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Good Practice: Financial Audit and Corporate Governance Guidance

Resource Accounts - Preparing for Audit

November 1997

CONTENTS

Introduction

Part 1: Accounting Systems, the Boundary, Accounting Policies and Materiality

• Accounting systems
• Data extraction facilities
• Systems documentation
• Implementation testing
• Boundary Statement
• Accounting policies
• Materiality
• Materiality in the preparation of accounts
• Materiality as used by the auditors

Part 2: The Opening Balance Sheet

• General audit objectives
• Consolidating assets and liabilities
• Tangible Fixed Assets
• External identification and valuation of fixed assets
• Internal identification and valuation of fixed assets
• Determining the asset population and loading the fixed asset registers
• Validating fixed asset register data
• Intangible Fixed Assets
• Investments, shareholdings and public dividend capital
• Stock and work-in-progress
• Debtors and creditors
• Validation of creditors, debtors, accruals and prepayments: tests of plausibility and age analysis
• Cash
• Provision for liabilities and charges
• Contingencies and commitments
• Taxpayers' Equity
• Separate Trust Statements
• Submitting the Opening Balance Sheet for audit

Part 3: The Summary of Resource Outturn

Part 4: The Operating Cost Statement and Statement of Recognised Gains and Losses

• General audit objectives
• Accounting for income
• Accounting for expenditure
• Notes to the Operating Cost Statement
• Consolidation of income and expenditure
• Management representations
• Submitting the Statement for audit
• The Statement of Recognised Gains and Losses

Part 5: The Cashflow Statement

Part 6: The Statement of Resources by Departmental Aims and objectives

• Departmental aims and objectives
• Reporting performance by objectives
• Attributing costs to aims and objectives

Part 7: The Statement on Internal Controls

• The internal control environment
• Departmental monitoring

Part 8: The first full set of accounts for audit

• Audit planning
• The "Interim" audit
• Pre-audit informal review of accounts matters
• Management review of draft accounts
• The "Final" audit
• Submission of signed account and audit certification
• The NAO's management letter

Appendices

1. Chronology
2. Opening balance sheet: checklist of supporting papers
3. Full set of accounts: checklist of supporting papers
4. Proforma letter of management representations for resource accounts
5. Select bibliography

Introduction

1 This guide is primarily addressed to departmental accountants responsible for introducing resource accounting. It gives general guidance on how departments should prepare for the external audit of their resource accounts. It is not intended to replace the detailed discussions between departments and their audit teams, but to provide a useful background to facilitate those discussions. It should be seen as complementary to the Resource Accounting Manual (RAM), a detailed knowledge of which is fundamental to the proper implementation of resource accounting. The references in this guide are to the version issued on 24 July 1997.

2 The guide is structured to reflect the Treasury's plans for departments to prepare "dry run" accounts, not intended for publication, for 1997-98 or 1998-99 prior to full audit and publication of accounts for all departments for 1999-00. Parts 1 to 7 address issues likely to arise in the dry run period leading up to the first full set of audited statements. Part 8 deals with the first, and subsequent, set of accounts prepared under a Treasury Accounts Direction. These require a formal audit opinion and will be laid before the House of Commons. For those departments which successfully "dry run" in 1997-98, the Treasury may issue a Direction for 1998-99. For the remainder the Treasury plan to issue Directions for 1999-00.

3 The main themes of this publication are:

• the audit of resource accounts will require different arrangements with departments from those they have become familiar with for the audit of Appropriation Accounts;
• consult the NAO as early as possible on unusual or difficult technical accounting issues, wherever possible providing the department's view;
• the selection of appropriate accounting policies, in accordance with the RAM, is an important early step and one on which the NAO need to be consulted;
• the Opening Balance Sheet is very important, and requires detailed external audit consideration; as such the department's decisions, calculations and validations must be recorded to allow the necessary audit coverage;
• keep the NAO fully informed of developments as they arise to avoid last minute "surprises" to either party during the "final" audit each year;
• ensure the accounts presented for audit have been subjected to documented rigorous validation checks and management review, and are accompanied by good quality working papers.

And although the NAO expect to be consulted and will be pleased to advise and recommend on any issues, management must accept that it is their responsibility to determine whether or not to implement the advice and recommendations.

4 Throughout this guide:

'Evidence' icons highlight those areas where audit evidence requirements are stated;

'Consultation' icons mark those places where requirements to inform and consult the NAO are stated;

Shaded boxes in the text contain general information and advice which draw upon the NAO's experience of auditing and advising various clients.

Responsibilities

5 Departments will be required by their Accounts Directions to prepare accounts which are "true and fair". Departmental Accounting Officers acknowledge their personal responsibility for the accounts in signing them; they also have extensive responsibilities for the propriety and regularity of their department's finances and for the keeping of proper records.

6 The Comptroller and Auditor General (C&AG) is the statutory external auditor of departmental resource accounts and is the head of the National Audit Office (NAO). He forms an independent opinion, based on his audit, on the accounts and on the regularity of the financial transactions included in them, and reports his opinion to the House of Commons.

7 The Accounting Officer and his finance team must therefore produce accounts for audit which they can demonstrate show a "true and fair" view of the department's operations and state of affairs at the balance sheet date, and that the expenditure and income have been applied to the purposes intended by Parliament. Accounting Officers and their finance teams therefore need their own assurances that department finances and financial systems are in good order, and should ensure that the accounts are supported and validated by comprehensive reviews before being presented for audit.

8 The NAO, on the other hand, has to perform sufficient additional work to form an independent opinion as to whether or not the C&AG should agree, and report to Parliament, that the accounts do indeed show a "true and fair" view.

9 In planning their approach to auditing a department's resource accounts, the NAO will initially be concerned to ensure that:

• as auditors, the NAO has sufficient knowledge of the business and operations of the department;
• the department's accountants understand their responsibilities and the relationship with the external auditor;
• the department's accountants are familiar with the "true and fair view" requirements of the RAM;
• the department has acceptable financial systems in place, along with arrangements to provide annual assurance on the reliability of such systems; and
• the department has arrangements in place to produce reliable accounts along with adequate supporting working papers to an acceptable timetable, and to ensure key staff are available at all stages of the audit until the accounts are laid.

10 Appendix 1 presents an outline of the chronology of events in the normal accounts/audit cycle, and relates to a department producing resource accounts for audit for the year 1998-99. Some of the events listed could in practice take place earlier than the dates shown. The timings should be taken as an indication of the latest feasible dates, rather than as ideal dates.

11 Audit teams will wish to make sure that departments understand the nature and extent of the evidence they and the NAO will need - in general, the more reliable the evidence provided by the department in support of the accounts, the easier the audit process will be for both the department and the NAO. Appendices 2 and 3 are checklists of the evidence to be included with the accounts provided for audit to the NAO. Audit teams will put the NAO's experience and expertise at the service of departments to provide information and advice.

12 The NAO will welcome feedback on the usefulness of this publication, addressed to audit teams; or to Martin Sinclair, Director, Room B352, National Audit Office, Buckingham Palace Road, London SW1W 9SP.

Part 1: Accounting Systems, the Boundary, Accounting Policies and Materiality

Accounting systems

1.1 The NAO will wish to satisfy itself that each department implements sound and auditable financial accounting systems which, together with work on the opening balance sheet and other aspects of the accounts, will help them produce accounts which attract an unqualified opinion. Prior to issuing an Accounts Direction, the Treasury will look to the NAO to confirm the adequacy of the department's accounting systems to support resource accounts. The NAO will therefore look to be fully consulted when departments are introducing new systems or modifying existing ones.

1.2 Departments should recognise that the accounting systems must, for the time being, support a variety of uses, such as:

• cash based Appropriation Accounts;
• Resource Accounts, including
• linkages between departments and agencies;
• the various output cost statements and analyses required by RAM; and
• resource-based Estimates;
• internal management reporting, including
• setting and monitoring resource budgets; and
• interim management accounts.

1.3 The type of system selected by departments will vary according to their accounting information needs. For the smallest departments a 'bolt on' to a cash accounting system may suffice. However, for most departments a fully fledged accruals-based system will be needed to cope properly with resource budgeting as well as resource accounting, enabling managers to track accruals based expenditure against budget.

1.4 Box 1 provides an indication of the main function requirements.

1.5 When specifying accounting software, departments should state routines for the production of financial statements as deliverables from the supplier. Box 2 provides the considerations for a proper Chart of Accounts.

The Cash Flow Statement: separate figures are needed for cash financing of operating expenditure; payments for fixed assets; receipts from the sale of fixed assets; cash financing must be separated from non-cash financing for reconciliation purposes; financing of expenditure must be separated from financing of capital transactions.

Aims and Objectives: departments must be able to identify the direct costs attributable to the defined aims and objectives as well as identifying the indirect costs which need to be apportioned to them.

Output and Performance Analysis Statement: the accounting records must be able to support the financial information in this statement.

Notes to the Accounts: some notes to the accounts need figures in greater detail to provide the analyses required; examples are:

• movements on fixed assets;
• the reconciliation of net operating cost to control total and net resource outturn;
• the analysis of net resource outturn and net operating cost by function;
• the analysis of net operating costs by spending body.

