorities. We are grateful to Sir Tony for identifying a number of practical ways in which the profile and operation of audit can be raised within local public bodies, noting that, in some instances, existing governance arrangements fail to appropriately escalate concerns identified by external audits.

78. The department strongly agrees with Sir Tony’s recommendation that the external auditor be required to present an annual audit report to a Full Council meeting, irrespective of whether the accounts have been certified. Although we note that many local authorities feel existing reporting arrangements to audit committees are sufficient, we believe that presentation to Full Council is an important opportunity for potential risks or concerns to be escalated in a timely way and that this should be best practice. We will explore options with relevant stakeholders including the LGA and the NAO as to how this can best be achieved, and whether the 30 September milestone is most appropriate. If a legislative opportunity arises, the department will consider enshrining this in statute.

79. For the same reason, the department also agrees with the other strands of recommendation 4. We will work with key stakeholders such as CIPFA, the NAO and the LGA to ensure that, where appropriate, new guidance is issued which addresses the recommendations relating to meetings between chief officers and the external auditor and the appointment of an independent member(s) to audit committees.

80. We also note Sir Tony’s observation that a very limited number of PIRs have been issued since 2015, which could mitigate against the timely and transparent escalation of issues (‘Redmond Review’ (2020), p.60). We will give this finding further consideration as we implement the above recommendations.

81. Finally, the department agrees with Sir Tony that the sharing of key information with external auditors should be strengthened where possible within existing frameworks. We will work with the DHSC, the Department for Education, the Home Office and the NAO to support the sharing of key information between inspectorates and external auditors, and with CIPFA, the NAO and the LGA on strengthening engagement, where possible within existing frameworks, between external and internal audit.

Improving the transparency of local authorities’ accounts to the public

Rec 19. A standardised statement of service information and costs be prepared by each authority and be compared with the budget agreed to support the council tax/precept/levy and presented alongside the statutory accounts.

Rec 20. The standardised statement should be subject to external audit.

Rec 21. The optimum means of communicating such information to council taxpayers/service users be considered by each local authority to ensure access for all sections of the communities.

Rec 22: CIPFA/LASAAC be required to review the statutory accounts, in the light of the new requirement to prepare the standardised statement, to determine whether there is scope to simplify the presentation of local authority accounts by removing disclosures that may no longer be considered to be necessary.

82. The Redmond Review found that a “lack of transparency and understandability of local authority accounts raises a fundamental and serious challenge in terms of transparency and public accountability”, noting that “without an appropriate level of transparency [council taxpayers and the media] may not have the information to challenge their local authority effectively” (Redmond Review’ (2020), p.60). The Review describes how local authorities’ accounts “as currently structured and presented, do not enable the public to understand how local authorities are stewarding public funds” (Redmond Review’ (2020), p.60).

83. The department agrees with Sir Tony’s recommendations that all local authorities be required to prepare an audited standardised statement of service information and costs. These should be short and accessible, for example one or two pages. Standardised statements should be communicated to all taxpayers and service users, and we will explore how this can be done, for example, alongside or with council tax bills from 2022.

84. As noted at the start of this response, transparency is a crucial element of sustaining public confidence in local democracy, which is why the 2014 Act introduced the requirement for councils to publish information through the Transparency Code Alongside this statutory requirement, the sector has made great strides around openness – councils are publishing more and more data in open and accessible ways. They are doing this both to enhance transparency but also because they see that improving data improves decision making and the use of resources. We are keen to build on this and make it easier for residents to understand how their council uses its resources and how services perform. Progress on this wider agenda was delayed by the Covid-19 response but is now resuming and we are developing proposals to discharge our commitments in the National Action Plan for Open Government.

85. An important part of this wider agenda must be around finances and making information easier to understand and get hold of for the general public, even where it is already available from government or on an authorities’ website. The standardised statement has the potential to do this in relation to local accounts.

86. Whilst the department recognises that some authorities already produce some form of accounts summary statement, we agree that to ensure all taxpayers across the country can effectively hold their council to account, more is needed to improve the accessibility of all authorities’ accounts’. These measures will go some way towards further improving local transparency and accountability.

87. Our ambition is for the standardised statements to be introduced as soon as possible. The department will work closely with CIPFA as they lead on the development and consultation with local government to produce a product, with a view to rolling statements out in 2021/22. As part of this work we are considering whether we may need to change regulations to mandate the inclusion of the statement alongside the accounts. We will also engage with the NAO on the required changes to the Code of Audit Practice.

