Internal Audit and external audit – joint working

Report: 9
Date: 22 September 2006
By: Chief Executive and Clerk

Summary

This report sets out how the District Auditor (appointed by the Audit Commission) and MPA Internal Audit plan to work together to ensure that there is optimum audit coverage and effective coordination of audit activity during 2006/7 and future years. It also explains steps being taken to ensure that the District Auditor can rely on the work of MPA Internal Audit in the future, having regard to the recently introduced International Standards on Auditing (UK and Ireland) – ISA(UKI)s.

A. Recommendation

That the Committee notes the respective roles of the District Auditor and MPA Internal Audit and endorses their proposals for working together from 2006/7 onwards.

B. Supporting information

1. The work conducted by the Audit Commission’s appointed District Auditor to audit the accounts of the Authority needs to meet the requirements of the ISA(UKI)s which apply to accounts prepared for the year 2005/06 and afterwards. Compliance with these standards has had an impact on the way the District Auditor places reliance on the work of Internal Audit.

Role of the District Auditor

2. The District Auditor, appointed by the Audit Commission, conducts the audit in line with the Code of Audit Practice, approved by Parliament in 2005. The auditor’s objectives are to review and report on:

• the Authority’s financial statements and its statement on internal control; and
• whether the Authority has made proper arrangements for securing economy, efficiency and effectiveness in its use of resources.

3. To support the work on the annual financial statements, the District Auditor is required, among other things, to obtain an understanding of significant financial systems. For these purposes, significant systems are defined as being those whose failure to process transactions or produce balances correctly could lead to a material misstatement in the financial statements that would lead the auditor to qualify the audit opinion.

4. It is not the District Auditor’s role to direct Internal Audit, nor to specify its work. These are matters for the Authority, having regard to its own assessment of risk and the CIPFA Code of Practice for Internal Audit. Nevertheless, when conducting work on the annual financial statements, the District Auditor may take into account the work of Internal Audit, including any relevant systems documentation and testing of significant financial systems, provided that the work meets the requirements of the ISA(UKI)s. The District Auditor must be able to re-perform a sample of tests carried out by Internal Audit in order to place reliance upon its work.

Role of MPA Internal Audit

5. Internal Audit is defined as "an assurance function that primarily provides an independent and objective opinion to the organisation on the control environment comprising risk management, control and governance by evaluating its effectiveness in achieving the organisation’s objectives. It objectively examines, evaluates and reports on the adequacy of the control environment as a contribution to the proper, economic, efficient and effective use of resources." (Chartered Institute of Public Finance and Accountancy (CIPFA) 2003 Code of Practice for Internal Audit in local government).

6. In order to carry out its assurance function effectively, Internal Audit uses a risk-based approach to determine how best to measure the adequacy and effectiveness of the control environment in the MPS. This risk based approach aims to ensure that the Treasurer’s responsibilities under s127 of the GLA Act 1999 for the proper administration of its financial affairs is fulfilled and that an effective internal audit service is provided to the Authority. Currently Internal Audit has identified some 200 distinct and separate business and financial systems in the MPS that make up the control environment. These are ranked according to their inherent risk and in each financial year the current risk is calculated and used to draw up the annual audit plan for system reviews that is subsequently approved by the Corporate Governance Committee.

Impact of support to the District Auditor on the Internal Audit Programme

7. The amount of Internal Audit staff resource needed to complete the programme of work is calculated on the premise that only a limited number of systems are reviewed each year and that over a rolling period of five years every system will be reviewed at least once. The highest risk systems, including many of the systems that the District Auditor considers to be material to the annual accounts, are planned for review three times in the five-year cycle. Thus, full system audit reviews are only likely to be conducted on approximately a third of the material systems subject to annual review by the District Auditor in any given year. Without a significant increase in staff available for systems audit work it would not be possible to conduct systems audits of all material systems in each year.

8. An increased amount of Internal Audit work on key material systems for the annual accounts has the potential to reduce the extent of required external audit work, where the District Auditor is able to place reliance on Internal Audit’s work. However, time spent by Internal Audit on auditing key material systems reduces the time available to complete other audits within the risk based plan. Assumptions about the relative costs of internal audit compared to external audit, which underpin the approach to audit cooperation generally practiced in local government, are not necessarily valid in the MPA. Furthermore, the potential savings in the external audit fee could prove to be marginal unless the MPS delivers concurrent improvements in the system of internal control and its processes to produce accurate financial statements.

The way forward - working together to manage the audit process

9. The District Auditor and Internal Audit propose a number of steps to ensure an appropriate balance to address the differing needs of the Authority and external audit.

1. The District Auditor and Internal Audit are committed to a more proactive and earlier discussion on internal audit planning to ensure that wherever possible sufficient resources are allocated to the audit of high-risk material financial systems.
2. The District Auditor will provide Internal Audit with full details of material financial systems and the key controls in those systems that need to be tested each year. Any change in that requirement will be notified to Internal Audit at the beginning of the financial year in question.
3. Internal Audit will set aside a guaranteed number of audit days in each financial year to conduct audit tests on the material systems identified by the District Auditor. It is proposed to increase the current time allocation from 40 days to 60 days. Internal Audit will notify the District Auditor of any material systems or key controls that cannot be tested by the December deadline.
4. Internal Audit will conduct full systems audit reviews of those material systems that are identified in the annual programme through the risk assessment process used to identify the internal audit need.
5. The Director or Deputy Director of Internal Audit will meet monthly with the District Auditor’s Audit Manager to discuss progress with joint working, audits and investigations.

C. Race and equality impact

There are no implications for race and equality in these proposals.

D. Financial implications

The reliance to be placed by the District Auditor on the work of internal audit is a significant factor in the District Auditor’s risk assessment for annual audit planning. Progress in this area, along with concurrent improvements in the Authority’s system of internal control and its processes to produce accurate financial statements as well as other specific actions previously identified in the District Auditor’s Plan (for example further development of the Managed Audit agenda), should contribute to a reduction in the audit fee over time.

E. Background papers

None

F. Contact details

Report author: Peter Tickner, Director of Internal Audit, MPA and Neil Gray, Audit Manager, Audit Commission

For information contact:

MPA general: 020 7202 0202
Media enquiries: 020 7202 0217/18

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