VAT: Expenditure must be reported inclusive of irrecoverable VAT in the Operating Cost Statement and its Notes; income must be recorded net of VAT; and expenditure capitalised must include irrecoverable VAT.

1.6 The NAO will also be concerned with the following areas:

• the audit trail : a clear and proper audit trail is essential for the accounts to be auditable - see Box 3;
• data selection, entry and extraction facilities;
• documentation; and
• controls and security : see Part 7.

Data extraction facilities

1.7 It is important that the systems, including those outsourced, incorporate facilities to download or otherwise access prime accounting records which support the figures in the financial statements. The systems should therefore include "user-friendly" data extraction facilities which:

• allow users to produce reports without technical support;
• provide logic to support flexible record selection;
• support multiple sort keys;
• produce hierarchical levels of summarised data;<
• permit table look-up and expansion of codes to text;
• list reports to magnetic files and hard copy, as well as to the screen;
• provide output files in a form conforming with the input requirements of common PC spreadsheet, database management, word processing and graphics packages;
• save selection parameters in files for future use;
• list selection parameters as part of the printed report; and
• permit interrogations to be run interactively or in batch mode.

1.8 The circumstances of each department will require different audit approaches. However, the NAO's main data extraction requirements are likely to include the following:

• clear format and location of data;
• computer assisted audit techniques (CAATS);
• downloading or other access to global transaction data; and<
• use of the system's standard enquiry facilities.
• Audit teams will provide the exact details for each department.

Systems documentation

1.9 A good standard of technical documentation is necessary for proper internal control and to support data selection and extraction. System documentation should therefore include:

• an overview describing the purpose, operation and job scheduling of each of the functional modules (General Ledger, Accounts Payable, Fixed Assets etc) comprising the system;
• a high level graphical description of all processes in terms of their inputs and outputs, the programs which process them, and the databases/files/tables created/read/written;
• a list and description of all databases, files and libraries giving standard field names and formats (eg character, binary, packed decimal etc); and
• details of how to use the data extraction and retrieval facility, including worked examples at a level which enables staff with limited technical knowledge to create and run simple interrogation and downloading jobs.

Implementation testing

1.10 Each department must ensure that the new systems, or modifications to the existing ones, meet the specifications and its needs. As department's Internal Audit units are responsible for providing assurance to the Accounting Officers on systems of control, they will almost certainly wish to examine systems implementation issues. The NAO will review the extent to which management has tested the new systems and will look for evidence from the testing carried out that results matched the predictions. Departments should ensure that all aspects are tested, including, for example "close down" and, where appropriate, consolidation.

Boundary Statement

1.11 For many departments, particularly the more complex, it will be very useful to prepare a 'Boundary Statement' as an internal document. This would do two things:

• it would identify all the entities having links with the department (Ministerially, by statute, administratively etc) and articulate the decisions and rationale for including those entities which are to be consolidated; those entities to be recognised in the accounts in some other way such as partial consolidation or as investments; and those entities to be excluded, other than through the funding flows;
• it would identify the range of assets and liabilities the department will account for by reference, for example, to location or divisional responsibilities; it would identify those assets and liabilities where there is doubt as to which entity carries their main risks and rewards, and articulate the agreed decisions on these along with the reasons.

1.12 The Boundary Statement would thus serve as a useful stage in the development of accounting policies, dealt with later. It will also help inform the 'Basis of Consolidation' note in the accounts. Departmental staff will find Financial Reporting Standard 5 "Reporting the substance of transactions" of help in determining asset accounting policies as it provides guidance on the need to recognise "ownership" for accounting purposes instead of applying the strict legal definition. Some boundaries may be difficult to define, and Box 4 provides some guidance.

1.13 Having decided the entities to be consolidated, departments need to consider any problems which should be addressed at this stage, including:

• different accounting policies;
• non-coterminous year ends; and
• the need for audited financial statements from these entities to meet their consolidation timetable.

These issues are dealt with further at paragraphs 2.5 to 2.12 below.

1.14 The NAO will welcome an early opportunity to comment on any proposed Boundary Statement and the implications identified; or, in the absence of this, any unusual aspects of a department's boundary, and the implications for the Accounting Policies to be disclosed in the accounts.

Accounting Policies

1.15 It is fundamental to the "true and fair" view that the accounting policies underpinning the financial statements are appropriate to the specific circumstances of each department and comply with the requirements of the RAM. In the accounts, the Accounting Officer confirms that appropriate policies have been selected and applied consistently. In his audit opinion the C&AG includes a statement asserting that the accounting policies are appropriate to the departments circumstances, consistently applied and adequately disclosed. If this is not the case, the opinion might need to be qualified. The NAO will therefore welcome early discussions on the accounting policies to be applied and disclosed in the accounts. Such policies should be reviewed each year - new policies may be required and may need to be disclosed, and some policies may need to be revised. The NAO should be consulted on any such proposals.

1.16 The NAO will expect to see accounting policies disclosed for all material groups of assets, liabilities, income and expenditure. The usual policy areas disclosed in accounts are shown at Box 5 depending on the circumstances of each department. The NAO will therefore welcome discussions on accounting policies proposed not addressed at Box 5, or where some of the items in Box 5 are considered inappropriate. Guidance on them is included in the RAM and the underlying accounting standards.

1.17 In order to ensure consistency across the department and from year to year, the NAO will also expect all the accounting policies, practices and treatments, including those for non-material areas, to be standardised and disseminated to all staff involved. This is usually done in the form of an Accounting Manual as required by paragraph 1.4.2 of the RAM.

1.18 Once acceptable accounting policies are in place, the NAO's audit will address whether or not they are being applied. Material failure in the application of an accounting policy is likely to result in a qualification of the accounts. Management should therefore ensure all accounting policies are being observed.

Materiality

1.19 Materiality is a concept which is central both to the preparation and audit of accounts. It provides a basis for determining how accurately transactions and balances need to be disclosed, and it underlies all professional standards on financial reporting. Materiality is defined as follows in the Accounting Standards Boards "Statement of Principles for Financial Reporting":

"Information is material if it could influence users' decisions taken on the basis of the financial statements. If that information is misstated or if certain information is omitted, the materiality of the misstatement or the omission depends on the size and nature of the item in question judged to the particular circumstances of the case."

1.20 A further definition is provided in Statement of Auditing Standard 220 "Materiality and Audit" issued by the Auditing Practices Board, as follows:

"An expression of the relative significance or importance of a particular matter in the context of the financial statements as a whole. A matter is material if its omission or misstatement would reasonably influence the decisions of an addressee of the auditors' report; likewise a misstatement is material if it would have a similar influence. Materiality is not capable of general mathematical definition as it has both qualitative and quantitative aspects."

1.21 It is important to recognise therefore, that materiality is a relative concept, and that it applies in the context of the way in which the user of the information might have acted differently had material error or omission not been present. Materiality may be considered to have three separate elements as follows:

• by value: in relation to a particular figure in the accounts, this element of materiality seeks to answer the question "By how much would this figure have to be inaccurate to distort the users overall view of the accounts?" Obviously, an error of a few thousand pounds might be material to a small account, whereas an error of the same absolute size might be immaterial to the view given by the accounts of, say the Ministry of Defence or the Department of Social Security;
• by nature: the question asked here is "Does the error affect a figure in the accounts which users expect to be stated with a high degree of accuracy or which is likely to be of great interest to them?" This recognises that in any set of accounts some s are more material than others; examples are - senior staff and board members' emoluments; the audit fee and the amount payable to the Consolidated Fund;
• by context: the question being addressed here is "Is the error material because of its implication for other aspects of the accounts?" In dealing with resource accounts the following errors, for example, even though they might be small in absolute terms would be likely to be material by context: errors in stated amounts which, if not adjusted, would
• trigger the payment, or non-payment, of bonuses to senior staff;
• result in the reported achievement of a key performance measure when it has not, or that it has been missed when it has, in fact, been achieved; and
• indicate that the department has net current assets when it has, in fact, net current liabilities.

Materiality in the preparation of accounts

1.22 Materiality is defined in terms of the accounts as a whole. However in arriving at this view, the preparers of accounts will have had to apply materiality considerations when deciding on the detailed accounting policies to be followed in compiling the accounts. Examples of such materiality decisions include those which set the capitalisation threshold, whether stock holdings are sufficiently small to allow items for consumption to be expensed on purchase rather than accounted for in detail as stock, and the degree of accuracy to which accruals and prepayments at the year-end need to be estimated.

1.23 Materiality also comes into play when management review the outcome of the accounts preparation process. At that stage, management have to decide whether errors which have come to light as a result of their review are sufficiently material, individually and/or in aggregate, to merit amendments being made to the accounts prior to them being submitted for audit. If management decide against amending the accounts, the auditors expect this decision to be made known to them together with a list of the unadjusted errors.

1.24 There is one area associated with accounts preparation where materiality considerations do not apply - this is in the area of reconciliations. The purpose of a reconciliation is to reconcile, and thus the failure to pursue differences on reconciliation on the grounds that they are small defeats the purpose of the exercise. As a minimum there would need to be a sustainable and acceptable explanation of any such differences.

Materiality as used by the auditors

1.25 Auditors use the concept of materiality both at the planning stage of the audit, when deciding what and how much work needs to be done, and in evaluating the results of the audit. These are sometimes known as "planning materiality" and "reporting materiality" respectively.

