Public Audit Committee

Meeting date: Thursday, June 29, 2023

Official Report 618KB pdf

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Section 22 Report: “The 2021/22 audit of Scottish Canals”

We have two principal items on our agenda. The first is consideration of evidence on “The 2021/22 audit of Scottish Canals”. I welcome our three witnesses: we are joined by Stephen Boyle, the Auditor General for Scotland; Mark Taylor, the audit director at Audit Scotland; and Joanne Brown, who is a partner at Grant Thornton UK LLP.

We want to put quite a number of questions to you but, before we get to those, I ask the Auditor General to make a short opening statement.

Many thanks, convener, and good morning, committee. I have prepared this report under section 22 of the Public Finance and Accountability (Scotland) Act 2000 on the 2021-22 audit of Scottish Canals. My report brings to your attention on-going issues with Scottish Canals’ valuation of its assets and the completeness and accuracy of its records. Those issues are so significant that they have resulted in the auditors issuing a disclaimer on Scottish Canals’ financial statements for the second year in a row.

The committee might recall that, in February of last year, I reported on similar issues that were raised through the previous year’s audit of Scottish Canals. The issuing of a disclaimer of an audit opinion is a serious matter, which indicates that the auditors have been unable to provide an opinion on the financial statements due to insufficient appropriate audit evidence. In this case, there is a lack of public assurance over Scottish Canals’ financial position and performance, and the regularity of its transactions.

The basis for the disclaimer is Scottish Canals’ valuation of its property, plant and equipment assets. Scottish Canals has faced significant challenges adapting to the financial reporting and accounting framework that is required of it as a non-departmental public body—specifically, to the way it now has to value those assets. It has taken steps to address the auditors’ concerns but progress has been limited by the quality of its underlying documentation and data.

Scottish Canals now needs to develop an effective plan to ensure that it can meet its financial accounting responsibilities as a matter of urgency. Scottish Canals needs to work together with Transport Scotland, in its role as Scottish Government sponsor division, to ensure that the implications of the accounting rules that Scottish Canals must work to are fully understood and reflected in its planned response. They should work together to ensure, too, that Scottish Canals has the capacity and expertise to deliver the improvements that are now needed. Those issues will be a central focus for the incoming external auditors during the 2022-23 annual audit. I will continue to monitor Scottish Canals’ progress and report further as necessary.

As you have noted, convener, I am joined by Mark Taylor, who has led on the preparation of the section 22 report, and by Joanne Brown, from Grant Thornton, who is the appointed external auditor for 2021-22. We look to answer your questions.

Thank you very much for setting the scene with that opening statement, which had a great deal of similarity with the evidence that we took around this time last year.

We will go straight to questions. I invite deputy convener Sharon Dowey to begin.

This is the second year in a row that the auditor has issued a disclaimer on the audit opinion. Is it correct to state that, in 2020-21, the auditor’s concerns arose from assets that had not been valued and that this year’s concerns are related to a lack of audit evidence to support the valuations that have since taken place?

Yes, that is largely the case. I will pass over to Joanne Brown, who can set out for the committee the judgments that she arrived at in issuing a disclaimer of opinion, but first I will quickly give some additional context.

Last year’s section 22 report highlighted issues around the availability of evidence. Scottish Canals, in its evidence to the committee, set out its intention to undertake a full valuation exercise. As we note in our report, that is evidence of some progress. However, Scottish Canals has not yet been able to provide robust evidence to support the valuation numbers and disclosures that were set out in its accounts, in order to satisfy the external auditors that those were complete and accurate to allow them to issue an audit opinion.

Joanne can set out her judgments for the committee.

There was a series of issues in 2021 that led to the disclaimer, but the principal issue concerned the accounting records that supported the valuation in 2021. That included evidence of the existence of assets, the record keeping within the fixed-asset register and a number of other issues around accounting for property, plant and equipment.

