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Executive Summary

The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to comment on the Audit Commission's paper, A New Framework of Financial Reporting and Accountability in Local Government.

These comments have been prepared in consultation with members of the ACCA's Public Sector Technical Issues Committee, a group of experienced accountants working in the public sector.

ACCA welcomes this paper, the second in a series of 'think pieces', as an important contribution to a fundamental review of the overall framework of accountability of local authorities.

While ACCA accepts that there are a variety of users of local authority financial reports, we consider that the electorate should be considered the defining class of user of local authority annual reports and financial statements. This assumption will provide greater clarity to the needs of this user group and, thus, the form and content of the information which should be provided by local authorities.

We also consider that the paper is insufficiently challenging as it assumes that the public sector should follow private sector practices of financial reporting. We accept that changes are necessary to enable local authorities to treat their financial transactions in a manner which is consistent with UK GAAP. We do not necessarily consider, however, that current departures from UK GAAP are particularly significant in terms of the quality of local authority financial reporting. The financial reports of a local authority should reflect the fact that the roles and objectives of local authorities are fundamentally different from those of private sector businesses. Electors require additional performance measures and information to enable them adequately to assess the relative success of their authorities. As a result, the financial statements of a local authority play a lessor role in fulfilling overall accountability demands and reporting responsibilities than is the case for private sector entities.

The paper assumes that stakeholders require more information but does not consider whether they would be content to pay the associated additional costs. We believe that there is evidence that electors are demanding additional financial information from their local authorities. The costs of providing such additional information should, where possible, be balanced with any assumed benefits.

General comments

The local electorate is the defining class of user


1. ACCA considers that the local electorate fits the description as the defining class of user of local authority annual reports and financial statements. The electorate is the group of users to which local government is legally accountable. Earlier this year, a joint ACCA/HFMA (Healthcare Financial Management Association) working group produced a factsheet on Financial Reporting in the NHS. The group concluded that "the citizen, likened to an involuntary investor in public sector assets and services, is the defining class of user in the context of the public sector".
   
   
2. The report of the Commission on Public Private Partnerships, also issued earlier this year, argued that "Accountability is a term used in several different ways, but at its heart is a relationship between a principal who commissions a service and an agent who carries it out. For public services in modern democracies the principals are citizens who require a public service".
   
   
3. Identifying the information needs of users would be easier if one group, the local electorate, was identified as the defining class of user of local authority annual reports and financial statements. This recognition would then form a rational basis for reforming the whole structure of local authority reporting. ACCA considers, however, that further empirical research is needed to identify what information local electorates require to enable local authorities truly to fulfil their stewardship and accountability functions. These information needs would then have to be balanced with the additional costs of providing any such further information. Our initial assumption is that the accountability needs of the local electorate will be broader than the purely financial, extending to embrace accountability in the areas of environmental impact and community well-being.
   
   
4. The Commission's paper does not recognise the local electorate as the defining class of user, but only recognises it as a subsidiary group. So, for example:
   
   
   • the electorate is not mentioned as part of the audience for the paper at paragraph 7
     
     
   • neither is it mentioned in the summary to the section of the paper on Users and their information needs
     
     and
     
     
   • it is mentioned only as one of 29 groups on page 22.
   
   
   Stewardship and accountability
   
   
5. There are two aspects of the relationship between local authorities and their electorate which are relevant when considering financial accounting requirements: stewardship and accountability. Local authorities have a stewardship function. They have to demonstrate to their electorates that the public assets which they hold have not been misappropriated and that all expenditure is proper and correct. That is, it has been spent in accordance with the authority's agreed budget and by following the authority's financial regulations and other regulatory and legal requirements.
   
   
6. Local authorities are also accountable for the way in which public monies are spent. They should be held to account for the quality, efficiency and effectiveness of the services which they provide.
   