1.26 "Planning materiality" is primarily concerned with materiality by value. The auditor calculates the highest level of "tolerable error" for the estimated accounts as a whole, that is the highest amount which would not distort the overall view of the accounts given to the addressee of the audit report. Since auditors rarely examine all transactions or balances, allowance is made within this "tolerable error" leaving only a fraction for the incidence of errors identified during the audit. The auditor then assesses the risk of this level of error in the balances and transactions and focuses the audit work accordingly. This threshold, which is very dependent on the audit approach adopted and therefore rarely disclosed by the auditor, does mean however that figures which are "95 per cent right" or thereabouts will, almost invariably, not be good enough.

1.27 "Reporting materiality" applies at the end of the audit when all errors are evaluated and viewed in relation to the known outturn on the account. "Planning materiality" and "reporting materiality" only really differ where outturn is significantly different from that estimated. It is also at this stage that the auditors consider their findings "by nature" and "by context", and errors or omissions may be considered material which otherwise by value would not.

1.28 There are a number of issues considered by auditors when evaluating the audit findings:

• an error or omission found in one area such as stock may in itself not be material; but if errors have also been found in other areas such as debtors or fixed assets, then the total errors may exceed the materiality threshold. Because of this effect, all errors and omissions are recorded during the audit for consideration when the results across all areas of the account are assessed against the reporting materiality;
• unadjusted errors identified by the department need to be taken into consideration by the auditors when evaluating the audit findings against reporting materiality; departments should make this information available to the auditors; and
• audit work often involves the use of sampling techniques, ie a statistically representative number of transactions or balances are examined during the audit with the aim of drawing conclusions about the populations from which they were drawn. If errors are found in the sample, then sampling theory requires the effect to be extrapolated across the entire sampled population. As a result, an error which appears immaterial in isolation could actually represent a material error in relation to the total figure being audited.

1.29 Once all the errors and omissions found during the audit have been identified, the auditors schedule them into what is colloquially known as the "overs and unders schedule". This summarises all the unadjusted monetary errors and omissions and enables a view to be taken as to their net effect on the accounts. If the net effect is that the total error is less than the reporting materiality threshold, and there are no errors or omissions which are material by nature or context, then an unqualified audit opinion should result.

1.30 If, on the other hand, the net effect is greater than the reporting materiality threshold, the audit team will discuss with the department what adjustments can be made to bring the overall level of error down to an acceptable level. However not all errors are capable of being adjusted - for example those which stem from a failure of "regularity" can rarely be rectified. And those which are calculated from a statistical sample may require the department to carry out some extensive remedial work to remove the extrapolated effect of the sample. For whatever reason, where material unadjusted error remains in the accounts a qualified opinion will result. This will normally be accompanied by a report by the C & AG to Parliament explaining the background to the qualification.

1.31 Different materiality considerations apply to the audit work on opening balance sheets. In such cases auditors will normally set a much lower level of materiality to reflect the fact, amongst other things, that this is the first time that such balances will have been subject to audit and there is no accumulation of knowledge and experience on which to base the normal level of materiality. This also allows the auditor in future years to concentrate audit work on testing the movements on the balance sheet, in the safe knowledge that the opening balances were checked with great thoroughness. Departments should recognise as a result, that the auditors may require finer adjustments to the opening balances.

Part 2: The Opening Balance Sheet

2.1 The Balance Sheet (Schedule 3) is designed to provide a financial picture of the assets and liabilities of the department at a point in time. The form of the Balance Sheet used is similar to that required by the Companies Act. The only changes are in the terminology used to describe certain line items which has been revised to reflect the central government context of the information.

2.2 The first balance sheet produced - called the Opening Balance Sheet - will need to be prepared for the start of the dry run year; that is at 1 April 1997 for those departments preparing dry-run accounts for 1997-98, and as at 1 April 1998 for those dry-running in 1998-99. This will be subject to rigorous audit examination because future audits depend upon the accuracy of this position. And Treasury will look to the NAO for assurance from their audit of this opening position as part of the progress to an Accounts Direction. To ensure that this audit work proceeds smoothly, it is vital that audit teams are consulted by departments when they plan the preparation of their Opening Balance Sheets. No formal opinion will be provided on this balance sheet, but the results will be discussed with the department and adjustments may be required. However, the final view on this balance sheet and any adjustments made as a result of the audit will be taken on completion of the audit of that year's closing position.

2.3 Box 6 provides the main audit requirements for newly created opening balances.

General audit objectives

2.4 In examining whether the assets and liabilities as stated in the accounts meet the requirements of the audit opinion, the NAO will determine whether they comply with the general audit objectives outlined in Box 7. As part of this, they will consider whether the combination of systems, controls, validations and management reviews address these objectives.

Consolidating assets and liabilities

2.5 The RAM requires departments to consolidate all the entities within the departmental boundary, applying FRS 2. Consolidation has been defined as:

"A method of accounting under which the information contained in the separate financial statements of the parent and its subsidiaries is presented as though for a single entity. After any consolidation adjustments for such matters as minority interests, intra group transactions and to obtain uniformity of accounting policies, the amounts for assets and liabilities, revenue and expenses in the individual statements are added together on a line by line basis to form the consolidated accounts."

2.6 The following are important considerations for departments when preparing consolidated accounts:

• that the financial statements of entities as used for consolidation purposes are suitable for inclusion in the department's resource account ie they must be signed and audited before being consolidated into the resource accounts;
• that any re-classification of income, expenditure, assets or liabilities of entities being consolidated as required to support resource account disclosures is feasible and auditable;
• that other information to support additional resource account disclosures from entities being consolidated is available and auditable;
• that agencies presently dry-running will be ready in time and can provide the information required for consolidation;
• that the accounting periods of all the entities are coterminous and they have uniform accounting policies - see below;
• the process of adjusting assets and liabilities - see below; and
• the process of adjusting revenue and expenses - see Part 4.

2.7 Since most public sector entities operate to an April to March accounting year, the problem of different accounting periods is unlikely to be significant. The Treasury have asked to be consulted on all cases where the year-ends differ, and equally the NAO would wish to be involved. Concerns about uniformity of accounting policies should also be minimised in that all entities should be complying with RAM. This requirement should not be seen as precluding some variation, for example in the choice of capitalisation thresholds or depreciation rates. The NAO will look for evidence that departments have carried out a review of the accounting policies of the entities within their boundaries, and will welcome early discussion on any policies deemed inconsistent.

2.8 The pre-consolidation adjustment of assets and liabilities needs to be carefully considered where, for example, fixed assets or stock are sold or transferred to entities within the boundary or there are amounts owing to and from the parties. The basis of pricing items for sale or transfer is crucial, and any profit element should be removed before consolidation. Thus the first part of the process will be to ensure such sales or transfers are identified, for example as a result of machinery of Government changes. The NAO will wish to see that reliable arrangements have been put in place, either manually or as part of the underlying systems, to capture this data. In most instances, however, any transfers of assets do not involve any element of profit and adjustments will not be necessary.

2.9 Where undertakings within the boundary owe amounts to each other, these amounts must be cancelled out before consolidation to avoid overstating assets and liabilities. Any provision by one party against such debts must also be removed before performing the consolidation.

2.10 Additional problems may arise where "joint ventures" are involved, especially as this is a term which can mean a number of different things. The treatment will depend on spending control requirements and the Treasury require to be consulted on all such cases, except where the entity is deemed an extension of the department, in which case it will be fully consolidated. The NAO will also wish to be consulted. If deemed to be within spending controls there are several options:

• the joint venture is a subsidiary in which case the assets and liabilities should be consolidated in the normal way;
• the joint venture is an associate in which case the assets and liabilities should be consolidated on the equity basis defined in SSAP1 as amended;
• the joint venture is neither a subsidiary nor an associate - in which case it should be treated either as an investment or consolidated on a proportional basis where the department consolidates a share of the assets, liabilities, revenue and expenses in proportion to its share in the venture.

2.11 In examining the results of consolidation the NAO will wish to see that any findings from the external auditor of the entity being consolidated, especially those affecting the audit opinion on the entity, have been taken into consideration.

2.12 Although FRS 2 considers the matter in terms of other entities producing financial statements, some larger departments may be involved in consolidating self accounting units which are themselves part of the department. The same considerations apply, but the NAO will need to discuss and agree with these Departments the stages of external audit involvement. Clearly there are risks in consolidating unaudited information, and the department and the NAO may wish to carry out some pre-consolidation audit. This has implications for the timetable, and has not been allowed for in Appendix 1.

Tangible Fixed Assets

2.13 A Tangible Fixed Asset is defined as "an asset held for use on a continuous basis in the departments activities; it has a physical identity and an expected economic life of more than one year." The normal categories of tangible fixed assets are:

• Land and Buildings;
• Plant and Machinery;
• Fixtures, fittings, tools and equipment; and
• Assets in course of construction.

These categories can be sub-divided to reflect a more appropriate reflection of the types of assets held by the department. For example, in practice motor vehicles is a common sub-category, and computers may be an appropriate category for some departments. Land and Buildings is always sub-divided to differentiate between freehold and leasehold, and then between long (more than 50 years) and short (all other) leases. The NAO will welcome discussions on the categorisation of tangible fixed assets should the department wish to adopt a less conventional categorisation. Note that property held as an investment must be shown in the balance sheet in compliance with SSAP 19.

