Important changes for municipal audits: Practical considerations for CPAs

If you perform financial audits of municipalities or of legal persons related to a municipality, or are interested in a new area of practice in the municipal sector, a number of changes to legislative provisions on municipal audits brought about by the Act to amend various legislative provisions concerning municipal affairs and the Société d’habitation du Québec (SQ 2018, c. 8, formerly known as Bill 155) could have important implications for you:

• Broadening of external municipal auditors’ mandate with respect to audits of financial statements of legal persons related to municipalities, regional county municipalities (RCMs) or regional boards.
• New obligation of municipalities with at least 10,000 residents but fewer than 100,000 to have an external CPA auditor or the Commission municipale du Québec (CMQ) conduct a value-for-money (VFM) audit.

external audits of legal persons related to municipalities

 Effective January 1, 2019, the “external auditor” responsible for the “financial audit” (while this is the term used in the text of the Cities and Towns Act, it refers to financial statement audits) of a municipality, an RCM or a regional board (for simplicity’s sake, we will refer to all of these as municipalities) must also conduct the financial audit of legal persons “related” to that municipality. A related legal person means a legal person that is part of the reporting entity of a municipality, or a legal person of which the municipality or a mandatary of the municipality appoints the majority of the board members or holds more than 50% of the outstanding voting shares or units.

Since this obligation applies to municipal audits conducted in 2019 (for 2018 financial statements), it is possible that the municipalities affected have already or are in the process of appointing their external auditors. That said, the nature and scope of those external auditors’ mandates will change significantly due to the fact that they will also audit the financial statements of related legal persons, some of whom may have never been audited in the past. Before taking on such a mandate, CPAs must ensure they follow appropriate procedures regarding the acceptance of audit engagements, especially when it comes to evaluating their competence, capabilities and independence.

Moreover, these related legal persons may already have appointed the auditor of their 2018 financial statements, as many are in fact legally bound to do so. It is therefore possible that more than one auditor will be engaged to perform the audit of a legal person’s financial statements. In some cases, the auditors will decide to conduct separate engagements, and in others, a joint audit. This unusual situation raises a lot of questions for which neither the new provisions nor the auditing standards in the CPA Canada Handbook – Assurance provide any clear answers.

Nevertheless, here are some matters CPAs should consider in these two cases:

• Communicate with the other auditor to agree on the approach to be followed, including coordinating your audit work to avoid duplication.
• Together with the other auditor, try to plan your individual audits and share your work and results, while ensuring compliance with the standards on audit work and results. In separate engagements, each auditor must be able to provide an audit opinion on the overall audit engagement and take full responsibility for it, including the work performed by others (for instance, another auditor). In a joint engagement, the joint auditors share responsibility for the audit.
• Maintain documentation on all work performed in the file, and properly document the audit file (i.e. communications, reviews performed and supervision provided) to ensure compliance with the standards.

value-for-money audits

Under the new provisions, municipalities with fewer than 100,000 residents will be required to undergo a VFM audit effective January 1, 2020. The CMQ will perform the VFM audits of municipalities with fewer than 10,000 residents.

The VFM audit of a municipality with more than 10,000 residents but fewer than 100,000, and its related legal persons and organizations, will have to be entrusted to an external auditor, who must be a CPA, unless the municipality has adopted a by-law entrusting its VFM audit to the CMQ. The municipality can choose to entrust the VFM audit to the external auditor who already performs its financial statement audit or another external auditor who will focus on the VFM engagement only.

Whether you are already the external auditor of a municipality or wish to respond to a call for tenders to perform only the VFM audit of a municipality, you should take into account the limits of your skills and consider the following:

• Value-for-money auditing requires specialized expertise that is quite different than that needed for financial statement audits; being qualified for one does not necessarily mean you are qualified for the other.
• Value-for-money auditing requires extensive knowledge of the environment under audit. CPAs must be able to determine the areas requiring such an audit, as they will set out what the VFM audit focuses on. They may then need to get acquainted with the procedures in these areas, find comparables and establish best practices so as to make an informed judgment. All of this is very time consuming.

External auditors engaged to perform the audit of a municipality’s financial statements as well as its VFM audit must comply with the independence standards. For a specific audit engagement and depending on the nature of the VFM mandate, auditors are required to identify threats to independence, evaluate the significance of those threats and, if the threats are other than clearly insignificant, identify and apply safeguards to reduce the threats to an acceptable level.

Before undertaking a VFM engagement, CPAs must ensure that they will be able to fulfill their duty of objectivity. Even though they are conferred immunity for VFM engagements under the new provisions, CPAs should keep in mind that their report may be critical of certain aspects of a municipality’s management, and may therefore put them in a difficult position.

In short, while VFM auditing is an interesting practice area to develop, CPAs should not underestimate the challenges they may face in developing their expertise in this area as external municipal auditors. CPAs should be aware of the work involved in VFM auditing when responding to a call for tenders by a municipality. Before submitting a proposal, be sure to properly assess the resources required to perform a VFM engagement.