   
7. An authority's financial statements, and especially the audit report, are key to the authority fulfilling its stewardship function. These documents, however, are not usually a source of useful information beyond providing some assurance to the electorate that public monies entrusted to the authority have not been misused or used for personal gain. This view is consistent with the comment in paragraph 102 of the Commission's paper that: "many authorities are openly sceptical about the value of published financial statements, arguing that it is a waste of public money to produce published accounts that no-one reads".
   
   
8. The wider accountability function of an authority is probably achieved mainly through the personal experience of the electorate. Citizens do not necessarily have to be told whether their local school is providing their children with a proper education, whether their bins are collected each week or whether the repairs on their council house are undertaken promptly and carefully.
   
   
9. This personal experience will, however, be complemented by the local media reporting on the wider successes or otherwise of the authority and the electorate would probably also benefit from the production of an annual report by the council. In paragraph 31 below we suggest that expanding the range of reporting requirements to include environmental and social reporting can further strengthen the wider accountability function.
   
   Use of local government management letters
   
   
10. In 1999, ACCA published a research paper on the use of local government management letters. This research found that the management letter "provides a wealth of detail about the financial state of an authority, on how well the authority is managed and on the audit process itself". The paper from the Audit Commission could have benefited from considering how local authority management letters could be used to better affect to improve local authority accountability. For example, there could be a requirement that members discuss the management letter at least at committee level.
    
    Parallels with the private sector are limited
    
    
11. The stewardship, and especially the accountability, relationships between a local council and its electorate are very different from those between private sector companies and their shareholders. Thus the particular information needs and the way the council's accounts are presented need to be considered carefully. Best practice, in terms of presenting annual reports and accounts in the private sector cannot necessarily be used directly as a guide to reporting in the public sector.
    
    
12. The electorate is interested in the quality of the services which they use, they are much less interested in the financial results. In contrast, the financial results are the raison d'être of the private sector. Shareholders are interested in the profit level of their company and much less so in the quality of the goods or services which it provides. This was emphasised recently by Margaret Hodge (Higher Education Minister - The Guardian 6 September 2001) when she said that "the public sector is financed by taxpayers' money and legitimised by the popular vote. This demands a different level of accountability from the private sector".
    
    
13. The particular stewardship and accountability relationship between local councils and their electorates needs to be considered carefully when determining the financial reporting and other information needs of the electorate. The cost of providing additional financial information should also be considered. Additional information will not be effective if the electorate does not want it or if it is not used to hold the local authority to account. For these reasons we feel that general developments in private sector financial reporting are not always "directly relevant to local authorities" (paragraph 66 page 20). Such developments should be considered for their relevance and, where appropriate, adapted to the local government environment.
    
    Weaknesses identified by the Audit Commission
    
    
14. ACCA agrees with all but two of the weaknesses in financial reporting and accountability identified in the Executive Summary to the Commission's paper on page 2. We do not fully agree with the possible implications of the following two bullet points:
    
    
    • the statutory framework for the production and approval of the annual accounts has not succeeded in encouraging elected members to accept ownership of the accounts
      
      
    • local authority accounts contain significance departures from UK generally accepted accounting practice (UK GAAP), which reduce the clarity of the financial statements and undermine comparisons with other public bodies.
      
      
15. We do not accept that the first point is a weakness as council members themselves may be described as users rather than producers of the annual accounts. The accounts, although primarily part of the accountability framework between the authority and the electorate, can also be used by the council to hold the management of the authority to account. In the private sector the board will be interested in ensuring that the annual accounts portray the company in the best possible light, for example, by choosing the most appropriate accounting policies. This aspect is much less important for local authorities where the annual accounts (including the audit report) are only one way in which the management of the authority demonstrates its proper stewardship of public assets to the council and ultimately to the electorate.
    
    
16. We accept that changes are necessary to enable local authorities to treat their financial transactions in a manner which is consistent with UK GAAP. We do not necessarily consider, however, that current departures from UK GAAP are particularly significant in terms of the quality of local authority financial reporting. The financial reports of a local authority should reflect the fact that the role and objectives of local authorities are fundamentally different from private sector businesses. As a result, the electorate requires additional performance measures and information to enable them adequately to assess the relative success of their authority. A uniform approach to financial reporting between local authorities and the private sector is not therefore necessarily appropriate.
    
