APPENDIX C - INTRODUCTION OF AN AUDIT COMMITTEE OR EQUIVALENT : Executive on 27/06/2006

Waverley Borough Council Committee System - Committee Document

Meeting of the Executive held on 27/06/2006
APPENDIX C - INTRODUCTION OF AN AUDIT COMMITTEE OR EQUIVALENT

Summary & Purpose

Councils in England and Wales are being encouraged to set up an Audit Committee, or to introduce arrangements that would ensure the roles and functions of an Audit Committee are fulfilled. The District Auditor, in his Annual Audit Letter (which is included elsewhere on the agenda) has made comment that Waverley’s internal control arrangements would be enhanced and brought up to date with the introduction of such a Committee. Comprehensive Performance Assessment scores are also improved by the existence and the sound working of such a Committee.

This report therefore sets out the purpose and scope of an Audit Committee and makes recommendations on a model to be developed into a working solution. The Executive is recommended to approve the model and agree an appropriate date for implementation.

APPENDIX C

Waverley Borough Council

EXECUTIVE – 27TH JUNE 2006

Title:

INTRODUCTION OF AN AUDIT COMMITTEE OR EQUIVALENT

[Wards Affected: All]

Summary and purpose:

Councils in England and Wales are being encouraged to set up an Audit Committee, or to introduce arrangements that would ensure the roles and functions of an Audit Committee are fulfilled. The District Auditor, in his Annual Audit Letter (which is included elsewhere on the agenda) has made comment that Waverley’s internal control arrangements would be enhanced and brought up to date with the introduction of such a Committee. Comprehensive Performance Assessment scores are also improved by the existence and the sound working of such a Committee.

This report therefore sets out the purpose and scope of an Audit Committee and makes recommendations on a model to be developed into a working solution. The Executive is recommended to approve the model and agree an appropriate date for implementation.

Environmental implications:

There are no direct environmental considerations arising from this report, but it should be noted that an Audit Committee would be charged with responding to any audit or inspection reports that had an implication for environmental policies and services.

Social / community implications:

There are no direct considerations arising from this report, but it should be noted that an audit committee would be charged with responding to any audit or inspection reports that had an implication for social/community policies and services. Additionally, the introduction of an Audit Committee would have beneficial consequences in that the public would be able to gain greater assurance that the Council is ensuring its policies and actions are appropriate and give value for money.

E-Government implications:

As with environmental considerations, whilst there are no direct implications, an audit committee would be charged with responding to any audit or inspection reports that had an implication for e-government policies and services

Resource and legal implications:

The direct resource implications would arise from potentially increased members’ expenses (special responsibility allowances and mileage claims), but more significantly the indirect implications are the officer time spent in dealing with audit matters, administering the committee arrangements and implementing decisions of the committee. It is anticipated that staff costs will be met from existing budgets.
Introduction

1. Following a number of high profile frauds within the private sector, such as Enron, various reports have been issued in recent years concerning corporate governance arrangements and requirements. This has led commercial organisations to introduce Audit Committees to oversee governance arrangements. Voluntary and charitable organisations have followed suit.

2. Within the public sector, many organisations are required to have such a Committee. Local government is almost alone in not being required to have them, but recently Comprehensive Performance Assessment (CPA) has raised the issue. One of the key lines of enquiry is internal control, and Audit Committees or equivalent are propounded as a core feature of a sound, modern system of corporate governance.

3. CPA involves consideration of an authority’s internal control arrangements. To obtain the maximum score, it must be demonstrated that the authority has a sound method of delivering the core functions of an Audit Committee. There are good reasons for introducing one at Waverley, quite apart from seeking to score well in CPA, which are outlined in this report.

4. CIPFA has therefore recently published “Audit Committees: Practical Guidance for Local Authorities”, which is based upon research. It is, by definition, tailored to the needs and circumstances of local authorities, whereas other guidance that is available for commercial organisations is not wholly appropriate and would need to be modified. This report has been based on CIPFA’s guidance. The full guidance can be obtained upon request from the Audit Manager.

