“Auditors have been encouraged to scrutinise council accounts to ensure that balance sheets are not being manipulated in order to justify commercial ventures.
The National Audit Office has released a new guidance note for local government auditors, covering a range of issues thrown up by recent changes in regulation and council practice.
The section on commercialisation has been produced in response to the growth in council commercial activity as a means of dealing with substantial funding reductions, the note said.
“Auditors should be mindful of any incentives to achieve a particular balance sheet position that arise from an authority’s commercial activities when planning their audit work,” the note said.
The note also brought auditors’ attention to the changing nature of investment activity, primarily in commercial property, carried out through asset-backed joint-venture arrangements, rather than traditional debt-backed approaches.
It said: “The scale and nature of authorities’ commercial activity brings both risks to the auditor’s value for money arrangements conclusion and the opinion on the financial statements.
“The former covers the reasonableness of decision making, including the relevant risk assessment, appropriate skills of the authority and the appropriateness of advice.”
Councils need to consider the impact of commercial ventures both on the accounts of any standalone entities, as well as the group accounts, it said.
The note also warned councils that the general power of competence, introduced in the Localism Act 2011, does not give them unlimited powers over their decisions relating to commercial ventures.
It said: “Auditors in considering their value for money arrangements conclusion will need to assure themselves that schemes have been entered into following appropriate legal and financial advice, having regard to Wednesbury principles of reasonableness.
“While the general power of competence has made it easier for authorities to undertake commercial activity, this power does not override the need for authorities to comply where there is already an existing legal duty, for example, compliance with the capital financing regulations.”
Elsewhere,the NAO note encourages auditors to ensure that councils are complying with rules allowing councils to use certain capital receipts on revenue funding.
“With pressure to find revenue funding authorities may incorrectly apply the guidance to apply capital receipts for a revenue purpose contrary to the requirements of the capital financing regulations,” the NAO said.
In March last year, auditor KPMG warned that warned that plans by Northamptonshire County Council to spend £40.9m in capital receipts on transformation projects were “not on any view achievable”.
Auditors,the NAO said, should determine whether councils have complied with the capital receipts flexibility guidance, and review the “reasonableness and realism” of councils’ assumptions.
“Auditors should be alert to the risk that authorities may misapply the flexibility to convert ineligible capital receipts to support their general fund expenditure,” it said.
The NAO note also reiterated the role of the auditor in cases where councils might decide to issue a section 114 notice.
In situations where a section 114 notice could be issued, auditors should seek discussions with the NAO and “engage with the section 151 officer regarding consequent courses of action should the section 151 officer’s actions not be successful in averting an unbalanced budget.”
Stephen Sheen, managing director of local government finance consultancy Ichabod’s Industries, said: “Auditors are required to have regard to the guidance when planning and carrying out their audits.
“This doesn’t mean that they have to agree with it, but they must have considered it in arriving at any position that they take on the relevant issues.”