2.14 Tangible Fixed Assets need to be:

• recorded in fixed asset registers (FARs) with an identifiable audit trail eg reference numbers and labels;
• reconciled to general ledger balances;
• subjected to annual management checks for existence/continuing use/remaining life/ obsolescence etc;
• revalued annually using appropriate indices and considered for any permanent diminution in value ("impairment");
• subject to proper purchasing procedures to ensure that all additions are identified and recorded; and
• subject to proper sales or write-off procedures to ensure all disposals are properly recorded.

In addition, land and buildings should be subject to professional external valuation at intervals of not more than five years.

External identification and valuation of fixed assets

2.15 The requirements for the valuations of land and property are contained in the Treasury publication 'Capital Charging for Property - Accounting Guidance'. The NAO will wish to see any Statements of Requirement for external valuers.

2.16 The illustrative timings in Appendix 1 portray a scenario in which the valuer is chosen without competition. This is not a NAO recommendation, but a convenient simplification. Competition may mean that more time should be allowed in the period leading up to the issue of the Statement of Requirement. And there are timing issues associated with exploration of the availability of valuers, EU contract requirements, assembly of a suitable tender panel, &c, which are not represented in Appendix 1.

2.17 Box 8 presents some guidance on the tasking of professional valuers.

2.18 Obtaining a valuation report does not absolve management from its responsibilities. The report should always be subject to review by management for reasonableness, and, for second and subsequent valuations, for consistency. The valuation report is an important source of audit evidence. The NAO will wish to acquire a copy soon after the report has been delivered to the department. Electronic copy on disk would be most welcome.

Internal identification and valuation of fixed assets

2.19 Many of the principles set out in Box 8 also apply when departments use their own staff to identify and value assets. However, departmental staff should not be used to value property. Other assets may be valued by reference to historic cost, where sufficiently reliable evidence exists, updated by an appropriate price index and depreciated according to the chosen accounting policy. For further information see the Treasury publications 'Accounting for Capital Assets - A Working Draft of Guidance' and the subsequent Supplement (currently under review). Alternatively, other assets may be valued by reference to appropriate catalogues giving current prices. Such catalogues will be important audit evidence, and appropriate trails need to be provided to these sources and any indexation adjustments.

Determining the asset population and loading the fixed asset registers

2.20 The NAO will wish to be consulted on the departments choice of capitalisation threshold; and on (any) plans to extrapolate valuation data to assets not covered by valuers.

2.21 The reconciliation of initial Fixed Asset Register value totals to the valuation reports is important audit evidence. The NAO will seek assurance that such a reconciliation is being generated.

2.22 Care must be taken to establish the correct cut-off point for the reckoning of disposals, additions, and enhancements. All and only those transactions which took place after the valuation date should be reflected in the Fixed Asset Registers after the valuation data have been loaded.

Validating fixed asset register data

2.23 Departments should validate the Fixed Asset Register figures which underpin the Opening Balance Sheet. For land and buildings, evidence will be needed to show the source of information and procedures followed to establish the completeness of the records. For other fixed assets, validation may be achieved by circulating FARs to inventory holders, asking for confirmation of the accuracy and completeness of the records. Comments should also be sought on any circumstances bearing upon valuation, such as undue deterioration in physical condition, technical obsolescence, or other marked reduction in expected use of the asset as compared with the depreciation profile. Inventory holders should be required to respond with statements to the effect that, subject to stated amendments, they believe the FARs to be accurate.

2.24 The requests to inventory holders should remind them that physical existence checks are to be conducted by staff independent of those responsible for custody of the assets. Where asset populations are large, it may not be feasible to conduct all verifications at the Balance Sheet date. A phased programme of verification will normally generate sufficient audit evidence. Departments should discuss their proposals with the NAO, who will be particularly interested to study any proposed programme which does not provide for 100% coverage each year.

2.25 The confirmations from inventory holders provide important audit evidence. The NAO will seek assurance that they are being generated.

2.26 An audit trail must be retained of any FAR adjustments arising from circulation of FARs to inventory holders.

2.27 In most cases there will be some asset movements (additions, enhancements, and disposals) between the original valuation and loading of FARs, and the Balance Sheet date. Lists of additions, enhancements, and disposals should be scrutinised within the finance function for conformity with expectation. Commercial FAR software packages have facilities for producing such lists. For other FARs it may be necessary to compile them manually. The lists might also - perhaps only on an exception basis - be referred to inventory holders for confirmation that they are correct and complete, and for advice on apparently anomalous features. The NAO will require copies of the lists, together with documentation of the validation procedures performed.

2.28 In most cases depreciation and revaluation (indexation) will be recorded between the original valuation and the Balance Sheet date. Departments should check these figures for reasonableness - some guidance is given in Box 9. The documentation of this work provides audit evidence.

2.29 Departments have to determine an accounting policy for capital enhancements, that is an approach to deciding the extent to which outlays such as those on maintenance and repair of buildings, should be expensed (charged to the Operating Cost Statement) in year, or capitalised as asset enhancements.

2.30 Guidance on the capitalisation of enhancements is provided in Exposure Draft 51 ('Accounting for Fixed Assets and Revaluations'), the ASB discussion paper 'Measurement of Tangible Fixed Assets' and 'Accounting for Capital Assets: A Working Draft of Guidance' (currently under review). There is much room for judgement in interpreting the guidance to the circumstances of each department. The NAO will welcome early consultation on the matter.

2.31 Care needs to be taken in capitalising other costs of acquisition such as the cost of the staff involved. The NAO will welcome discussion on any proposals in this area.

Intangible Fixed Assets

2.32 There are three basic categories of intangible fixed assets:

• development expenditure;
• goodwill; and
• concessions, patents, licences, trade marks and similar rights and assets.

2.33 Where appropriate, development expenditure may be deferred to future periods - paragraphs 3.10.2 to 3.10.5 of RAM refer. The NAO will wish to see that the criteria (listed in SSAP 13 and at 3.10.2 (b) of RAM) have been met and that the period of amortisation is appropriate

 2.34   Goodwill and other intangibles are to be accounted for in accordance with FRED 12, a summary of which is provided at paragraphs 3.10.10 to 3.10.15 of RAM. The NAO will wish to be fully consulted on the recognition and accounting for these assets.

Investments, shareholdings and public dividend capital

2.35 Fixed asset (ie longer term) investments, including shares in limited companies, should be reported at market value unless this is not available when historical cost should be used. The basis of market valuation needs to be provided by way of a note, and the source and calculation are important audit evidence. Movements in valuation, other than impairment, need to be recorded through the Revaluation Reserve. The NAO will wish to see that arrangements are in place to capture this information, and will expect share certificates to be available as audit evidence.

2.36 Short term investments, including the use of surplus funds, in marketable securities should be recorded as current assets at market value. Movements are included in the Operating Cost Statement. The calculation of market value is important audit evidence.

2.37 Public Dividend Capital (PDC) and loans issued to public bodies not consolidated in the resource accounts should be reported at historical cost. Movements need to be recorded by way of a note, and the NAO will wish to see that arrangements are in place to capture this information.

Stock and work-in-progress

2.38 The requirements for stock and work in progress holdings are provided at Box 10. 2.39 The NAO should be consulted on the determination of the classes of item to be included on the balance sheet as stock, or where stock is not deemed to be material to the balance sheet and is to be expensed.

2.40 Requirements for stocktaking to provide sufficient evidence of the existence and condition of stockholdings are generally more onerous than those designed to meet S4 of the Exchequer and Audit Departments Act 1921 with which some departments may be familiar. There is a presumption that the annual stocktaking programme must cover the great majority (by value) of the stocks. Ideally the stocktake should be at the year end; otherwise an annual rolling programme may be sufficient but the NAO should be consulted. In assessing the likely sufficiency of the audit evidence which will be available, the NAO will review with the department any stocktaking programme, and the history and treatment of discrepancies found. Agreement on the stocktaking strategy needs to be reached before the Balance Sheet date: should NAO's subsequent audit work reveal that there is insufficient evidence to support the account balance, it may then be difficult or impossible to generate the evidence required. Members of the audit team may wish to attend some stocktakes as observers and will therefore need to be advised of the department's stocktaking programme.

2.41 Unusual stock such as stockpile goods, military reserves, confiscated property, foreclosed property and intervention stocks require careful consideration. The NAO will welcome early discussions on these areas, along with any other unusual aspects such as decisions on when stock is regarded as issued or consumed.

2.42 A record should be kept of the reconciliation of the physical counts to the book records showing the treatment of all discrepancies identified. An audit trail should be retained of any write-offs and amendments to stock records.

 2.43 Equally importantly, this audit trail will also need to demonstrate the value attributed to the stock and be able to demonstrate that this meets the requirement of being current replacement cost (where held for continuing use) or the lower of cost or net realisable value as per RAM paragraphs 3.12.1 to 3.12.15.

 2.44 Where Work in Progress on long term contracts (RAM paragraph 3.12.7) is material, the proposed basis of valuation should be discussed with the NAO.