The exercise in 2021-22 was very complex. Scottish Canals had a project plan and sought to get a valuation. In doing the valuation in 2021-22, it also made a decision that it would value the canal itself as an asset; that was not something that it had done in the 2021 accounts and it included a number of complex judgments and estimates. While we agreed, and could see, that the valuation model in 2021-22 was reasonable, Scottish Canals still lacked underlying data and evidence around some of the significant material judgments and estimates in the accounts. We saw some similar themes in 2021 around evidence of the existence and ownership of assets, record keeping, and the data that supported the cost information that Scottish Canals proposed to feed into the valuation model. It is very complicated and Scottish Canals did a lot of work but, unfortunately, the underlying records do not support some of the material numbers in the financial statements, which led to the disclaimer of opinion.

Would you say that Scottish Canals is in a worse position this year than it was last year?

Joanne Brown will have a view on that, having been the auditor for a number of years.

As we looked to set out in the report, there are signs of progress. Scottish Canals sought to undertake a complex programme of valuations. What it has not yet done is address all the clear evidence that is required, not just to satisfy the auditors; the accountable officer and the board, given their responsibilities, will also want to be satisfied on those same points.

As the section 22 report sets out at paragraph 15, a number of steps are still required in order to meet the requirements of an external auditor in order that they can issue a clear opinion on the annual report and accounts. There is some progress that we would want to recognise, but there is quite a bit of a way to go.

The other rationale that we arrive at in the report is that Scottish Canals, together with its sponsor division, needs to have a clear plan as to how it will arrive at a valuation methodology that can allow it, and its auditors, to see the evidence that is necessary to satisfy accounting requirements.

How unusual is it for a public body to have a disclaimer on the audit opinion that is issued in respect of its annual accounts for two consecutive years?

It is very, very unusual. I do not think that there are other examples that we can think of in which an auditor has issued a disclaimer of opinion. I will ask Joanne Brown to set out her experience.

The committee may also be interested to know that when auditors issue opinions, they have a range of options. The most common opinion that you will see is an unmodified—what is known as a clean—audit opinion, which says that the auditors are satisfied that it presents a true and fair view: there are no material misstatements and no concerns about the regularity of expenditure. There are then gradations from that, of which the disclaimer of opinion is the most serious. Joanne Brown will have an additional perspective on that, as a practising external auditor.

From our perspective, as the Auditor General outlined, a disclaimer of opinion is highly unusual. A disclaimer of opinion arose because we were unable to get assurances that the financial statements did not materially misstate the valuation of Scottish Canals. The balance sheet shows £407 million of assets. As an auditor, we work to a materiality level. We have set that level, from assets, at £4 million and, based on our audit work and testing, we were unable to conclude the nature of the errors. We identify and believe that there are errors in the accounts, but we have not been able to quantify those errors and that is why we have the disclaimer of opinion.

When organisations have a disclaimer of opinion, it is quite difficult for them to get a clean opinion the following year. We discussed that with Scottish Canals in relation to its project plan and the amount of work that it was undertaking. It is not impossible, but for Scottish Canals to have moved away from a disclaimer we would have had to reaudit the 2020-21 numbers, which included the prior year misstatements. We opted not to do that reaudit, given the number of errors that we were accounting in the 2021-22 audit, because we were not confident that those prior year restatements were going to be materially correct.

We undertake our audit work as we would if we were to give a clean opinion. We considered whether Scottish Canals would be able to take the number of actions that we outlined for it to take and on what timeline, and whether it would be sensible for us, as auditors, to wait until those actions had been taken before going back to conclude our audit of 2021-22. However, our auditor judgment was that the time that that would take would be too long for us to hold the 2021-22 audit open and that is why we then issued the disclaimer of opinion.

The report explains that

“The issuing of a disclaimer on the audit opinion, means that the auditors cannot provide assurance on the use of public money by Scottish Canals during 2021/22.”