5. This report sets out the case for an Audit Committee at Waverley. The Executive is asked to consider the suggested solutions and recommend to Council that either a Committee be introduced, or that an alternative solution be implemented, with effect from the start of the 2007/08 financial year. There would be much detail to be considered and resolved, which could not be resolved at this meeting of the Executive and it is envisaged that further reports will be necessary to report on the progress made in the implementation of the selected solution.

6. Throughout the report, where reference is made to an Audit Committee, this reference (unless clearly to the contrary) also encompasses the option of ensuring an Audit Committee’s functions are delivered by alternative means. Similarly, where reference is made to the District Auditor, this is intended to encompass any future change should Waverley’s appointed auditor ever be a commercial auditing company/partnership.

Purpose of an Audit Committee

7. An Audit Committee is regarded as a sound means of bringing independent, effective assurance into the Council’s corporate governance arrangements. This assurance would be in respect of:
· Risk management framework
· Control environment and arrangements
· Financial performance
· Non-financial performance (processes and controls)
· Financial reporting

To achieve this, the work of the Committee would include, but not be restricted to, considering and reviewing the risk management arrangements, reports and reviews on performance and review of the processes for preparing the Council’s statement of accounts, and ensuring internal and external audit recommendations are implemented appropriately.

8. It would bring about greater awareness within the Council of the need for internal control and the implementation of both internal and external audit recommendations. Public confidence may also be bolstered, as internal check would be increased. It would also, as a consequence, add weight to internal and external audit work and any other internal or external reviews/inspections. The essential matter to consider is the independence of the Committee, which has significant implications for its membership (see also the section in this report concerning membership of an Audit Committee).
9. In calling it an “Audit Committee”, one could be led into thinking it only deals with auditors. Whilst the Audit Manager and the District Auditor, and the Director of Finance, would be key contacts, drivers of the committee’s business and sources of advice, it would also require contact with many other managers of the Council, including service managers. It would also have a role in challenging the work of both the Executive and the various Committees, including overview and scrutiny.

Core functions (including current arrangements for their fulfilment)

10. The core functions of an Audit Committee, what they entail and how they are currently performed are set out in the following table:

Function/scope	Description	How performed at present
Risk management arrangements, the control, environment and associated anti-fraud and anti-corruption arrangements	Consider the effectiveness of the authority’s arrangements	Strategic risks are discussed and agreed with the Executive and the Shadow Executive. Operational risks are defined and agreed at officer level, and reported to the Executive. The risk management policy is approved by the Executive, and is open to call-in by O&S and ratified by Council. Plans exist to present 2006 review of risk management to O&S beforehand. Anti-fraud and anti-corruption policies are approved by the Executive and full Council. The Director of Finance reviews them, and a report is made to members if changes are recommended. Other codes of conduct relating to staff are similarly reviewed and issued by the Head of Personnel and Central Services in consultation with Management Team.
Action is taken on risk-related issues	Seek assurances from auditors and inspectors that action is being taken	Internal audit recommendations are agreed with relevant managers, and an action plan prepared which is considered by Director of Finance and Managing Director. Recommendations are followed up with managers either at next audit (where annual reviews occur) or approx. six months after final report issued. Two Local Performance Indicators are published: % recommendations agreed and % implemented. External audit recommendations similarly agreed with relevant managers and Director of Finance. Annual Audit Letter, which does not contain detailed recommendations, presented to the Executive and published on the Council’s website. Officers monitor actions to mitigate risks (likelihood and impact); changes reported to Executive (see above).
Assurance statements	Review to ensure these properly reflect the risk environment and action necessary to improve it	Statement on Internal Control approved by the Executive and Council along with the Statement of Accounts. Risk management as described above. Annual Internal Audit report presented to the Executive. Annual Audit Letter considered by Leader, relevant portfolio holder, Managing Director and Director of Finance prior to presenting to Executive. Inspectorate reports discussed and agreed by service managers, and reports made to Executive, and O&S committees as appropriate.
Internal audit strategy, plan and performance	Approve (but not direct) strategy and plan; monitor performance	Internal Audit plan prepared in consultation with senior and chief officers; agreed between the Audit Manager and the Director of Finance. Plan variations agreed between Audit Manager and Director of Finance and summary reported along with summary of performance within the Annual Internal Audit report. Audit strategy approved by Executive; reviewed by Audit Manager and changes considered necessary recommended to Executive.
External audit plan	Comment upon depth of work	Details discussed with District Auditor by the Director of Finance, who liaises with the portfolio holder. Reported to Executive.
Internal audit reports	Review summaries and seek assurances that action taken as necessary	As outlined above.
Audit Manager’s annual report	Receive and consider	Currently presented to the Executive.
Reports of external audit and other inspection agencies	Receive and consider	As outlined above: details of external audit reports dealt with by officers and not presented to members except Annual Audit Letter. Reports on inspections taken to Executive, and O&S Committees as appropriate.
Relationships between internal and external audit, inspection agencies and other relevant bodies	Ensure relationships are effective and audit process is actively promoted	Officer-level discussions take place between internal and external audit; external audit uses internal audit’s work in forming their opinion. Inspection agencies tend to come to Waverley infrequently and tend to specify who they wish to see and what work they wish to do. Members (Executive/O&S) are advised of planned inspections, and inspectors meet key members as part of their planning and fact-finding.
Financial statements, external auditor opinion and management response	Consider financial statements and ensure suitable accounting policies and treatments are followed and any changes justified; provisions are justifiable; external auditor’s comments on significant adjustments and internal controls	Statement of Accounts presented to the Executive for approval by Council. Detailed progress on actions is not reported to members other than in the Annual Audit Letter; otherwise these are monitored and implemented by the Director of Finance in conjunction with Managing Director/ Management Team.