    
17. We accept that basic symmetry is important between the accounting policies of different local authorities. It is difficult, however, to use the accounts of local authorities to judge their relative level of success as each authority has different priorities and local environments. Such comparisons require different means including, for example, nationally and locally determined performance indicators. Thus we do not accept the emphasis expressed in paragraph 107 of the Commission's paper that the "preparation of accounts in accordance with UK GAAP on a true and fair basis is … a pre-condition of high quality financial reporting in the public sector".

    Responses to specific questions asked by the Audit Commission

    Should authorities be required to prepare a summarised 'annual plan' in March of each year which would be distributed to every household and replace the BVPP summary and the council tax leaflet at billing authorities?
    
    
18. Yes, they should. The production of a summarised 'annual plan' would be an advantage if it resulted in combining the two existing documents and thus led to cost savings. The costs of producing such a plan should, however, be considered carefully and compared with any benefits to or demand from the electorate. It may be more cost effective to make such a summary available on demand rather than sending the plans direct to each household.
    
    Should local authorities be required to produce and publish an annual report in September of each year, containing the financial statements and information on the actual performance of the authority against BVPIs and local performance indicators?
    
    
19. Yes, they should. Local authorities should be required to produce an annual report and we consider it is reasonable that this should be produced within six months of the end of the year to which it relates. The mechanism of publishing such a report should, however, be considered carefully to ensure that the costs are justified by any additional benefits. Local authorities should be allowed maximum flexibility in the format of such reports to enable best practice to evolve. Consideration should be given to combining this annual report with other statutory requirements, for example, for each school to provide an annual report to parents.
    
    Should a summarised version of the annual report also be circulated to every household?
    
    
20. Probably not. The costs and benefits of such an exercise should be considered carefully before it is made mandatory. Research should be undertaken in those authorities which provide a summary to each household and in those which use alternative means to distribute the reports, for example, reporting them in a local council newsletter. The costs and benefits of alternative approaches to annual reporting to the electorate should then be carefully studied.
    
    What is the potential impact of this new reporting framework on the structure and content of the BVPP?
    
    
21. The new reporting framework should ensure that the two proposed documents are easier to understand and that the information contained in them will be published more promptly. However, research would be needed to ensure that the costs of producing the new documents are justified by additional benefits.
    
    Do stakeholders feel that local authorities are doing all they can to exploit the power of the internet to improve financial accountability?
    
    
22. No. We consider that there is a range of practice. We also consider that any additional costs of reporting on the internet should be justified by the benefits, in terms of improved financial accountability. The inclusion of financial accounts on a council website is desirable but would not justify the development of such a site. The financial accounts should be relatively low on a council's list of communication priorities.
    
    Should the leader, or directly elected mayor if applicable, sign the accounts on behalf of the council?
    
    
23. No. We consider that it should continue to be the responsible financial officer which signs the accounts on behalf of the council. This is because the accounts are partly a way in which the management of the authority fulfils its stewardship function to the council (see also paragraph 15 above).
    
    Should councils be required to convene an open public meeting at which the annual report and accounts are considered prior to being approved by members?
    
    
24. No. Councils should be allowed to consider whether such a meeting would be popular locally rather than making it mandatory. Schools are required to hold annual parents meetings to consider their annual reports. In some cases, the attendance at these meetings is very low. If such meetings are to be held by local authorities, we consider that it would be better for them to occur after the annual accounts have been audited (over 10% of English authorities make significant amendments to their accounts after they have been reviewed by the auditor).
    
    Should the statutory timetable for the publication of local authority accounts be brought forward to improve their usefulness for accountability and decision-making purposes, as well as to support the introduction of WGA?
    