Debtors and creditors

2.45 Debtors are amounts receivable as at the Balance Sheet date no matter when they fall due for payment. They are normally sub-divided into Trade Debtors, Other Debtors, Prepayments/Accrued Income and Deposits and Advances. They should be stated at their net realisable value after allowance for bad and doubtful debts. Creditors, on the other hand, are amounts payable as at the Balance Sheet date. They are normally sub-divided into Trade Creditors, Other Creditors, Accruals and Deferred Income and Short Term Loans, Borrowing and Provisions. They should be stated at the full amounts due.

2.46 Box 11 provides the requirements for Trade Debtors and Creditors.

2.47 Where the department operates an accruals accounting system, debtors and creditors are generated directly from the books. If the accounting system is a cash accounting one, a special exercise is needed to identify those invoices received and issued before the year end for which the payment is made - or the receipt received - in the following financial year.

 2.48 Identification of accruals and prepayments is a less mechanical process, requiring detailed knowledge of the departments business. Box 12 provides some guidance. It is important to remember that there should be no netting off of related debtors and creditors; this practice (known as offset) is only allowable in special circumstances. If in doubt, the NAO would be pleased to advise. Remember also that debtors and creditors need to be split into amounts receivable/payable within one year and after more than one year for the related notes, and, where material, on the face of the account.

 2.49 The NAO will welcome an early opportunity to review the departments initial analysis of its expenditure and the resultant identification of debtors and creditors; and to review the methodology for calculating major accruals and prepayments. The NAO will need copies of documentation supporting the calculation of major accruals and prepayments.

Validation of creditors, debtors, accruals and prepayments: tests of plausibility and age analysis

2.50 Plausibility checks of creditors, debtors etc. are a normal part of the validation procedures which are intrinsic to accounts production. Accountants responsible for initially producing the figures should apply plausibility tests and submit the results with the figures to supervising accountants for review. Reviewers must use their own experience and knowledge to test the plausibility of the figures, and to appraise the results of the plausibility tests which have been reported to them. Box 13 provides some guidance on plausibility checks.

 2.51 The NAO will expect the results of plausibility checks to be made available to them when the Opening Balance Sheet is presented for audit. Audit teams should be consulted on methodology at an earlier stage.

 2.52 Analysis of creditors and debtors by age is part of the departments validation of Balance Sheet figures. Commercial accounts software will offer 'aged creditors' and 'aged debtors' reports. Old balances should be investigated to establish the substance of the liability or the recoverability of the debt. Debts which are assessed as bad must be written off; and consideration given to making a provision for doubtful debts. The basis of any provision, including a "nil" provision, is important audit evidence; as are the 'aged' reports, the record of consideration of them and the investigations made and action taken. Where debtors include staff loans for example, departments should confirm the amount outstanding with each member of staff at least once a year (and preferably at the year-end).

 2.53 For significant debtors, the NAO will need independent evidence of the validity of the debt, and may therefore make direct contact with the debtor (after consultation with the department). Where this is likely to be significant, the NAO will need the schedules of debtors at a very early stage (before the accounts are submitted for audit) so that this process can be completed with the rest of the audit. Often the only significant debtor will be HM Customs and Excise, i.e. recoverable VAT paid in January, February, and March. Here the department should reconcile the debtor to the VAT recovery received in May of the following financial year - this is important audit evidence.

Cash

2.54 Cash consists of cash in hand, including material stocks of postal orders and stamps, and deposits with the Paymaster and other financial institutions which are repayable on demand. Balances not yet drawn down from the cash voted by Parliament are not included. Deposits, including those denominated in foreign currencies, are repayable on demand if they can be withdrawn at any time without notice and without penalty or if a maturity or period of notice of not more than 24 hours or one working day has been agreed. Deposits not meeting these requirements should be included in debtors or identified separately as short term investments.

 2.55 The NAO will wish to see that proper arrangements are in place to ensure reliable figures are provided for cash in hand at the year end. This will normally entail evidenced cash counts and stocktakes of the other forms of cash. The NAO will also wish to receive direct confirmation of year-end balances from all commercial banks employed by the department and other bodies within its boundary. This is normally done via requests to the banks from the department, and audit teams will make the arrangements. Departments should ensure they maintain complete and up-to-date lists of commercial bank accounts in use during the year including those with nil balances and others closed before the year end. Arrangements are in hand for the NAO to receive direct from the Paymaster independent confirmation of departments' year-end balances. The year end reconciliations of the bank and Paymaster balances to the figures reported in the accounts are important audit evidence.

Provision for liabilities and charges

 2.56 The rules on this are currently laid down in FRED 14, and the NAO will wish to be consulted on the proposed recognition and valuation of any provisions. Some typical examples are given in Box 14. In considering the need for provisions, departments will have to look beyond their boundary to consider entities which may be unable to meet all their liabilities and where the eventual charge will fall on the department. The NAO will wish to see that such a review has been fully carried out. 

2.57 Very long-term liabilities such as nuclear decommissioning will need to be discounted at the standard public sector rate. Where discounting is applied the NAO will wish to see the discount calculation. Box 14 Some likely areas requiring provisions

Decommissioning costs where the department is obliged, legally or constructively, to bear the costs of remedying the environmental damage or contamination, or to perform restorative work; identified and calculated in line with paragraphs 4.4.2 to 4.4.9 of RAM.

Pensions and Superannuation only to the extent by which the Accruing Superannuation Liability Charge (ASLC) has not been completely discharged by payments of contributions.

Early Departure Costs only for the 20% departments are funding themselves; further guidance is available in paragraphs 4.6.4 to 4.6.9 of RAM.

Re-organisation costs where the department is demonstrably committed to the re-organisation, and the costs are not associated with ongoing or new activities.

Others: such as an onerous contract.

Contingencies and commitments

 2.58 Departments will require a system to identify potential contingencies - both contingent gains and contingent losses. On the basis of prudence, contingent gains should not be recognised in the accounts. Contingent losses should be recognised if there is sufficient evidence to indicate that the loss will occur. But such contingent losses which are not recognised in the accounts should be disclosed by way of a note unless the loss is regarded as remote. Security reasons may preclude detailed disclosure in the notes, although the amounts involved should be included in any aggregate totals provided. The NAO will wish to be consulted about the extent of disclosure, and will seek assurance that all contingencies have been provided for or disclosed in the notes where appropriate. 

2.59 Similarly, departments should have a system to identify obligations to make future payments - usually on contracts for non-routine services or business activities which are non-cancellable (or cancellable only at significant cost) extending beyond the balance sheet date. Examples include major building works and PFI contracts. These will need to be disclosed by way of notes to the accounts, distinguishing between capital commitments and other. The NAO will be pleased to discuss the need for, and the form of notation, for specific instances; and will seek assurance that all appropriate commitments have been disclosed.

Taxpayers Equity

 2.60 For resource accounts, the capital and reserves section of the balance sheet is termed the Taxpayers' Equity. The usual constituent parts of this section are provided in Box 15. The NAO will wish to be consulted where any unusual line items are to be introduced to this section.

Separate Trust Statements

 2.61 Departments receiving revenues or holding funds and investments for other than departmental objectives are required to report them in separate Trust Statements to be appended to the accounts. This will include, for example, tax revenues and funds held on behalf of third parties, such as client funds held by the Insolvency Service, assets seized by Customs and Excise, and client funds held by the Lord Chancellors Department. Treasury have asked to be notified of all cases. The Trust Statements will not be covered by the opinion on the resource accounts, but it is the intention to provide a separate opinion on such Statements, depending on their auditability. The NAO will wish to be consulted on the form of such statements.

Submitting the Opening Balance Sheet for audit

 2.62 The Opening Balance Sheet for audit should be supplied to the NAO together with the supporting papers summarised in Appendix 2.

2.63 Adjustments necessary as a result of NAO's audit of the Opening Balance Sheet must be implemented well before the production of the first full set of accounts. The indicative timings shown in Appendix 1 are stated with this consideration in mind.

Part 3: The Summary of Resource Outturn

3.1 The Summary of Resource Outturn (Schedule 1) is designed to enable Parliament to compare the sums voted in Estimates with the resources and cash actually consumed. The Schedule is unique to resource accounting and has no equivalent under GAAP. It will play an important role in resource budgeting. The Schedule shows:

• a comparison of outturn against estimate in respect of voted resource expenditure and the related cash requirements;
• a reconciliation of total resource expenditure to the cash requirement for both outturn and estimate;
• an explanation of variances between estimate and outturn; and
• details of receipts payable to the Consolidated Fund.

3.2 No real problems are anticipated with this Statement; it is included here for completeness. However the NAO will wish to see that the required format has been fully complied with, and this should form part of managements review.