88. As noted above in paragraphs 20 and 35, the department will make available additional funding to local authorities in 2021/22 to enable them to prepare the above standardised statements. We will confirm individual authority allocations next year.

89. Finally, the department agrees with Sir Tony that this is an opportunity for CIPFA/LASAAC to consider whether there is scope to simplify the presentation of local authority accounts by removing disclosures that may no longer be considered to be necessary. The earliest that simplification could be reasonably incorporated into the main accounts is through the 2022/23 Accounting Code, and we will work with CIPFA LASAAC to determine what can feasibly be achieved in that time scale. Depending on the ambition, significant changes to the accounts may require a phased approach. We will consider further with CIPFA LASAAC.

Action to further consider the functioning of local audit for smaller bodies

Rec 14. SAAA considers whether the current level of external audit work commissioned for Parish Councils, Parish Meetings and Internal Drainage Boards (IDBs) and Other Smaller Authorities is proportionate to the nature and size of such organisations.

Rec 15. SAAA and OLAR examine the current arrangements for increasing audit activities and fees if a body’s turnover exceeds £6.5m.

Rec 16. SAAA reviews the current arrangements, with auditors, for managing the resource implications for persistent and vexatious complaints against Parish Councils.

Rec 23. JPAG be required to review the Annual Governance and Accountability Return (AGAR) prepared by smaller authorities to see if it can be made more transparent to readers. In doing so the following principles should be considered:

• whether “Section 2 – the Accounting Statements” should be moved to the first page of the AGAR so that it is more prominent to readers
• whether budgetary information along with the variance between outturn and budget should be included in the Accounting Statements
• whether the explanation of variances provided by the authority to the auditor should be disclosed in the AGAR as part of the Accounting Statements

90. The department welcomes Sir Tony’s finding that no serious concerns were identified with the functioning of local audit for smaller bodies (‘Redmond Review’ (2020), p.73).

91. We note Sir Tony’s recommendations to review the proportionality of external audit for smaller bodies, current arrangements for managing persistent complaints against parish councils and the transparency of the AGAR. The Department would welcome action by SAAA and JPAG on these recommendations.

92. In its consideration of options as to how best to establish strong systems leadership for local audit (set out above), the department will consider the implications for the functioning of local audit for smaller bodies, not least because smaller bodies are regulated by the same Code of Audit Practice. This will include consideration as to how any new systems leader for local audit should work with SAAA to examine assurance levels and fees if a body’s turnover exceeds £6.5 million.

Annex A: Summary of MHCLG’s response to the recommendations made by the Redmond Review

Action to support immediate market stability (recommendations 5, 6, 8, 10, 11)

Recommendation	MHCLG Response
5. All auditors engaged in local audit be provided with the requisite skills and training to audit a local authority irrespective of seniority.	Agree; we will work with key stakeholders to deliver this recommendation
6. The current fee structure for local audit be revised to ensure that adequate resources are deployed to meet the full extent of local audit requirements.	Agree; we will look to revise regulations to enable PSAA to set fees that better reflect the cost to audit firms of undertaking additional work
8. Statute be revised so that audit firms with the requisite capacity, skills and experience are not excluded from bidding for local audit work.	Part agree; we will work with the FRC and ICAEW to deliver this recommendation, including whether changes to statute are required
10. The deadline for publishing audited local authority accounts be revisited with a view to extending it to 30 September from 31 July each year.	Part agree; we will look to extend the deadline to 30 September for publishing audited local authority accounts for two years, and then review
11. The revised deadline for publication of audited local authority accounts be considered in consultation with NHSI(E) and DHSC, given that audit firms use the same auditors on both Local Government and Health final accounts work.	Agree

Consideration of system leadership options (recommendations 1, 2, 3, 7, 13, 17)

Recommendation	MHCLG response
1. A new body, the Office of Local Audit and Regulation (OLAR), be created to manage, oversee and regulate local audit with the following key responsibilities: - procurement of local audit contracts - producing annual reports summarising the state of local audit - management of local audit contracts - monitoring and review of local audit performance - determining the code of local audit practice - regulating the local audit sector	We are considering these recommendations further and will make a full response by spring 2021.
2. The current roles and responsibilities relating to local audit discharged by the: - Public Sector Audit Appointments (PSAA) - Institute of Chartered Accountants in England and Wales (ICAEW) - FRC/ARGA - The Comptroller and Auditor General (C&AG) to be transferred to the OLAR	We are considering these recommendations further and will make a full response by spring 2021.
3. A Liaison Committee be established comprising key stakeholders and chaired by MHCLG, to receive reports from the new regulator on the development of local audit.	We are considering these recommendations further and will make a full response by spring 2021.
7. That quality be consistent with the highest standards of audit within the revised fee structure. In cases where there are serious or persistent breaches of expected quality standards, OLAR has the scope to apply proportionate sanctions.	We are considering these recommendations further and will make a full response by spring 2021.
13. The changes implemented in the 2020 Audit Code of Practice are endorsed; OLAR to undertake a post implementation review to assess whether these changes have led to more effective external audit consideration of financial resilience and value for money matters.	We are considering these recommendations further and will make a full response by spring 2021.
17. MHCLG reviews its current framework for seeking assurance that financial sustainability in each local authority in England is maintained.	We are considering these recommendations further and will make a full response by spring 2021.