As a disclaimer was also issued for the 2020-21 accounts, what are the wider implications of not having assurance on Scottish Canals’ use of public money over the past two years?

The first point that I will emphasise is that it is a very serious matter. Public bodies that receive funding from the Scottish budget are required to lay their accounts in the Parliament. As Auditor General, I have the option to consider whether to accompany the laying of an annual report and accounts with a section 22 report. As the committee is aware, I do that on a number of sets of accounts over the course of the year, to highlight matters emerging from the annual audit.

For those other sets of accounts, the assumption is almost always that they are accompanied by an unmodified opinion. However, because of the circumstances, we are highlighting in today’s report that there is not the assurance that the Parliament would typically receive on the contents of the annual report and accounts, because there is a disclaimer of opinion. The implications and the seriousness were very much part of our thinking in bringing that to the Parliament’s attention. It is not as if there is a qualified opinion, which is one of the interim steps that an auditor can take. A qualification is usually on a specific aspect of an annual report but, because a disclaimer extends much wider than that, it says that the committee and, therefore, the Parliament, does not have assurance in totality over that annual report and set of accounts.

In your view, has Scottish Canals already failed to meet its public accountability responsibilities to comply with the financial reporting manual requirements in the 2020-21 and 2021-22 reporting years? Is the same conclusion of failure likely to be reported for the current financial year?

I will take those points in reverse order. As Joanne Brown said a moment or two ago, it will be difficult to resolve all the issues in a short time. However, I do not want to pre-empt that entirely. It is important that the incoming auditors, together with the Scottish Canals leadership team and the sponsor body, have a clear understanding of their intentions to move forward and address some of the issues that are highlighted in today’s report. It is clear, however, that it will be challenging. These are complex issues and it will take careful consideration from Scottish Canals and Transport Scotland to come up with a clear plan to have the assets valued and reported in a way that will satisfy audit responsibilities.

09:15  

I am paraphrasing slightly, but your other point was about understanding and ownership. The accountable officer of Scottish Canals sets out clearly in the annual report and accounts their responsibilities, one of which is overall compliance with the requirements of the financial reporting manual as it relates to assets and other matters. The committee might wish to explore further with Scottish Canals its understanding of those requirements.

What are the consequences for Scottish Canals if it continues to fail to meet its public accountability responsibilities?

That is less clear. Ultimately, Scottish Canals is primarily funded by grant in aid from the Scottish Government through the budget setting arrangements. It will be important for the Scottish Parliament, as it considers future budget setting arrangements, to be satisfied that the funds that are allocated to Scottish Canals are being spent properly. Most typically, that assurance comes from regular audit assurance and recognition of accountable officers’ responsibilities in the accompanying accounts. When that chain is broken by a disclaimer of audit opinion, it is effectively saying that the auditors cannot give the Parliament the typical assurance that it would expect from the awarding of public funds through the budget act.

Paragraph 4 of the report is pretty damning, is it not? It says:

“the auditors were unable to conclude whether:

• the annual report and accounts give a true and fair view

• expenditure & income were regular ...

• the Annual Report & Accounts are free from material misstatement

• adequate accounting records have been kept.”

That is a fairly heavy charge sheet, is it not?

It is, convener. We cannot overstate the seriousness of an external auditor disclaiming their opinion and the ramifications of that: not having “a true and fair view” that the regularity of expenditure—the amounts spent by a public body—was consistent with legislation and budget acts. Joanne Brown’s annual audit report, which accompanies the section 22 report, sets out many examples of where documentation and data were not available to support the valuation figures that were presented to her by the leadership of Scottish Canals. Joanne might want to give the committee more detail behind that, but paragraph 4 sets out a significant set of circumstances.