The alternative to an Audit Committee

11. Both CPA and the CIPFA Code of practice for Internal Auditors in Local Government refer to an Audit Committee “or equivalent”. This acknowledges that some authorities might consider that such a Committee might not be necessary and the necessary functions could be undertaken by alternative means.
12. One alternative would be to formalise and endorse the current arrangements, with appropriate modifications. This, though, would still leave a situation where there is no member involvement in some of the functions. In the Use of Resources assessment, the District Auditor acknowledged that other Committees, such as Overview and Scrutiny Committees, undertake some of an Audit Committee’s functions. The Internal Audit Charter and Strategy were both approved by the Executive, and the Audit Manager’s annual report is also presented to the Executive.

13. The Executive also deals with the District Auditor’s Annual Audit Letter and Annual Plan, the various assurance statements (such as the Statement on Internal Control after it has been considered by the Corporate Overview and Scrutiny Committee) and approves the risk management policy. There are plans to refer the latter to Overview and Scrutiny Committees in order to improve the element of challenge. What is arguably missing in some of these matters is that the opportunity to challenge is missing; that could be addressed by opening up overview and scrutiny business to encompass the financial statements, assurance statements etc.
14. The District Auditor, again in the Use of Resources assessment, made specific reference to the following functions of an Audit Committee that are not currently undertaken with any member involvement:
· Approval of/comment upon the Internal Audit Plan
· Monitoring of the Internal Audit Plan
· Consideration of summary internal audit reports

The latter function would include taking action to follow-up implementation of recommendations made in internal audit reports.

15. Therefore, it may be regarded as a reasonable alternative that with the opening up of overview and scrutiny business, and inclusion of the issues in the preceding paragraph in the Executive’s business (subject to call-in from Overview and Scrutiny Committees) that Waverley could demonstrate that the functions of an Audit Committee would be fulfilled.

An Audit Committee at Waverley

16. With the introduction of an Audit Committee, audit and governance matters would become part of formal Council business, which (as outlined above) would provide backing to, and raise the profile of, such matters. It has been the case that in some authorities, the Executive, sitting separately to discuss audit and governance issues, has assumed the role of an Audit Committee. However, such a solution does not meet in full the requirement for independence, and with the single party Executive there is a risk that it would not be regarded as independent of party policies and preferences.

17. Some other authorities have assimilated Audit Committee roles into their Standards Committee Terms of Reference. Whilst this reduces the number of Committees, and may be justified on the grounds that standards issues are allied to audit and governance issues, there are differences (see also paragraph 23 below). CIPFA guidance is clear in that it says that the Audit Committee should be able to review the work of any Council Committee, and this would include the Standards Committee. As the Standards Committee is responsible for ensuring there are high levels of good conduct and probity amongst members, it forms an integral part of the system of internal control. This is exactly what an Audit Committee is responsible for reviewing, and independence would arguably be compromised if the Standards Committee were also charged with audit responsibilities.