Enhancing the functioning of local audit, and the governance for responding to its findings (recommendations 4, 9, 12, 18)

Recommendation	MHCLG response
4. The governance arrangements within local authorities be reviewed by local councils with the purpose of: - an annual report being submitted to Full Council by the external auditor - consideration being given to the appointment of at least one independent member, suitably qualified, to the Audit Committee - formalising the facility for the CEO, Monitoring Officer - Chief Financial Officer (CFO) to meet with the Key Audit Partner at least annually.	Agree; we will work with the LGA, NAO and CIPFA to deliver this recommendation
9. External Audit recognises that Internal Audit work can be a key support in appropriate circumstances where consistent with the Code of Audit Practice.	Agree; we will work with the NAO and CIPFA to deliver this recommendation
12. The external auditor be required to present an Annual Audit Report to the first Full Council meeting after 30 September each year, irrespective of whether the accounts have been certified; OLAR to decide the framework for this report.	Agree; we will work with the LGA, NAO and CIPFA and other key stakeholders to deliver this recommendation, including whether changes to statute are required
18. Key concerns relating to service and financial viability be shared between local auditors and inspectorates including Ofsted, Care Quality Commission and HMICFRS prior to completion of the external auditor’s annual report.	Agree; we will work with other departments and the NAO to deliver this recommendation

Improving transparency of local authorities’ accounts to the public (recommendations 19, 20, 21, 22)

Recommendation	MHCLG response
19. A standardised statement of service information and costs be prepared by each authority and be compared with the budget agreed to support the council tax/precept/levy and presented alongside the statutory accounts.	Agree; we will look to CIPFA to develop a product through consultation with local government. We will work with CIPFA to deliver this recommendation
20. The standardised statement should be subject to external audit.	Agree; we will work with CIPFA, the LGA and the NAO to deliver this recommendation
21. The optimum means of communicating such information to council taxpayers/service users be considered by each local authority to ensure access for all sections of the communities.	Agree; we will work with the LGA and CIPFA to deliver this recommendation
22. CIPFA/LASAAC be required to review the statutory accounts, in the light of the new requirement to prepare the standardised statement, to determine whether there is scope to simplify the presentation of local authority accounts by removing disclosures that may no longer be considered to be necessary.	Agree; we will look to CIPFA to deliver this recommendation

Action to further consider the functioning of local audit for smaller bodies (recommendations 14, 15, 16, 23)

Recommendation	MHCLG response
14. SAAA considers whether the current level of external audit work commissioned for Parish Councils, Parish Meetings and Internal Drainage Boards (IDBs) and Other Smaller Authorities is proportionate to the nature and size of such organisations.	Agree; we will look to SAAA to deliver this recommendation
15. SAAA and OLAR examine the current arrangements for increasing audit activities and fees if a body’s turnover exceeds £6.5m.	We are considering this recommendation further and will make a full response by spring 2020
16. SAAA reviews the current arrangements, with auditors, for managing the resource implications for persistent and vexatious complaints against Parish Councils.	Agree; we will look to SAAA to deliver this recommendation
23. JPAG be required to review the Annual Governance and Accountability Return (AGAR) prepared by smaller authorities to see if it can be made more transparent to readers. In doing so the following principles should be considered: - whether “Section 2 – the Accounting Statements” should be moved to the first page of the AGAR so that it is more prominent to readers - whether budgetary information along with the variance between outturn and budget should be included in the Accounting Statements - whether the explanation of variances provided by the authority to the auditor should be disclosed in the AGAR as part of the Accounting Statements.	Agree; we will work to JPAG to deliver this recommendation

1. This recommendations (and the department’s response) applies only to principal local authorities (i.e. not police and crime commissioners or fire and rescue authorities) ↩

2. This recommendations (and the department’s response) applies only to principal local authorities (i.e. not police and crime commissioners or fire and rescue authorities) ↩