On that point, as auditors we look to management to provide suitable underlying documentation to support the balances within the financial statements and show that they are fit for audit purpose and that they tie back into the trial balance and the actual accounts. As our external audit report outlines, we encountered a number of difficulties in doing that. In particular, we had challenges in reconciling certain information through the valuation report back into the draft accounts. That did not reconcile in a number of draft account versions that we received. We had concerns about additions, and whether those were treated in the right financial year. We had concerns about whether there was duplication of additions and about assets under construction and, within that, whether some of those assets that had been capitalised were in fact not assets and should have been put through the revenue account.

There were many examples of what we felt were potential errors in not just the valuation but the accounts as a whole. The reason for our opinion being a disclaimer is that the size of those balances is very large in the accounts of Scottish Canals; the property, plant and equipment balances touch on a number of areas in the accounts, including income and expenditure, the depreciation charge and the revaluation reserve. We felt that those errors were pervasive across the financial statements. The reason for the opinion on the wider annual report and accounts being caveated is that, when you read the annual report and accounts, the front-end narrative includes a number of balances that we are unable to give assurances on in the financial statements.

Before I move on to Craig Hoy, I note that when we took evidence last year from Transport Scotland, it described the situation as it was then as “a fairly narrow point” and, again, said:

“it is a narrow point about the evaluation of assets.”—[Official Report, Public Audit Committee, 24 March 2022; c 14.]

Is that how you would characterise it?

No, it is not. Stepping back for a second to look at the purpose of Scottish Canals, I would highlight that one of its core responsibilities—its strategic objective—is to maintain the canal network, part of which is about its associated value, the cost of maintenance and the records that go alongside that. So, no, I would not agree that this is a narrow technical point. Grant Thornton has reached the opinion that the valuation of the assets affects so much of the running of the business and the disclosures of its performance over the course of the year, and that that pervasiveness suggests that the matter is central to the activity of Scottish Canals.

Perhaps I can add a little to what the Auditor General has just said and say something that I think goes to the root of your original question, convener. We have issues with valuation and the result is that there is no assurance across anything in the accounts. That is our fundamental concern in terms of the disclaimer: there is no assurance here for the Parliament or, I have to say, the accountable officer in the Scottish Government, Transport Scotland, the Treasury and, indeed, the whole system when it comes to the confirmation that the audit process provides to everybody about the robustness of a set of accounts. That is the fundamental concern here.

Thank you. That was very clear and we appreciate that. Craig Hoy has some questions.

I do not want to repeat or, perhaps, to labour some of the points that the convener has already made, but I note that paragraph 5 of the report says:

“The auditors reported that they had not received all information and explanations required for their audit in relation to the property, plant and equipment balances. The auditors also raised concerns about the overall quality and timeliness of Scottish Canals accounting records and working papers. This has led to significant delays to the audit process.”

I can second guess what you are going to say, given your responses to Mr Leonard, but is it safe to say that your concerns go far wider than the issues related to the property, plant and equipment balances?

Yes. If the committee finds it helpful, Joanne Brown can set out in a bit more detail the nature of some of the interactions that she and her team had with Scottish Canals, but your question speaks to a couple of other issues that we touch on elsewhere in the report about the capacity that exists in the leadership and finance team of Scottish Canals. There has been significant turnover in the finance team, and there has also been a change of leadership in the organisation, with the recent appointment of a new chief executive.

Those issues are relevant to the circumstances in which we find ourselves today. It has been challenging for Scottish Canals to prepare a complete set of annual report and accounts. Joanne might well refer to this, but in the version that she was originally presented with for audit, a number of significant elements that should have been in a set of annual report and accounts were missing. Some to-ing and fro-ing and a number of iterations then followed.

Before I pass over to Joanne, I also want to highlight not just the quality of the accounts but their timeliness. Public bodies are required to lay their accounts before Parliament by the end of the calendar year, or nine months after the end of the financial year. Those accounts were finally laid just a few weeks ago. Timeliness is relevant to scrutiny, so that Parliament can be satisfied. As a consequence of that, we are many months after the laying date.