    
25. Yes. If whole of government accounts are introduced within the agreed timetable, it would appear sensible to bring forward the statutory timetable for the publication of local authority accounts on a gradual basis. The benefits of producing more timely accounts should, however, be considered against the additional costs incurred. In the private sector, timely reports are necessary as shareholders use these to assess the entity's future cash flows. In the public sector, however, financial accounts may only serve a stewardship function and so their timeliness is less important (see paragraph 7 above). For this reason we consider that the final sentence of paragraph 53 of the paper, which claims that increased timeliness of authority accounts "can only have a beneficial effect", somewhat overstates the case.
    
    Would the introduction of summary financial statements and simplified financial reviews reduce or increase accountability for the stewardship of public funds?
    
    
26. Yes, it would probably increase such accountability. We consider that the audit report should, however, be provided in full with any summary financial statements due to its particular importance in fulfilling the authority's stewardship function. The introduction of summary financial statements may encourage a wider readership of the accounts and may give them greater understanding.
    
    Would the introduction of a new financial statement analysing resources by aims and objectives improve the presentation of information on financial performance?
    
    
27. Yes, if it replaces rather than being in addition to other financial statements. The addition of a further statement to the financial statements could lead to confusion. If there is a use for such a statement then perhaps it should be included within the Best Value Performance Plan (BVPP). Some authorities prioritise the budget against the council's key objectives and, with associated performance targets, is published in a combined BVPP/budget document.
    
    
28. It would also depend on the balance of cost and benefits. There are also a number of problems associated with this approach, for example: · different authorities have different priorities and objectives; · expenditure could be moved from one objective to another; · some activities would contribute to more than one objective; · the accounts would be less objective and could be more susceptible to manipulation.
    
    Should local authorities be required to publish a statement of internal control, including internal financial control, signed by the leader or directly elected mayor on behalf of the council?
    
    
29. Yes. The publication of an annual statement of internal control should assist in raising the profile of corporate governance amongst members and officers. This is an area in which local government has some catching up to do when compared to the NHS or central government.
    
    
30. The chief executive rather than the council leader should, however, sign the internal control statement. It is the chief executive and the senior management team which is accountable to the council for the quality of the authority's internal control system. The council is then accountable for ensuring that their management team implements an effective system.

    Other comments

31. ACCA is disappointed that the Commission's paper makes no mention of the wider aspects of environmental, social and sustainability reporting. This is now common place among larger companies in the private sector and is also undertaken by a number of local authorities. Several local authorities have developed plans under Local Agenda 21 and some are also using the Eco-Management and Audit Scheme. We consider that local authorities should be encouraged to use the Global Reporting Initiative as a sustainability reporting framework to supplement their financial reports. Discussion of environmental, social and sustainability reporting in the paper could also have built on previous work from the Audit Commission, for example It's a Small World (June 1997). ACCA has recently commissioned some research, An Exploration of Sustainability Reporting in the UK Local Government Sector. We would be happy to provide a copy of the research report to the Commission as soon as it becomes available.
    
    
32. We do not fully agree with the statement at paragraph 110 that the "surpluses or deficits generated by local authority activities, and the level of general reserves, are powerful indicators of financial health and the success of members and officers in exercising stewardship over public funds". This statement ignores the fact that local authorities may be constrained as around 80% of their income comes via central government. Thus authorities do not have full and effective control over their income. In addition, financial surpluses may arise due to a failure to provide the agreed level of services and deficits may be an indication of a rapid response to a change in local needs.
    
    
33. At various points in the Commission's paper, councillors are likened to members of private sector company boards. We do not consider that such a comparison is reasonable. Board members are appointed for their skills and competencies and are specifically charged with managing the various functions of the company. Council members, on the other hand, are elected and do not usually have the particular skills or experience which would be necessary to effectively challenge the executive management of the authority. Their prime concern is with the quality of services provided and ensuring that executive management carry out their decisions in a cost effective manner.
    
    

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