Accounting Errors at CCC - Post 10/15 in a series - Ernst & Young Fails to Challenge Accounting Treatment

10 - 2018/19 - Ernst & Young fails to challenge accounting treatment

EY took over from BDO as CCC’s auditor for the 2018/19 audit onwards.  EY did nothing to challenge the City Deal accounting treatment in 2018/19 or 2019/20.  It carried on where BDO left off, issuing unqualified audit opinions on both years’ financial statements.  On page 44 of the 2018/19 audited accounts, CCC wrote in the section on General Accounting Policies and Judgements:

The Council previously judged that the appropriate accounting treatment for the City Deal funding from Central Government to the Greater Cambridge Partnership (GCP) of £20m per year from 2015-16 to 2019-20 was the recognition of the total funding as a grant in 2015-16, along with a debtor for £80m.  This accounting treatment continues to be applied with a further £20m received in 2018-19, reducing the debtor balance to £20m.

The same message, (only with the debtor balance reducing to zero) was included in the 2019/20 accounts.  The £20m overstated debtor balance, the £20m overstated usable reserves balance, and the understated £20m revenue in both years were all above the final materiality thresholds EY set for those audits of £16.1m and £19.58 respectively.   

Yet Mr Hodgson steadfastly chose to say and do nothing.  He had access to CCC’s and BDO’s stated reasons for the change in accounting in 2016/17.  All the relevant documents are in the public domain on CCC’s website.  In addition, EY’s Cambridge office is adjacent to BDO’s office.   

Following EY’s appointment, both audit partners have met regularly to discuss the progress of the outstanding objections.  It is therefore inconceivable that Mr Hodgson was unaware of Mr Mason’s 2018 objection on City Deal accounting, or was unaware that the City Deal accounting treatment breached the CIPFA Code and CCC’s stated accounting policy for income and expenditure recognition.   

He could not have been ignorant of the fact that the 2018/19 financial statements were not free from material misstatements, or that his statements to the contrary in his audit opinions were false.

Between 2019 and 2022 I submitted four objections about CCC’s draft accounts to EY.  Up to October 2022 Mr Hodgson declined to accept or reject any of them on the stated grounds that he could do nothing until BDO had completed its investigations into Mr Mason’s two historical objections.  That conduct breaches the National Audit Office’s Code of Audit Practice that auditors are obliged to comply with under Section 20(5) of the Local Audit and Accountability Act 2014 (LAAA 2014) – see Appendix 2 below.

Thus, by 2022, six formal objections to CCC’s last six annual accounts remained outstanding.  One of the matters in my 2020/21 objection was the accounting treatment for City Deal 2, whereby, as with City Deal 1, all five years’ worth of City Deal 2 grant income were recognised in year one (2020/21) as a single grant.  City Deal 2 was worth £200m over five years, so the incorrect accounting recognised £200m as grant revenue for 2020/21 alone, instead of the correct value of £40m, as set out in the determination documents.   

The result was that in 2020/21, revenue, debtors and usable reserves were all overstated by £160m, over eight times the materiality threshold EY set for its audit of CCC’s 2020/21 accounts.  Those overstatements meant that the draft usable reserves balance of £375,478,000 was overstated by 74% - hardly an immaterial difference.

During the 2021 statutory inspection period under Section 26 of the LAAA 2014, I asked to inspect and have a copy of that year’s City Deal grant determination document, which contained the conditions CCC alleged did not exist.  I already had copies of previous years’ determination documents from a contact at the National Audit Office (NAO).   

CCC’s Head of Finance repeatedly wrote to me asserting that no such document existed.  I mentioned this lack of cooperation from the senior officer in my objection to EY on the 2020/21 financial statements which was submitted on 13^th September 2021.  I sent a copy of the objection to CCC Finance.   

Just three hours later, CCC’s Head of Finance wrote to me enclosing copies of two determination documents covering the 2020/21 financial year.  The grant value in each document was £20 million.  Both documents contained the expected grant conditions that CCC had previously denied existed, but now acknowledges.

In its audit plan for the 2020/21 audit EY presented to the A&A Committee in September 2021 (Agenda Item 8), the auditor made no mention of any audit work to be done on City Deal accounting, despite the scale of the overstatements in the draft financial statements or his knowledge of Mr Mason’s outstanding 2018 objection.   

At that same meeting, Mr Mason submitted a written question about City Deal accounting.  The question and the answer from the Head of Finance can be found online (Timestamp 13.22) and in the minutes (Appendix 1).  The Head of Finance’s response was factually incorrect and misleading on several counts:

·       CCC had not been consistent in its treatment of GCP funding.  In 2015/16 it accounted correctly for that year’s grant, on an accruals basis (see Sections 4 and 5 above),

·       The revenue frontloading accounting treatment does not comply with the CIPFA Code (accruals basis) or with any recognised accounting policy,

·       The Head of Finance misquoted from the CIPFA Code and fabricated content that is not in the Code.  He conspicuously omitted to mention the overriding obligation to account for capital grants on an accruals basis.

·       Adding short and long-term debtors to balance the overstated revenue does nothing to correct or diminish the false accounting. The net result is still £160m overstated revenue, debtors and usable reserves which simply did not exist in that financial year.  Users of the accounts, such as short term lenders and central government had still all been materially misled.

·       In addition to creating long and short term debtors for the non-existent revenue, the resulting “reserves” were taken to the same Capital Grants and Contributions Unapplied Reserve, which on CCC’s own definition is designed for grants already received.

Following that response, the Committee Chairman stated that he would expect City Deal accounting to be looked at by the external auditor as part of its audit work that year.

After that September meeting, I wrote to Private Eye magazine, providing a copy of the draft accounts and other background evidence.  The magazine sought professional opinions, including from a former investigator at the Serious Fraud Office and a former investigator at the Financial Reporting Council.  The resulting articles published on the magazine’s Rotten Boroughs page in November 2021, January 2022, and June 2022 are shown in Appendix 3 below.