Audit Commission's demise risks audit independence

THE ABOLITION OF the Audit Commission might provide a great opportunity for auditing firms to claim a chunk of the estimated £184m of business at stake. But, as the saying goes, with great power comes great responsibility. The government is, to an extent, outsourcing democracy.

At the heart of this is the future of “public interest reports”. However, post-commission, there is potentially little incentive to stop firms sweeping delicate matters under the carpet.

Currently, under Section 8 of the Audit Commission Act 1998, auditors are required to consider whether, in the public interest, they should report on any matter that comes to their attention during the audit. They do so through the issuing of public interest reports. These special reports range from the mundane – the late filing of a parish council’s accounts – to fodder for the national press: the Westminster cash for homes scandal or the loss of local taxpayers’ money in the Icelandic banks, for example.

Evidence from a range of groups submitted to the Commons’ Communities and Local Government Select Committee enquiry into the future of local authority auditing, which began this week, is almost unequivocal in emphasising the importance of the reports. The likes of BDO, KPMG, CIPFA, the Local Government Association, Westminster and Gateshead councils, among others, came out in favour of their retention.

But, issuing the reports are, among other things, costly, generate media interest and are embarrassing to the authority under the spotlight. Indeed, the commission’s own evidence suggested that local authorities have in some cases “sought to have auditors removed”. Unsuccessfully, as it happens, as the Audit Commission absorbs the liability of the auditors and councils are bound to the commission.

Protecting auditors

But, with the commission gone, where is the protection for auditors? The costs of issuing the reports are off-putting in the first place. And Professor David Heald, of the University of Aberdeen Business School, told the MPs the insurance provided by the Audit Commission will have to be borne by the auditors themselves, potentially leading to an increase in fees. The BDO evidence suggests there should be arbitration on who covers the costs of contentious cases.

However, this highlights the major problem – a local authority that has to bear the costs of a damaging report is unlikely to want to choose that auditor again under the freedoms they will be afforded by local government secretary Eric Pickles.

The current favoured protection for firms is the concept of local audit committees, independent from the council, choosing the auditors, and thereby unlikely to punish firms that raise concerns in the public interest.

But this is not without its drawbacks – the committees are not a statutory requirement and any move to make them statutory could defeat the purpose of the reforms to give democratically elected councils greater freedoms.

Furthermore, they would be an extra cost to the authorities in times of austerity and finding the expertise to sit on the committee, and properly scrutinise the council, would not be simple.

Whatever happens, the protection for auditors who wish to issue the reports will not be as robust as when the Audit Commission was in place. But perhaps the more pertinent question is: why would any firm wish to issue a report?

This concern seems to be valid. CIPFA says there have been a “dearth” of public interest reports in foundation trusts since they have appointed their own auditors, a view shared by Professor Heald.

Crisis of conscience

David Walker, the former director of communications at the Audit Commission, said: “As far as we can see, the auditor would have no incentive other than their conscience to put themselves in the firing line and jeopardise the relationship with the client by issuing a public interest report.”

He added that the commission noted that the threat of a public interest report was normally sufficient to make councils improve their performance management. But these threats are hollow without protection in place.

Mike McDonagh, head of public sector at KPMG, said the main incentive was professionalism. “It comes to the professional integrity of the individual. If, by doing the right thing, you lose the client, then so be it.”

Which is a noble sentiment. However, an underlying theme throughout the submissions to the enquiry is to open the market beyond the Big Four. In this case, for a medium-sized firm that wishes to retain its newest – and biggest – client, the concept of putting the public interest ahead of the firm’s financial future might be asking too much.