Industry urges government to address “fragile” public sector audit market

The UK government’s impending overhaul of audit regulations must include a separate review for the public sector in order to avoid further damage to an already “fragile” market, industry participants have said.

The recommendations were first touted by the Institute for Chartered Accountants in England and Wales (ICAEW) in a letter submitted to HM Treasury on July 15. Improving corporate reporting for the public sector is even more in the public interest than it is for large private companies, it argues.

“There is significant public interest in ensuring that audit and corporate reporting are functioning effectively for public sector bodies, so it is important the government seizes this opportunity to strengthen it,” the letter says.

“Taxpayers need assurance that public bodies are spending money effectively and safeguarding public assets.”

Comprised of four “key recommendations”, the ICAEW’s letter first urges the government to conduct a separate review to consider how the principles outlined in its original consultation paper could apply in the public sector.

The ICAEW goes on to argue that such bodies should be excluded from the newly reformed scope of the Public Interest Entity (PIE) criteria which formed a core part of the Department for Business, Energy and Industrial Strategy’s whitepaper. Hinged on a series of recommendations made in The Brydon Review, this would broaden the definition and place up to 2,000 organisations within the purview of the new audit regulator.

However, the ICAEW argues in its letter that the PIE definition “captures far too many entities and risks overwhelming the system”. It notes, for example, that relatively small public sector bodies may meet the proposed thresholds even where a public interest case cannot be made or is not relevant.

“Our view is that central and local government-owned companies should be explicitly excluded from the PIE definition.”

This view is mirrored by Chris Brown, head of public sector at Azets, who argues that sufficient scrutiny measures, such as public meetings and Freedom of Information, already exist in public sector audit.

“One of the problems is that when you talk about PIEs, it’s hard to argue that public sector bodies shouldn’t be included in those. But really, it’s about commercial public interest.

“There’s already a huge amount of additional transparency that exists in the public sector that doesn’t exist in the private sector.”

Brown also notes that the National Audit Office and the Auditor General already acts as an independent public spending watchdog in the UK, and that the point of the new PIE regime is to “replicate that kind of scrutiny in the commercial sector”.

“That job is already being done, so there’s no need for it to happen in the public sector,” he says.

The ICAEW also cites market capacity among its key recommendations, arguing that increased scrutiny of public sector audit could further raise what is already a high entry barrier for firms.

The letter notes the ‘key audit partner’ requirement (a qualification issued by the ICAEW) as an example of this high barrier.

“When considering how the reforms should apply to public sector bodies, the government must consider whether any new requirements could further worsen the capacity and market sustainability issues,” it says, noting that just two firms conduct more than 70 percent of local government audits.

“Urgent action is needed to address this issue, but the solutions proposed in the whitepaper for larger companies, such as managed shared audit, would not work in the local audit market.”

Also addressed in the letter is the need for fee increases in public sector audit, and the suggestion that new requirements must be accompanied by appropriate funding to supplement these increases.

Brown notes that commercial audit is “a lot more lucrative”, and that this results in a natural gravitation away from the public sector.

“When you have a shortage of qualified auditors in the market and fewer people wanting to come into the profession, that means firms have got to make a decision about which type of audit they focus on. And they’re tending to move towards commercial audit because it’s more lucrative.”

Both sides conclude by warning of the long-term impacts of these flaws, arguing that it is of significant interest to the taxpayer that financial reporting in public sector bodies is functioning effectively.

“Over a period of time, you’ll get a gradual reduction in the quality of financial statements,” says Brown.

“The value for money that the public gets will be less because there will be more inefficiencies. That will result either in tax increases or reductions in public services.”

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