View from the top: Local authorities - a new focus on internal audit

My recent review of local government financial reporting and external audit raised a number of serious issues about the way in which the external audit market currently works in relation to local authorities. It found problems with the quality of audits: 40 per cent were not completed on time in 2018-19; there is a lack of knowledge and experience of the sector among some external audit firms; and a need for greater accountability. Reports were often not transparent and were difficult to understand, while the low fees appear to deter experienced auditors, because the work is less valuable than that in other markets for their firms.

This also raised questions about whether external audit is adequately testing the financial resilience of local authorities. Improvement here requires more interaction between statutory officers, external auditors, internal auditors and the audit committee.

Principal among my recommendations is the creation of a single over-arching body to oversee the whole process, a new fee structure and more training for external audit teams in local government finance. The office for Local Audit Regulation (OLAR) would monitor and assess audit performance and, importantly, could impose sanctions for significant under-performance.

I also believe that it is essential that audit committees are trained to ensure that they have the knowledge and capacity to offer sufficient challenge. All members of the committee do not need to understand the technicalities of the balance sheet, but they do need to know whether the local authority is financially sound. Senior executives (usually the chief financial officer and chief executive) should meet, formally, with the key audit partner, who would also present to the full council annually.

Furthermore, the relationship between external and internal audit needs to change. Much of the internal audit work already undertaken in local authorities is relevant to the external audit work, so we need to reinstate and reinforce the dialogue between the two. For example, it might be good to introduce conversations between the two types of auditors before audit committee meetings. This also means that reports currently produced by internal audit teams should be timely and effective.

Internal and external auditors may have regular contact throughout the year. It needs to be a continuous process. External auditors should have knowledge of local authority financing and accounting and internal audit may be able to assist with this. Under the NAO’s current Code of Audit Practice there is no requirement for the external auditor to consult or engage with internal audit, although this might be acknowledged as good practice.

We need to develop a clearer understanding of risk throughout local authorities and this involves support for good practice prevailing in the organisation. It should be fundamental to the culture of the organisation if best practice is to be understood and practised at all levels. Similarly, accountability and transparency need to be improved and should be an established principle at senior management level.

In the past, there have been concerns about whether more interaction between external and internal audit could impact the independence of external audit. I think the benefits of more engagement between the two outweigh the risks, although these must be managed appropriately. 

This article was first published in January 2021.