Kids Company puts the limitations of audits under scrutiny

The Charity Commission wants auditors to report their concerns to it more readily than they do, writes Liam Kay

Audits: check only a sample of the paperwork, says Nick Brooks
Audits: check only a sample of the paperwork, says Nick Brooks

One key question about Kids Company concerns the role its auditors played. Only 11 months before the charity collapsed in August 2015, they had signed off its accounts, which some saw as confirmation that all was well.

For example, Oliver Letwin, Chancellor of the Duchy of Lancaster, who has overall control of the Cabinet Office, told the Public Administration and Constitutional Affairs Committee inquiry into the charity that "the evidence we were getting from the auditors was not evidence of something that was financially mismanaged in the way that it has now come to light that it was".

Don Bawtree, lead partner for charities at the accountancy firm BDO LLP, says many trustees think audits will prevent fraud, even though they do not involve the forensic examination of the accounts needed to give true peace of mind.

And the accountant for Kids Company - Nick Brooks (left), partner at Kingston Smith - told the committee in a separate hearing about the limitations of audits, which assess only whether a charity's accounts are free of material misstatement and are a true and fair reflection of the financial position.

According to Brooks, auditors check only a sample of the paperwork, and the required assurance that the charity is a going concern applies only to the next 12 months. Any misgivings about the accounts are mentioned not in the report but in a "management letter" to the trustees.

Brooks revealed that in all three audits of Kids Company by his firm, the management letter warned that the charity was "living hand to mouth" with insufficient reserves - both factors in its eventual collapse. But Kids Company did not respond to two of the letters, and the Tory MP David Jones asked Brooks if it was a breach of duty on his part not to have raised the matter with the Charity Commission, which requires "failures in charity governance which lead to significant charitable funds being put at major risk" to be reported to it.

Brooks responded: "I am not sure I would go as far as to say that. But it is something that I would obviously take away with me and consider for future reference."

The Charity Commission is keen for auditors to report matters to them more often. They already have to report eight issues of material significance, including evidence of dishonesty or fraud; loss of funds; money laundering or criminal activity; terrorism; breaches of legislative requirements; risk of abuse or mistreatment of beneficiaries; and deliberate breach of a charity regulator's order or direction.

They also have discretion to report any matter relevant to the exercise of the commission's functions, but this power is rarely used. Nigel Davies, head of accountancy services at the Charity Commission, says auditors should use it more often.

"We think applying professional scepticism is not unreasonable," he says. "If they come across something that leaves them feeling unhappy, they exercise their professional discretion; and if they don't believe it is on the list of things they must report, they should report it as a relevant matter."

The commission is planning to work with professional bodies to put out key regulatory messages on reporting this year. A formal consultation on issues of material significance could be held before the summer in collaboration with the Scottish and Northern Irish charity regulators.

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