Local government property investment – the auditors’ roles

“Are these the magic money trees? The office blocks, shopping centres and petrol stations currently filling up the local government property portfolio with their promise of a harvest abundant enough to keep the fruit bowl full for years to come? Quite possibly, with a good soil for rooting, plenty of sunshine and lots of green-fingered attention. But also quite possibly not. Which is why you can expect a visit from your auditors, once they have remembered where they put their wellies.

It is a common scenario for auditors to have no knowledge of a substantial and risky project until it is too late for them to have any influence over it. Commercial sensitivities often lead to projects being run on a “need to know” basis, with external auditors joining internal auditors, scrutiny committees and sometimes even the section 151 officer on the other side of a firmly locked door.

The auditor may only find out about a project when the ink is drying on the contract, when there doesn’t seem much more to do than offer a sheet of blotting paper.

However, there is still a lot that the auditor can do that would be of benefit, even if there is nothing to be critical about.

For instance, the Spelthorne Borough Council £360m purchase of the BP campus with new borrowings of £377m against a budget requirement of around £13m is such a huge transaction that its mere existence surely justifies a public interest report from the auditors to reassure the local population that their new role as BP’s landlords will not weigh heavy upon them. There is no reason why public interest reports have to be reserved for bad news.

Unfortunately, auditors are not particularly keen on bringing good news. The best you will get is “negative assurance”: a declaration that, based on the investigations carried out, there is nothing that provokes the need for criticism. But this would still be a valuable contribution and is arguably what is required by the reporting duties in Schedule 7 of the Local Audit and Accountability Act 2014.

The least that we can expect is that auditors will eventually say enough to manage their reputation risk – limiting the possibility that someone at some point in the future could ask “where were the auditors?”. A couple of paragraphs in the audit letter affirming that it is an authority’s responsibility to make its own investment decisions and summarising the less reliable judgements by which those decisions have been taken.

So what will the auditors be particularly interested in?

Legal Powers

Since the introduction of the general power of competence, people seem more relaxed about identifying the legal powers supporting a decision. However, it is still important to know what powers are being exercised, particularly in understanding the implications of the limitations on those powers for a particular proposal.

For instance, the general power comes with restrictions on charging other than to recover costs and requires commercial activity to be run via a company. And the investment powers in the Local Government Act 2003 only extend to purposes relevant to an authority’s functions or the prudent management of its financial affairs. Advice confirming legality will be expected.

It is sometimes forgotten, by those without a legal background, that even if a power can be identified, then that power has to be exercised reasonably under the Wednesbury rules. Auditors will look for legal advice being properly grounded.

If an authority is borrowing to fund its purchases, there may also be questions about the propriety of borrowing to invest. Not so long ago this is something that would have rung alarm bells across the audit community. Judging by their appearance before the Public Accounts Committee in 2016, though, it does not seem a matter that DCLG and the Treasury are overly concerned by.

Finally, how are these projects integrated into the Prudential Framework? Arguments can be put that asset prices will rise to more than cover the cost of acquiring property and making good its depreciation, such that Minimum Revenue Provision (MRP) is not needed. But this is risking a potentially major funding problem if the value/cost relationship shifts adversely in the future. How can an authority demonstrate its legal duty to act prudently?

Value for Money

Auditors will be concerned to examine all the significant judgements, estimates and projections involved in a decision to invest. They will also review accounting treatments to ensure they align costs and benefits appropriately and look critically at funding and financing arrangements.

Exit strategies will also be relevant, particularly noting that if rental income falls sale of a property will only generate a capital receipt rather than revenue income that might fill the gap in the budget.

Any reporting in this area will be restricted to the adequacy of the arrangements put in place by the authority to achieve value for money and will not provide any comfort that it has actually been achieved.

Decision Making

Auditors will check that the authority has complied with its democratic framework and schemes of delegation, particularly if the proposal has proceeded on a “need to know” basis.

So, if you are in the process of bulking up your property portfolio, prepare for the muddy tread of your auditors as they come to gaze sceptically upon your magic money tree.

Stephen Sheen is the managing director of Ichabod’s Industries, a consultancy providing technical accounting support to local government.