18. Analysis therefore suggests that a separate Committee would be the optimum solution. It would also provide the best form of compliance with CIPFA guidance. The key aim would be to have as many members as possible who are not also members of any of the existing Committees, including the Executive, in order to avoid conflict of interest.

19. It would be up to Waverley to agree precisely which of these functions it would wish an Audit Committee to undertake. CIPFA has prepared a model set of terms of reference, and these are attached at Annexe 1, which are recommended for adoption at Waverley should it be agreed that an Audit Committee is to be introduced as these are considered to represent current best practice for local government.

Audit Committee responsibilities and Section 151 responsibilities

20. If an Audit Committee is established, its members must clearly understand the extent of their responsibilities. For example, whilst it would have a role in approving the Internal Audit Plan, the Director of Finance is the Council’s Section 151 Officer and it is part of his statutory duty to ensure that the Council has sound financial arrangements. This includes determining whether Internal Audit coverage is appropriate, and in order to fulfil his statutory duty the Committee would need to understand that it is there to support the Director rather than direct his actions and decisions. Therefore it would not be appropriate, for example, for it to determine the precise level of resources to be applied to an audit review. There are also operational reasons for such decisions to rest with management, as flexibility is required as the Plan may have to be adjusted in the light of developments and unforeseen events. It would be appropriate for the committee to define priorities, which would guide amendments to the Plan that may need to be made by the Audit Manager (in consultation with the Director of Finance).

Other Audit work not covered by the Audit Committee

21. There would be certain elements of both the Audit Manager’s and the District Auditor’s work that would not be reported to an Audit Committee. Both offer the service of support and advice, which is outside their statutory roles. Managers commission this work for example, they may need an independent review or may have issues on which they require an audit view. In such circumstances the decision to report such work to the Committee would rest with the relevant managers, as it is, strictly speaking, non-audit work.

Wider governance responsibilities

22. The plans and programmes of the District Auditor would be presented and discussed. Whilst the ultimate level of input will be restricted because of national requirements laid down by the Audit Commission, the Committee could ask that certain matters be investigated. The Committee would receive the District Auditor’s reports, and would have access to the District Auditor to discuss those reports and receive explanations. It could therefore contribute to the response of the Council to the District Auditor’s Annual Audit and Inspection Letter. It could also act as a co-ordinating body, seeking to resolve any differences in aims and intents between the District Auditor’s and internal audit’s work so as to increase efficiency and thus value for money.
23. In fulfilling its functions, the Audit Committee would need to review such strategies as:
· Risk management
· Assurance framework e.g. Statement on Internal Control
· Waverley’s codes of governance, standards and conduct
· Arrangements for securing value for money
· Anti fraud and corruption arrangements, “whistleblowing” policy etc.

The Council has a Standards Committee, which is required by law to deal with matters on member conduct. There is a synergy between the work of the Standards Committee and an Audit Committee, and the two would need to work in harmony. The key difference would be that the Standards Committee is responsible for approving and recommending to Council appropriate standards and codes of conduct, whereas an Audit Committee would be responsible for assessing their adequacy and implementation and making recommendations for improvement.

24. In reviewing financial statements, such as before the Council approves the Statement of Accounts, a view can be given on appropriate accounting policies, treatments and provisions included in the accounts. It will also be able to comment on responses made to the District Auditor’s recommendations and concerns raised in previous years.

Membership of an Audit Committee

25. There are certain central issues that would need to be resolved, as it is important that an Audit Committee has access to adequate expertise and skills e.g. financial, inquisitive, ability to probe, independent attitude etc. CIPFA suggests that authorities could consider appointing co-opted members, however the Audit Committee works on Council-focused business and officers believe co-opted members are not appropriate.

26. The work of an Audit Committee is not as concerned with personal conduct. Whilst there may be a need to deal with allegations of financial or other misconduct from time to time, the normal work is concerned with management of the Council. Given this difference and the following comments about the personal qualities required, appointments to the Committee should be from within Waverley’s own elected members and that the Committee should then be permitted to call for specialist advice as it considers necessary.

