CIPFA Audit Conference 2013: Keynote: Meeting the Performance Challenges

I enjoyed being at the CIPFA Audit Conference earlier this week. Here are my presentation slides.

My presentation was the opening one. I’d been a bit nervous about it beforehand, not about the giving of a presentation but about the content. I’m not an audit specialist so I decided to talk about performance challenges from a general, big picture point of view. What I was concerned about, then, was whether what I said would resonate with any of the sessions that followed. I stayed until mid-afternoon and I’d say that all the other sessions I saw had touch-points with what I’d said. That was a relief.

Aside from what I learned by watching other people's presentations, I also made a couple of new contacts which might result in some future projects. So, all in all, it was a good day for me.

Hear me speak at CIPFA's Audit Conference 2013

At rather short notice I have agreed to speak at the upcoming CIPFA Audit Conference in York on 22 May. I'm not a specialist in audit but fortunately my topic is broader than that: the financial and performance challenges facing the public sector. I've some ideas about what I want to say already but the preparation of a 40 minute talk will take me probably ten times that (and I'll do it the Presentation Zen way).

The future of public audit

I've just read a pamphlet called The Future of Public Audit (published by Solace Foundation Imprint). There are about a dozen articles/short essays in the pamphlet and, rather like the stereotypes of auditors, they are worthy but rather dull. Or, perhaps, a better adjective would be "earnest". The articles incorporate interesting ideas and insights about things like trust, transparency, the demise of the Audit Commission and self-improvement but they don't sparkle. Perhaps part of the reason for this is the subject matter itself but should articles about audit will always be so dry?

Perhaps it is the writers rather than the subject. All of the authors of the pamphlet I read were male, white and most were, to be polite about it, substantially experienced. We could do with some different people writing about this subject (and other aspects of financial management) to get some diversity of views and to do for the subject (in a small way) what Brian Cox is doing for science: making people interested in it.

I guess I have to be part of the answer. Here I am blogging about public finance so it is incumbent on me to make what I write interesting. I certainly hope to do that with posts like the one about the film Moneyball. I also try to do it in my lectures by including video and images in presentations and telling stories from my experience in order to illuminate the subject. But, nevertheless, I can't rest on my laurels. During the 1996 European Championships, Ruud Gullit coined the phrase "sexy football" to describe teams whose play was artistic and entertaining as well as effective. I don't think we can have "sexy audit" but could we at least have some sexy articles about audit? That's a challenge I've set myself.

Is Ruud thinking about how to make public audit sexy?

Competing for public audits

What does the OFT’s announcement that the audit market should be investigated by the Competition Commission mean for the audit of public organisations? When Eric Pickles announced in August 2010 that the Audit Commission would be abolished he stated that public organisations should be free to choose their auditors. One possibility is that the Audit Commission's own audit arm (formerly known as District Audit) could be floated off in some form to compete with the existing audit firms. I believe that Pickles's department has hired some management consultants to advise on how that might happen.

The abolition of the Audit Commission is, in its way, a classic piece of Conservative market deregulation. My personal view is that, generally speaking, market regulations were imposed by governments for good reason and deregulation makes things worse for most people, whilst allowing a few to make a lot of money. There are too many cases of deregulation resulting in a bad deal for consumers (eg price rises) if not worse (Enron-type frauds and scandals). Once local authorities and NHS trusts are in a position to choose their own auditor I am sure that the larger ones—the county councils, London boroughs, metropolitan boroughs, major acute hospitals—will receive suits from the 'Big Four' as well as some of the smaller firms. The process will be a beauty parade. The codes of practice that set out what comprises the audit of a major organisations means all the firms will provide the same service so the client organisation will pick the one they fancy. In the first year or two they might also get a good discount on the fee.

What the practice of the FTSE 350 companies shows is that once an audit firm is hired they very rarely are replaced. I suspect that's because there's little incentive. All the firms do more or less the same thing and charge more or less the same fee so why would a client organisation spend the time and trouble to have a new beauty parade every five or seven years? And if a new firm were selected as a result there would then be an element of disruption as the new auditors found out all they needed to know about the client's business and accounting system and so on. It's rather like changing your bank. Even if you could get a cheaper deal from a different bank, it would have to be a very significant improvement on your current deal for it to be worth the trouble of moving all your direct debits and all the rest of it.

Whilst the larger public organisations can look forward to being enticed by the Big Four audit firms I doubt that the smaller district councils, the ones whose budgets are still £10–20million and so are substantial organisations in their own right, will. They might see much the same effect, though, from the small and medium-sized audit firms who would be happy to have a regular income from organisations that will pay their bills and never go bust.

If the Audit Commission's audit division is floated off as a stand-alone organisation (New District Audit, perhaps?)then I expect it would compete for all shapes and sizes of audit. Its unique selling point would be its specialism in public sector audits and I expect that it would win some of the business. Prior to the Audit Commission's creation, local councils could choose between being audited by the District Audit or by a 'professional auditor'. (Back then hospitals were not part of trusts and the whole of the NHS was audited by the Exchequer and Audit Department, which was renamed the National Audit Office in 1983).  When local government was reorganised in 1974 202 boroughs had moved over to the professional audit, while 119 use the District Audit (Coombs and Edwards, 2004: 82). (There were 21 others who used the antiquated system of electing local people as auditors, a practice which I don’t think the secretary of state, or anyone else, is proposing to reinstate.) So back then the private sector held about 2/3 of the local government audit market. During its tenure the Audit Commission has favoured its own auditors with about 70% of the market. Would a stand-alone ‘New District Audit’ be able to hang on to 70% of the market. I doubt it. At least, I doubt it in terms of fees. There are about a thousand principal councils and NHS bodies currently audited by the Audit Commission (and many thousands more parish councils). The New District Audit might be able to win 70% of them as clients but the professional firms will focus on the bigger, more valuable clients and I can well imagine that they might secure 70% of the fees. And once they are in they’ll be very difficult to replace.

Reference: Coombs and Edwards, (2004) The audit of municipal corporations—a quest for professional dominance. Managerial Auditing Journal, 19(1), 68-83.

Choose your auditor wisely

About a week ago Eric Pickles announced his proposals for the audit regime for public bodies that would replace the current regime once the Audit Commission has been abolished. Public organizations with a turnover of at least £6.5million would be free to select their own external auditor in the same way that private companies do. As with all the local freedom announced by this government I don't doubt that there will be constraints but the proposals, so far, do not go into the details of the codes of practice or guidelines that would accompany this new freedom. Nevertheless, I have a couple of general observations to make.

Firstly, last week I read a newspaper snippet about a House of Lords report which claimed that the complacency of auditors contributed to the current financial crisis. The newspaper report mentioned that on average the FTSE100 companies change their auditors every 48 years. Given that some of the companies change of auditor would have been because Arthur Anderson collapsed after the Enron scandal one begins to wonder how often a large company changes its auditor when it does not have to. This kind of thing would be good news for the audit firms pitching for business from councils and hospitals because once they are appointed they might expect to receive fees for generations. I appreciate the government might include a requirement in the code of practice, or whatever, that means an audit firm has to be changed every 5 or 7 years but it seems to me unlikely since no such requirement is included in company legislation.

My second comment is to point out that the European Commission is heading in the opposite direction. Last year it published a consultation paper Audit Policy: Lessons from the Crisis where it said it was ‘considering the feasibility of a scenario where the audit role is one of statutory inspection wherein the appointment, remuneration and duration of the engagement would be the responsibility of a third party, perhaps a regulator, rather than the company itself.’