Open up, the auditor's here

Public-sector finance: council-funded bodies could soon come under the same scrutiny as private ones.

Local authority-controlled companies are likely to face tougher auditing procedures as a result of a Treasury review of audit standards in the public sector to be published soon. There has been growing concern at disparities in auditing standards between different types of public and publicly funded bodies.

The Audit Commission is worried by allegations that arm's-length companies have been used to circumvent restrictions on councils' political activities. There have been further allegations that some councillors have been employed by these companies and permitted to take excessive time off for council duties, in effect making them professional politicians by a back-door route.

The Audit Commission is constitutionally unable to consider the operation of council-funded bodies but will welcome the opportunity to do so, a spokesman says. "They are weekly audited. There have been local audit issues, but we don't have the remit to investigate," he adds.

The Treasury review arose from evidence submitted by the Chartered Institute of Public Finance and Accountancy (Cipfa) to the Nolan Committee, arguing that audit arrangements for quangos needed to be brought into line with those of other public bodies. The Audit Commission has specifically requested that tougher audits apply to local authority companies.

While councils' own activities are subject to rigorous scrutiny from the District Auditor and internal auditors, less rigorous procedures apply to funded bodies, including companies controlled or influenced by local authorities. It is only in exceptional circumstances that internal auditors will look at outside bodies, and District Auditors have no authority to examine their operations.

Funded bodies are subject to an annual audit, comparable to a private- sector audit, but this is not enough to establish if they are properly and effectively run, says Shelley Thornton, senior technical manager of Cipfa. "There is a disparity. Local authorities are subject to the public audit model, with a District Auditor appointed by the Audit Commission, giving in-depth examination of probity, propriety, legal issues and value for money."

The audit standards of a funded body, however, are usually more lax. "It depends on the controls the local authorities put in place, and what they require from them," says Ms Thornton. In her opinion, councils should demand open access to all accounts and management records.

The question of how funded bodies are audited has become more important, with local authorities expected to adopt more of an enabling role, buying in services from the private and voluntary sectors. Care in the community has increased the proportion of council budgets that goes to outside bodies, such as to charities that provide day care. But the voluntary sector also includes many companies that operate in politically sensitive areas, such as welfare rights and housing advice groups.

Local authorities are increasingly expecting funded bodies to sign up to service level agreements, which specify the outputs to be achieved. It can be argued that if a funded body is achieving specified outputs, then it is less important for its operations to be strictly audited. While this may deal with questions of efficiency and value for money, it overlooks the need to ensure probity in the use of public money.

It may be that smaller council-funded bodies can learn from the accounting regime being introduced for major charities in the new financial year, which will include a statutory audit obligation. Charities with over pounds 250,000 income per year will be required to adopt accruals accounting systems.

"Before March this year there is no established framework for accounting in charities," a Charity Commission spokesperson says. "Little charities have to prepare accounts but don't have to send them to us unless we want them. That deals with 80 per cent of charities. The under pounds 10,000 [per annum] brigade are afforded a very soft-touch regime."

But the Charity Commission is also publishing new guidelines on how smaller charities should prepare accounts, including the greater involvement of auditors on an ongoing basis. This could form the basis of improving audit standards in many smaller council-funded bodies.

"A full audit should provide added value not merely by checking the figures, but by identifying and concentrating on areas of risk," says Kate Kirkland, director of the charities group of the accountancy firm BDO Stoy Hayward, which has many charity clients.

"To do this the auditor needs to know the charity, understand what it is trying to achieve, where its money comes from and what internal control systems are in place to minimise risk and control expenditure. The real value of the audit process lies not just in the verification of accounts and the points raised in the management letter, but in the value that is added by innovative ideas and practical advice for improving existing financial systems and controls that will only come from those able to take a proactive role."

Many small organisations have dramatically changed their character and management practices, so new auditing arrangements are unlikely to be a problem. But some council-funded bodies have escaped the impact of the public-sector revolution. With about pounds 1bn being spent by local authorities on outside bodies each year, it is an oversight that needs to be put right in a hurry.