27. Independence from the Executive and other Committees of the Council is desirable. At present there is only one member who is not a member of any of the Council’s Committees. This would pose difficulties, and officers therefore recommend that the members in the key decision-making roles only be excluded. This would exclude members who are either members of the Executive, the Chairmen and Vice-Chairmen of the Overview and Scrutiny Committees, and members of the Licensing and Regulatory or Standards Committees. At present, this would leave 25 members eligible for membership. Members are asked to consider this suggestion.

28. The Audit Committee would ideally consist of members who possess relevant personal qualities and knowledge. The personal qualities are those of being able to question, probe and obtain clarification on complex issues. Relevant knowledge includes an understanding of the requirements of legislation and local arrangements, risk management, internal control, the Council’s core activities, accounting issues and regulation and compliance. A strong chairman is required, and discussions at meetings need to be free and open.

29. It is for the Council to determine the number of members that should sit on its Audit Committee, should it decide that this is the appropriate option to pursue. CIPFA suggests that if there are too few members, political balance might be difficult to achieve. HM Treasury guidance for central government suggests between three and five members. The quorum also needs to be defined. Three is perhaps too small, which leads to the suggestion that five would be most appropriate.

Suggested Work Programme

30. In its guidance, CIPFA states that authority's with Audit Committees generally hold meetings four times a year. CIPFA also acknowledges that authorities may determine the frequency and timing of its meetings according to its own needs. Taking four meetings per year as a starting position, the Committee’s work programme might be as follows:

March/April Consideration of internal and external audit plans

Update on internal audit reports issued and acceptance/implementation of recommendations

Details of any recent District Auditor reports and actions planned including Annual Audit Letter

June Consideration of statement of accounts

Consideration of Statement on Internal Control

Update on internal audit reports issued and acceptance/implementation of recommendations

November Annual report of Audit Manager, including plan variations/outturn for previous financial year

Report on risk management policy and risk reduction plans

Update on internal audit reports issued and acceptance/implementation of recommendations

January Update on internal audit reports issued and acceptance/ implementation of recommendations

31. However, members may wish to consider whether this arrangement is appropriate for Waverley or whether it would wish to vary this to an alternative such as two scheduled meetings per year, with any necessary additional meetings being arranged on an ad hoc basis as appropriate.

Conclusion

32. The District Auditor regards the Council as not following best practice, and its CPA scores will be adversely affected should it continue to operate without an Audit Committee, or equivalent. A separate Audit Committee would best deliver the aims and benefits of having such a Committee.

33. Introduction of an Audit Committee could be implemented at the earliest opportunity.

34. The frequency and timing of Audit Committee meetings will need to be determined by members, taking into account the guidance from CIPFA. The number of meetings needs to be determined. Whilst CIPFA suggests four per year, it might be considered that fewer meetings, supplemented with ad hoc additional meetings would be sufficient.

35. There are matters to be considered concerning the membership of an Audit Committee, not only as to the personal qualities and knowledge of its members but also achieve the desired independence from the decision-making roles and executive functions.

Recommendation

It is recommended to the Council that an Audit Committee be introduced and that consideration be given to the following measures:-

a. whether an Audit Committee should consist of five members;

b. whether the membership of an Audit Committee should exclude members of the Executive, Chairmen and Vice-Chairmen of Overview and Scrutiny Committees, and members of the Licensing and Regulatory and Standards Committees;

c. the frequency and timing of meetings;

d. an appropriate implementation date;

e. the work programme, as set out at paragraph 30 of the report; and

f. whether the Audit Committee should have access to specialist advisers, as considered necessary.

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Background Papers (DoF)

There are no background papers (as defined by Section 100D(5) of the Local Government Act 1972) relating to this report.
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CONTACT OFFICERS:

Name: Mr M Hill Telephone: 01483 523240

E-mail: mhill@waverley.gov.uk

Mr P Wenham Telephone: 01483 523238

E-mail: pwenham@waverley.gov.uk

Comms/exec/2006-07/052