3.3 Since this statement is unique to resource accounts, and to help avoid problems in its preparation, the following is offered by way of explanation:

• columns 1 to 3 show outturn figures for Gross Expenditure, Appropriations in Aid and a Net Total;
• columns 4 to 6 show requests for resource figures for Gross Expenditure, Appropriations in Aid and a Net Total as per the Estimates;
• column 7 shows the difference between the outturn net total and the net request for resources - to show how the department performed in reality against its projections;
• column 8 shows the outturn for the prior year for comparative purposes;
• "Non Operating Cost Appropriations in Aid" and "Net Cash Requirements" are separate totals: examples of the first would be the sale of capital items or repayment of loans; the second represents the cash estimated and spent by the department to carry out its functions as controlled by normal Supply procedures;
• the following three totals are key figures to show how well the department projected its expenditure and how successful it was in remaining within its budget:
  • Total Resources
  • Non Operating Cost Appropriations in Aid
  • Net Cash Requirement
• the next block of figures reconciles the Total Resource figures to the Net Cash Requirements by, for example, deducting non-cash items, movements in working capital, disposals of fixed assets and adding the decrease in liabilities and the purchase of fixed assets;
• Note that the figures for the purchase and sale of fixed assets are accruals-based amounts; any year-end creditors and debtors on these items will be included in movements in working capital;
• the next block is textual data providing explanations of the material differences between requests for resources and outturn, and providing information giving a clear picture for the reason; the reasons provided should be as informative as possible while remaining concise;
• the bottom block analyses the income that the department has received and, not being available to be appropriated in aid, has paid to the Consolidated Fund;
• the final note is included to provide a reference to other notes within the statements that will assist the understanding of the figures.
3.4 Working papers supporting the production of this statement, especially the calculations for the Reconciliation of Resources to Cash Requirements, are important audit evidence.

 Part 4: The Operating Cost Statement and Statement of Recognised Gains and Losses

4.1 The Operating Cost Statement (Schedule 2) serves a similar purpose to a Profit and Loss Account prepared under GAAP by the private sector, although the prescribed format is different. It has been designed mainly to meet the needs of Parliament and Treasurys budgetary control needs when resource accounts replace Appropriation Accounts. The Statement shows resources consumed during the year, and distinguishes between the department's own administration expenditure and its programme expenditure, net of departmental income. Administration costs, broadly equivalent to running costs under the existing regime, reflect the costs of running the department as defined under the Administration Cost Control Regime, together with associated income. Income is analysed in the notes between that which, under the Regime, is allowed to be offset against gross administrative costs in determining the outturn against the Administration Cost Limit, and that operating income which is not. Programme costs reflect non-administration costs, including payments of grants and other disbursements by the department.

4.2 To present administration and programme items as net costs, the Statement discloses and offsets income against relevant expenditure, programme by programme. Accordingly, some of the disclosures which would otherwise be made on the face of the account under GAAP are instead made in the notes to the accounts. This is to enable the allocation of all forms of expenditure and income to be made across administration and relevant programmes and to avoid complexity in the Statement itself. It means that items such as interest payable and receivable, depreciation and losses and gains made on asset disposals are disclosed in the notes to the accounts.

4.3 The costs and income figures shown in the Statement are calculated using accruals accounting principles - income or expenditure is included at the point in time at which it is earned or incurred, rather than when moneys are received or paid. For instance, for a service item the income will be considered to have been earned when the service has been completed, and this may be before or after the point at which it is invoiced to the customer, or before or after the point at which the cash is received. The Statement will reflect the costs associated with the activities undertaken by the department over the period.

4.4 In addition to the work on the Opening Balance Sheet, the NAO will carry out a "dry run" audit of the related Operating Cost Statement. Thus for an Opening Balance Sheet as at 1 April 1998, the appropriate Operating Cost Statement will be that for 1997-98. This should be seen as an opportunity for the department and the audit teams to ensure the exchange of information is adequate, and that the timetable for producing the accounts for audit is achievable. Appendix 1 sets out some indicative timings for addressing such issues. These are a guide to the latest feasible dates for the work, if the unpublished Operating Cost Statement is to be produced to the normal timetable. If this Statement is not prepared, such work will fall to be covered in the following year.

4.5 The NAO's audit work on this Operating Cost Statement (ie that for the period prior to the Opening Balance Sheet) will focus on such areas as:

• accounting systems
• accounting policies
• operation of key controls
• consolidations
• related party transactions
• exceptional items

 4.6 Before this statement is provided for audit, the NAO will welcome opportunities to comment upon:

• the proposed accounting polices and any variations to the standard Form of Account recommended in RAM;
• the Chart of Accounts and the accounts-production routines (whether manual or mechanical) for producing the accounts from the books of account;
• the programme of work to be carried out to provide management with assurance on the operation of accounting systems and internal controls eg by Internal Audit (see Part 7); and
• the programme of validation and quality assurance work which will be performed by departmental management on the accounts and supporting schedules prior to their presentation for audit.

General audit objectives

4.7 In examining whether the income and expenditure as stated in the accounts meet the requirements of the audit opinion, the NAO will determine whether they comply with the general audit objectives outlined in Box 16. As part of this, the audit team will consider whether the combination of systems, controls, validations and management reviews address these objectives.

Accounting for income

4.8 Income includes items such as fees and charges, rent, interest and EU funding whether treated as Appropriations in Aid or CFER. Importantly, it excludes Vote funding (dealt with through the General Fund), benefits from the National Insurance Fund and Consolidated Fund standing services. The figures must be included on an accruals basis (ie the amounts receivable), net of VAT and distinguished between "Administration" and "Programme" in line with related expenditure. Details are provided in paragraphs 6.1.1 to 6.6.1 of RAM.

 4.9 The NAO will be concerned to see that departments have ensured:

• the completeness of income, including proper accruals where material for each item;
• that income, other than recoverable VAT, has not been offset against expenditure before being brought to the account;
• that income is properly credited to either "administration" or "programme";
• that income has been properly disclosed and presented in the accounts in accordance with RAM;
• where income is received from services to other public sector bodies and external customers, in order to disclose this by way of note in line with the Treasury's Fees and Charges Guide, the figures have been identified from the chart of accounts, or evidence on the derivation of the figures is available.

Accounting for expenditure

4.10 Expenditure consists of all voted expenditure including actual insurance premiums, plus Consolidated Fund standing services and National Insurance Fund benefits and non cash costs such as depreciation, the capital charge and foreign exchange gains and losses. Importantly it excludes notional insurance (except for the Intervention Board) although the effect of this may be shown in the "Fees and Charges" note for services to other public sector bodies or external customers. Expenditure must be stated on an accruals basis (ie amounts payable) and distinguished between "Administration" and "Programme" - guidance is provided at paragraphs 7.1.4 to 7.1.6 of RAM.

 4.11 The NAO will be concerned to see that departments have ensured that:

• all expenditure for the year is properly accrued and brought to account inclusive of irrecoverable VAT;
• all novel and contentious expenditure has been considered for "regularity" and "propriety" purposes with the results available for management review and audit;
• expenditure is fully supported by appropriate evidence such as vouchers, and properly disclosed and presented in accordance with RAM;
• continuing and discontinuing activities have been properly identified in accordance with the principles in FRS 3;
• exceptional expenditure has been properly identified and presented in accordance with the principles in FRS 3;
• the capital charge has been correctly calculated, with proper tracking of the capital base to arrive at a reliable average cost ( see paragraph 7.4.5 of RAM); and
• all exchange gains and losses have been identified and properly calculated.

4.12 A significant element of most departments expenditure will be that on staff costs. In line with GAAP, these are defined as:

"The costs a department incurs in respect of the persons it employs under contracts of service."

In line with this definition departments should take care, for example, to exclude consultants' costs which are rarely contracts of service. These costs should be shown under other operating expenditure. Staff costs include the employer's contributions towards other pension costs, and the appropriate note in respect of the pension schemes in operation should be provided.

4.13 Departments should observe the recommended layout of the required note providing the breakdown of staff costs; and also ensure that all the salary disclosures have been made in the note to the accounts as required by paragraphs 8.5.1 to 8.5.4 of RAM; these disclosures should be supported by appropriate calculations and other evidence. The NAO will expect the department to carry out appropriate checks and validations to confirm the reliability of the payroll figures in the accounts, especially where this function is contracted out. Details are provided at Box 17. The results of this work should be retained as audit evidence.

Notes to the Operating Cost Statement

4.14 The other notes required to support this Statement are listed at paragraph 12.1.22 of RAM; paragraphs 12.1.13 and 12.1.14 along with 12.1.23 and 12.1.24 are also relevant.

4.15 The three main notes, other than those providing breakdowns of the figures in the Operating Cost Statement, are:

• the Analysis of Net Resource Outurn and Net Operating Cost;
• the Reconciliation of Net Operating Cost to Control Total and Net Resource Outturn; and
• the Analysis of Capital Expenditure, Financial Investment and Associated Income.

4.16 For the first of these, the analysis is by voted components of Net Resource Outturn, with additional adjustments to add expenditure not funded by Supply and take account of income not recognised in Supply, to reach Net Operating Cost.

4.17 On the second, the reconciliation comprises adjustments to the Net Operating Cost to remove income and expenditures which are outside the Treasury Control Total to reach Resource Budget Outturn - a Treasury control figure; and further adjustments to the Resource Budget Outturn to remove expenditure not funded from Supply and add back Supply funded expenditure outside the Control Total. This results in the Net Resource Outturn, which represents net expenditure on the same basis as the Parliamentary Supply Grant.

