Local Government: Results of the 2007–08 audits

1. EXECUTIVE SUMMARY

1.1 Introduction

Local governments are recognised in the State’s Constitution as the third tier of government. While administered under the Local Government Act 1989 (the LG Act), each council operates autonomously and is directly accountable to its constituency.

This report provides the results of our annual audit of each council, the entities they control, and each regional library corporation (RLC).

Issues of financial sustainability bear directly on the audit process, as we evaluate annually whether a council is still a going concern. However, we recognise that our annual assessment of financial sustainability is a by-product of our audit process and that the scope is limited to reviewing key financial ratios. The assessment is, nevertheless, of interest to those governing and managing councils—councillors and executive management—and to those who hold councils to account for their financial stewardship.

In Part 5 and Appendix D of this report we have included a detailed analysis of financial sustainability. This analysis provides data for each council and RLC, and a sustainability risk rating based on the five key indicators that we commenced reporting in 2003–04.

1.2 Results of audits

Local government entities are required by the LG Act to prepare financial statements, standard statements and performance statements. The financial, standard and performance statements must be independently audited, and an audit opinion expressed on each report. The statements and the accompanying audit opinions are included in the annual report for each entity.

The independent audit opinion adds credibility to the financial and other reports by providing reasonable assurance that the information in the statements is reliable.

A qualified audit opinion means that a statement has not been prepared in accordance with the relevant reporting framework and, therefore, is likely to be less reliable and useful as an accountability document.

1.2.1 Audit opinions issued

This year, clear audit opinions were issued on the financial statements and the standard statements for all entities in the local government sector. This continues the positive result for 2006–07, when clear opinions were issued for all entities.

Clear audit opinions were issued on the performance statements of 78 councils this year, compared to 79 councils last year. The performance statement for Buloke Shire Council was qualified because the annual budget did not set targets to enable actual performance to be judged.

1.3 Quality of reporting

The quality of reporting can be measured by its accuracy, the timeliness of preparation and finalisation of the financial report.

When the audit process reveals errors in the draft financial reports they are raised with the entity. If the errors are considered to be material, adjustments are requested. The frequency and size of errors requiring adjustments are, therefore, two direct measures of accuracy.

1.3.1 Quality of financial statements

Ideally each council should prepare only one draft set of statements requiring no adjustments. However, this financial year the majority of councils were required to adjust their draft accounts as a result of the audit process.

In 2007–08, the number of adjustments required indicates that quality control over reporting was not effective in most councils. Our analysis showed that, on average, three drafts of financial statements were needed prior to audit clearance.

To improve the timeliness and accuracy of their draft financial statements, most councils need to improve the processes and systems used to produce financial reports.

1.3.2 Quality of performance statements

While the data reported by councils was found to be accurate there remains considerable scope to improve the quality of supporting narrative.

In this respect it is hoped that our June 2008 better practice guide Performance Reporting: Turning Principles into Practice (2007–08:29) will serve as a catalyst for tangible steps to be taken by councils to significantly improve the relevance and appropriateness of performance statements.

1.3.3 Current and emerging issues

Local government entities must prepare their financial reports to comply with standards set by the Australian Accounting Standards Board (AASB). It is important that the local government sector stay abreast of emerging accounting issues.

Recently, there has been a move away from sector specific accounting standards to sector neutral, topic based standards. As a result, changes will affect financial reporting in local government entities through the withdrawal of AAS27 Financial Reporting by Local Governments, and the implementation of a new standard AASB 1051 on Land Under Roads.

The new standard on land under roads in particular will require councils to make elections and develop accounting policies that may have a material impact on council financial statements for 2008–09.

1.4 Effectiveness of internal control

Internal control encompasses the systems, policies, processes, behaviours and other aspects of an organisation that are established to ensure that their business objectives will be met.

Overall internal control as it relates to financial reporting was sound. Nevertheless, we identified some control weakness common to a number of councils, these include:

a lack of separation of incompatible duties
no independent review of changes to key data
incomplete and unapproved investment policies
inaccurate reporting in capital works budgets.

These issues are discussed further in Part 4.

1.5 Financial sustainability

To be financially sustainable, councils must have sufficient financial capacity to not only meet future expected requirements, but also to be able to respond to financial risks and shocks without radically altering their expenditure and revenue policies.

Our analysis of the five interconnected indicators of financial sustainability shows that there has been an overall improvement in financial sustainability of the local government sector in 2007–08. This year no councils received a high risk rating (three in 2006–07) and the councils rated as medium risk decreased from 18 to 15. Figure 1A summarises the results of our sustainability risk assessment.

Figure 1A
Summary sustainability risk rating

Source: Victorian Auditor-General's Office.

The medium risk ratings provided to 15 councils reflects the challenge the sector faces in addressing the maintenance and upgrade requirements of existing assets, while balancing community requests for new facilities.

While some improvement has been noted, providing sufficient funding to maintain councils assets should continue to be an area for the attention of councils.

1.6 Key recommendations

Councils should improve their end-of-year reporting processes including quality assurance checks of draft statements to identify and correct errors prior to submission for audit (Recommendation 3.1).
Councils prepare an accounting policy that documents whether they elect to recognise land under roads existing at 30 June 2008 (Recommendation 3.4).
Councils should put in place systems and processes to capture and record all land under roads acquired from 1 July 2008 (Recommendation 3.5).
Councils should obtain assurance from their chief executive officer that approved policies and procedures are being adhered to, and that there is adequate segregation of duties within accounts payable and payroll (Recommendation 4.1).
Councils should have a comprehensive investment management policy, which is approved by council and reviewed regularly (Recommendation 4.2).
Councils should receive regular reports regarding the value, risk and return of their investment portfolio (Recommendation 4.3).
Councils should more rigorously review the process and underlying assumptions relative to their capital works budget (Recommendation 4.6).

RESPONSE provided by the Secretary of the Department of Planning and Community Development

I am pleased that your report has shown an overall improvement in the financial sustainability of councils. I agree with your recommendations which my Department will continue to encourage and support local councils to implement. Additionally, I look forward to continuing to work with the sector and peak bodies on accounting and asset management initiatives.

1.3 General

The total cost of preparing and printing this report was $195 000.