4.18 The analysis of Capital Expenditure is required by "Request for resources".

 4.19 The working papers supporting all notes are important audit evidence.

Consolidation of income and expenditure

4.20 The general requirements of consolidation are dealt with at paragraphs 2.5 to 2.12 above. In consolidating the entities within the boundary departments must also look to eliminate the effect of "intra group" transactions. These are likely to include items such as overheads re-allocated to other parts of the department and other shared costs.  Departments also need to consider whether the presentation of income and expenditure in the accounts being consolidated is appropriate for the consolidated accounts. For example, expenditure treated as exceptional at the entity level may not be exceptional at the consolidated level. Notional insurance charges in agency accounts, where material, should be eliminated.

 4.21 The NAO will wish to see that arrangements are in place to identify all "intra group" transactions either manually or through the underlying systems. Where dealt with manually, the working papers will be important audit evidence.

Management representations

 4.22 In the closing stages of each year's audit, the departmental Accounting Officer is required to make formal representations to the C & AG on the content of the departments accounts, and certain other matters. An example of such a letter of representation is at Appendix 4. The letter includes the statement that: "in all material respects the transactions reflected in the accounts were regular and proper to the organisation". The audit team will wish to establish the nature of the delegations, instructions, controls and procedures upon which the Accounting Officer will rely when making these statements in future years.

Submitting the Statement for audit

 4.23 The Operating Cost Statement submitted with the Opening Balance Sheet for audit should be supplied to the NAO with the supporting papers summarised at Appendix 2.

The Statement of Recognised Gains and Losses

4.24 This will appear below the Operating Cost Statement and follows FRS 3, although the Net Operating Cost from the Operating Cost Statement (in lieu of the profit/loss in the business world) will not feature as this is financed either by the Vote or other source. Thus the word Total is excluded from the heading. The usual entries here will include the increase from the revaluation/indexation of tangible fixed assets, increases in market value of current asset investments and any unrealised currency translation differences on foreign investments. If the department has no such gains or losses in the period, a statement to this effect is required below the Operating Cost Statement.

Part 5: The Cashflow Statement

 5.1 The RAM requires all departmental resource accounts to include a cashflow statement. Subject to the provisions of RAM the exemptions in paragraph 5 of FRS1 will not be available to entities within the departmental boundary, unless specifically approved by Treasury. The Cashflow Statement (Schedule 4) is designed to provide information on the way the department has absorbed, and generated, cash (see paragraph 2.54) in the period. In effect this Statement summarises the movements of cash during the year, and is prepared generally in accordance with Financial Reporting Standard 1 (FRS 1). This requires analyses of the net cashflow on both operating activities and capital expenditure, and how this net cashflow has been financed. It is important that the format in the RAM is followed, and the NAO will welcome discussions if departments foresee any problems with this.

5.2 If the accounting system has been designed with the cashflow in mind (see Box 2 in Part 1) many of the figures in this Statement can be derived from this and the other primary statements and supporting notes. However, as some of the figures cannot be derived directly, a lot of care has to be taken in the production of this Statement, and it should be subject to detailed management review. The documentation must contain full audit trails to ensure the Statement reconciles with the opening and closing primary statements including all late adjustments.

5.3 The following should be noted:

• the flows must reflect all the entities within the departmental boundary;
• the Statement is concerned with external flows; internal flows should be eliminated on consolidation;
• the "financing" section will include the Vote drawn down from the Paymaster;
• interest receivable and payable are included in the Net Operating Costs and are not shown separately in the Operating Cost Statement; these items are therefore included in the Net Cash Outflow from Operating Activities rather than under the separate heading Returns on Investments and Servicing Of Finance required by FRS 1;
• three reconciliations are required either by way of Notes or in statements adjoining the cashflow statement:
• reconciliation of operating cost to operating cash flows;
• analysis of capital expenditure and financial investment; and
• analysis of financing.

Part 6: The Statement of Resources by Departmental Aims and Objectives

6.1 The purpose of the Resources by Departmental Aims Statement (Schedule 5) is to show an analysis of resources according to the departmental aims and objectives they are intended to serve. These aims and objectives will also be the basis for the annual Output and Performance Analysis report which departments are to produce as part of the resource accounting initiative but will publish separately from the accounts themselves. Schedule 5 is unique to resource accounting and has no equivalent under GAAP. It provides additional relevant information that is consistent with the other resource accounting statements.

6.2 There are four important aspects here:

• identifying the departmental aims and objectives;
• reporting performance against the Objectives;
• ensuring direct costs for each aim are properly identified; and
• agreeing the basis of allocation or apportionment for any indirect costs, or deciding to show unallocated costs separately.

Departmental aims and objectives

6.3 Aims and objectives are to be set by Ministers. The NAO will welcome an early sight of these as they are agreed.

Reporting performance by objectives

6.4 As performance will be reported against Objectives, the NAO will welcome early discussions on proposals before they are finalised. There is important linkage between these Objectives and the Output and Performance Analysis required by the Treasury. The Treasury are preparing a manual for the Output and Performance Analysis which will set criteria for performance measures.

Attributing costs to aims and objectives

6.5 Paragraphs 13.3.1 and 13.3.2 of RAM deal with this aspect. Ideally the direct costs of aims and objectives will be allocated to aims and objectives through the accounting system. For indirect costs which are to be apportioned across the aims and objectives, the NAO will need to:

• be satisfied that the bases of apportionment are appropriate to the circumstances; and

• see underlying reliable information supporting the actual allotment to the different aims and objectives.

6.6 There are numerous bases of apportionment. Some examples follow, but this list is not exhaustive:

• usage - eg on the same basis as expenditure by aims and objectives;
• in line with the management accounts;
• per capita - ie on the number of people employed on each aim or objective;
• on the basis of area occupied by the activities.

6.7 Where the basis chosen is other than in line with the direct expenditure, the department will need to provide evidence to justify the basis of allocation. Where, for example, the 'per capita' basis is chosen, evidence of the number of people employed on each aim or objective reconciled to the total staff employed will be necessary. Other bases may require more sophisticated arrangements such as time recording systems. Early discussion with the NAO on this is advisable.

Part 7: The Statement on Internal Financial Controls

7.1 The pro-forma suggested wording for the Statement on Internal Financial Controls will be circulated by Treasury. The Statement will not feature as part of the accounts covered by NAOs true and fair view certificate. Nevertheless it is Treasurys intention that these statements will be subject to NAO review, to allow the Comptroller and Auditor General to report that the information contained in the statement is not inconsistent with the information of which he is aware from his financial audit work on the departments Resource Accounts.

7.2 The Statement requires the department to specify, in broad terms, the framework of the system of internal financial controls maintained and operated by the department.

7.3 In addition, the Statement requires a note of the sources of assurance or information that allow the Accounting Officer to form a view as to the effectiveness of the system of internal financial controls. This will come mainly from the results of work of the internal auditors and executive managers within the department. For some departments this will require a re-focusing of the work of Internal Audit to ensure that all material financial systems are considered regularly, and that the appropriate assurances can be provided. The results of Internal Audit work, their reports and the assurances they provide are essential audit evidence.

The Internal Control Environment

7.4 Internal control is one aspect of corporate governance. Corporate governance is a system by which departments are directed and controlled. The Accounting Officers and Management Boards (if applicable) are responsible for the governance of their departments. Responsibilities include setting strategic aims, providing leadership to put them into effect, supervising the management of the business and reporting on their stewardship. Within that overall framework, the specifically financial aspects of corporate governance are the way in which the Accounting Officer (and Board) sets financial policy and oversees its implementation - including the use of financial controls and the process whereby the Accounting Officer reports on the activities and progress to Parliament.

7.5 Box 18 outlines key elements of a sound internal control environment. As with the wording of the internal financial control statement, some of these features such as the inclusion of independent board members will vary according to the nature of the central government body.

7.6 The NAO will be happy to discuss the implications of the Statement with internal audit units and departments. In assessing the adequacy of the financial systems it will be appropriate for Internal Audit to consider the external audit objectives outlined in Boxes 7 and 16 of this publication.

7.7 As part of their planning each year, the NAO's audit teams will wish to see the proposed programme of internal audits and will be pleased to discuss this with both the internal audit unit and management if required. The internal audit programmes and their results should feature on the Audit Committee's agenda and the NAO will be willing to attend such meetings to provide an external audit perspective. And the NAO will be pleased to attend other meetings of the Audit Committee by request.

Departmental Monitoring

7.8 The arrangements to provide continuing assurance that department's systems and finances are in good order are a matter for departments. They will, for example, determine where it is appropriate for positive assurance to be provided by regular internal reporting, and where exception reporting will be sufficient. Some candidate items for internal reporting are listed in Box 19.

Part 8: The First Full Set of Accounts for Formal Audit

Audit planning

8.1 The NAO's financial audit procedures require annual audit plans to cover a wide range of issues, such as knowledge of the business environment of the department, significant events and changes to the department's activities, risk appraisals, financial analysis and audit approaches, together with details of the department's timetable for preparing the financial statements and the NAO's timetable for auditing them. Planning information is normally drawn mainly from information gleaned during the previous year's audit. In the first audit year, there will still be a fair amount of familiarisation work to be done, and the co-operation of departmental staff is vital for this work.

8.2 The formal output of the liaison which takes place between the department and the NAO audit team at each audit planning stage is an agreed Client Liaison Schedule. This sets out who is responsible for preparing and making available financial information that is key for the audit of the accounts. Details vary from client to client, but a general indication of typical contents is given in Box 20. Departments should see the Client Liaison Schedule as forming a part of the general project to manage the production, audit, signing and laying of the department's resource accounts by 31 October each year as required by paragraph 14.1.1 of RAM. As part of this liaison process the NAO will provide an estimate of the notional audit fee each year.

Box 20 Contents of the client liaison schedule

Introductory statement:
"All relevant general ledger and fixed asset register transactions should be processed to allow a trial balance to be made available for audit purposes with the accounts for audit. Any subsequent amendments to this trial balance should be discussed in advance with the NAO at a wash-up meeting at the end of the final audit and supported by appropriate journal vouchers. It may well be that further adjustments are also required at this stage as a result of audit findings." List of items required by the NAO: Schedules, listings, letters &c required by the NAO Person Responsible Date Required Date Received Accounts for audit in the format of the final financial statements Chief Accountant 1/9/98 Draft Letter of Representation Chief Accountant 1/10/98 Transaction data in specified electronic forms April to December Accountant end Jan 98 January to March Accountant end Apr 98 [Various supporting schedules referred to at Appendix 3] Audit and Accounts Completion Timetable: Draft Foreword available Mr Bloggs early Oct 98 NAO review of draft Foreword NAO mid Oct 98 NAO clearance of accounts for audit subject to finalisation procedures, including post- balance sheet review NAO mid Oct 98 Receipt of signed Letter of Representation AO end Oct 98 Signature of accounts AO end Oct 98 Signature of audit opinion NAO end Oct 98 Management letter issued NAO early Nov 98 Response to NAO management letter AO early Dec 98

Note: The dates are provided for indicative purposes only, and with 1997-98 accounts in mind. They represent the latest feasible, rather than ideal, dates; and wherever possible the events listed should take place earlier than shown.

The "Interim" audit

8.3 To maximise audit efficiency and keep the year-end work to a minimum, the NAO aim to do as much work as possible before the year end. This approach will also reduce the pressure on both the department and the NAO in the key months of April to July when the department produces the accounts for audit.

8.4 Interim audit work, which usually starts in December or earlier, will consist mainly of transaction testing in expenditure areas, tests on fixed assets movements (additions, enhancements, and disposals) and review of assurances obtained by department management that systems and controls are operating satisfactorily. As such, the auditors will need access to books and records and will expect to find that transactions are fully supported by appropriate calculations and documentation.

8.5 Departments may produce one or more sets of interim accounts - half-year or quarterly accounts. The NAO welcome the production of interim accounts, particularly the opportunity afforded to present financial managers at all levels with accounts in statutory format drawn from the financial management information with which they have working familiarity. These managers should understand how the account figures are derived from such information; and should be involved in, and aware of the overall scope of, the validation procedures which underpin the reliability of the accounts.

8.6 The NAO will wish to see any interim accounts. Audit teams will value the opportunity to identify any problems concerning the nature of disclosures and the form of account. They may wish to perform some analytical procedures on interim figures, and to examine some accounts-preparation procedures, such as:

• reconciliation of General Ledger with Fixed Asset Register
• reasonableness checks of depreciation and revaluation
• plausibility checks on creditors, accruals, etc
• reconciliation of General Ledger to the Management Accounts

8.7 Reporting by the NAO to the department following interim audit work may be formal or informal, depending upon the nature of the findings. It will include any matters arising from NAO's appraisal of interim accounts and related procedures, although the C &AG does not provide an audit opinion on interim accounts. The department should also take the opportunity of the interim audit to bring relevant matters to the auditors' attention.

Pre-audit informal review of accounts matters

8.8 The NAO will be pleased to discuss presentational matters with the department before the date agreed for submitting the accounts for audit. If in doubt, the audit team will be happy to review a set of "dummy accounts" (ie in the style and format proposed for audit, but before the statements are populated with figures) at this stage; it is often possible to identify likely problems concerning the nature of proposed disclosures in the accounts and especially in the Notes to the Accounts, even before figures are finalised. Audit teams will aim to provide feedback within a few days.

Management review of draft accounts

8.9 Departments will produce draft accounts which they should then subject to verification and review before submitting for external audit. Problems are unlikely to emerge at this stage if the reconciliations, validations and tests of plausibility and reasonableness outlined in this publication have been performed satisfactorily. Box 21 provides some guidance on the additional checks which should be performed on the draft accounts before presenting them for audit. This also addresses the need for consistency between the financial statements and the Foreword. This analysis and the record of these checks should be provided to the NAO.

8.10 The trial balance is an important document for the auditors: for example,  they will use it to verify that account outturns will be tolerably close to the forecast figures on which their audit plan is based. The department's validation of the trial balance is largely a matter of checking that the trial balance is a proper reflection of the books of prime entry; ensuring there is a proper trail to demonstrate how the figures in the trial balance agree to the figures in the accounts, and comparing the figures with expectations. The NAO will expect to receive, together with a copy of the trial balance, copies of all the validations performed, notably a copy of the department's comparison of trial balance figures with prior year and forecast figures, with explanations of unusual or unexpected relationships, and notes of any matters outstanding.

The "Final" audit

8.11 The "final" audit focuses on the figures in the financial statements and their presentation. Although some can be carried out beforehand, this work can only properly begin once the accounts have been presented for audit. Ideally the accounts for audit provided to the NAO together with the material listed in Appendix 3 should be regarded as final: the department should have complete confidence in them, and should be prepared to recommend the Accounting Officer to sign them subject only to the NAO indicating that they have completed their audit.

8.12 The supporting documentation required in respect of the Closing Balance Sheet is largely as stated in Part 2 for the Opening Balance Sheet. Much of the material in Appendix 3 therefore repeats material in Appendix 2. For Balance Sheet items, one difference between the Opening Balance Sheet and Closing Balance Sheet positions is that in the latter case, year-on-year comparisons are added to tests of reasonableness and plausibility. Appendix 3 also contains three further items not present in Appendix 2 (because while normally required in support of full sets of accounts, they are unlikely to be relevant to Opening Balance Sheets): documentation of year-end journals; a list of (any) adjustments omitted on materiality grounds; and the departments draft Foreword which will be published with the accounts.

8.13 The emphasis for the audit of the closing balance sheet will be on the movements in the year. Thus the calculations supporting these movements, for example on fixed assets, provisions and reserves are important audit evidence. Departments should note that downward revaluations of fixed assets should only be reflected through the revaluation reserve to the value that the reserve has been increased by the same asset. The balance of the any downward revaluation must be charged to the Operating Cost Statement. This should also point up to departments the need to maintain the information on the effect of upward revaluation on each asset.

8.14 The NAO will look to see that management have re-visited provisions each year to determine whether the circumstances continue to justify them. Provisions no longer required should be released to the Operating Cost Statement - where material they may require separate disclosure in the accounts, and the Treasury have asked to be consulted. It should be noted that provisions are for specific circumstances, and the release of one provision and its credit to the Operating Cost Statement should not be offset by the creation of another.

8.15 Following a "wash-up" meeting to discuss matters arising from the audit along with any late adjustments required by the department, and agreement to any material adjustments, the audit team will normally give notice orally that the accounts for audit (amended as necessary) are acceptable, and that the audit has been completed. The Accounting Officer may then be invited to sign the accounts.

8.16: Once signed by the Accounting Officer, the accounts should be formally rendered to the C &AG together with a Letter of Representation which is also signed by the Accounting Officer. For general guidance a pro-forma letter is reproduced at Appendix 4. Audit teams will advise on the application of general principles to the circumstances of the individual department. It is normal practice to reach provisional agreement on the intended contents of the letter at a relatively early stage, and for the audit team to discuss the matter again with the department at the completion of the final audit. Departments should note the assurances to be provided in the pro-forma letter and ensure they have arrangements in place to support those assurances. The pro-forma letter at Appendix 4 should be used as a checklist of the arrangements which need to be made. In addition the NAO will normally require specific representations on individual matters where these are significant and have involved judgements by the department, such as a large negligence claim.

Submission of signed account and audit certification

8.17 The Accounting Officer should sign and date the Foreword, the Balance Sheet page, the Letter of Representation and initial all the other pages of the accounts. Two signed copies of the accounts should be sent to the Comptroller and Auditor General together with the Letter of Representations.

8.18 The final stages of accounts production and audit certification are often fairly compressed, so that it is unusual for any significant interval to elapse between the signing of the accounts by the Accounting Officer, and their certification by the Comptroller and Auditor General. Unless the date of certification is to be the same date as the date of the Accounting Officer's signature, the NAO Assignment Director for the audit will, immediately before advising the Comptroller and Auditor General to sign the audit certificate, confirm with a nominated officer of the department - usually by telephone - that the Accounting Officer "would still sign the accounts" (that is, that there have been no events coming to light after signature of the accounts which would alter the view taken by the Accounting Officer of their material truth and fairness). Thus there is a duty on the department to monitor events affecting accounts until the Comptroller and Auditor General has signed them, so that this assurance can be properly provided.

8.19 Departments should recognise that following completion of the fieldwork stage of the final audit, prior to recommending the Comptroller and Auditor General to sign the audit certificate, there are formal internal NAO review stages of the work to be carried out by the Assignment Manager and Director. Once the Comptroller and Auditor General has signed the accounts a copy will be returned to the department. Box 22 provides details of the audit certificate for resource accounts.

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