As Joanne Brown said, we are now already not in the financial year to be audited but the next one, so there is a risk that we could experience a backlog over a number of years. That is another reason why there needs to be a clear and comprehensive plan between Scottish Canals and its sponsor division for where it goes next in order to resolve the issues. Joanne can say a bit more.

On the financial statement audit work, which commenced in July, given the challenges that Scottish Canals had with valuation, we agreed that we would look at doing our audit work, excluding valuation, earlier in the process, so in July we were working off a trial balance. During the course of our audit, which concluded in May this year, we received seven or eight different trial balances from Scottish Canals. We received the first draft of accounts, which was not a full draft of accounts for audit, in January, and it was missing primary statements and key notes to the accounts.

We highlighted in our external audit report the need for better-quality accounts, better review of the accounts and better working papers that support the balances in the accounts. As the Auditor General said, the Scottish Canals finance team is very small and, during the financial year in question, there was significant turnover in that finance team, which resulted in a loss of corporate knowledge of Scottish Canals and made it difficult for the team to provide suitable explanations and working papers to auditors to support the numbers in the accounts. Individuals who prepared those accounts and worked to prepare the accounts were not there throughout the audit period. The organisation has some challenges around what records are held physically and what records are held electronically.

One of the key challenges, specific to property, plant and equipment, relates to the data and records that were held by the engineers in the project management system and the inability to reconcile them with the fixed-assets register. A lot of work was done and progress was made during 2021-22 to do that reconciliation, but the engineering records and the project records do not support some of the cost information that has been used in the valuation to inform the financial statements. We identified a number of issues that were wider than property, plant and equipment, and we have an action plan for Scottish Canals to take forward. Principally, I want the organisation to improve the quality of the accounts and the working papers that sit underneath them.

Regardless of the size of the team, that sounds pretty poor, given that we are talking about the public purse. The report states that auditors did not receive all the information or explanation that was sufficient for the audit in terms of property, plant and equipment balances. Did you get the impression that the staff who were there were fully engaged with the process, and were they open and transparent with you?

I would not flag any concerns about openness and transparency. The organisation has a very small team, and one of its particular challenges has been the capacity, skills and experience that are required to do the valuation work. The team highlighted that risk, but the core finance team needed significant time to work with the consultants to produce the valuation and to answer the consultants’ questions on underlying data and so on. That directed the team away from the financial statements, but we would still look to it to be able to do that work. Regardless of its being a small team, it should have been able to do a self-review of accounts and it should have had records that produce a good set of accounts with the underlying data. The team should have been able to answer effectively the auditors’ questions and to provide the data to support the balances. That was very challenging, over the period.

Obviously, accountability is linked to capacity and competence. Do you get the impression that there was some failure of past or present leadership in the organisation?

09:30  

Personally, I think that Scottish Canals underestimated the challenge of the valuation in terms of the time commitment and the data that it would need to support the valuation work and, within that, the skills that would be needed in, for example, capital accounting. Although the organisation looked to the consultants for the valuation, it underestimated the skills and experience that it would need internally to be able to produce a set of accounts and information that would support the consultants in the valuation exercise.

In 2021-22, Scottish Canals focused on the point that was made in the prior year about valuation, but did not necessarily pay enough attention to the underlying records and the points that were raised in the prior year audit that it did not manage to address, which, in turn, supported another disclaimer this year.

You have produced a disclaimer in two years. On the basis of your engagement to date and looking at the present situation, would you say that Scottish Canals now has the bandwidth, capacity and competence to ensure that we will not be doing the same thing again this time next year?

That question is probably for me, Mr Hoy. We cannot yet give you that assurance. As Joanne Brown set out, her audit has just finished; it has been only a few weeks since she disclaimed her opinion. The incoming auditors will have a handover, review her judgments and take their own view about the adequacy of records.

I repeat my remark that it will be challenging to resolve all the issues that are set out in last year’s report and today’s in time to satisfy the requirements for a clean audit opinion. However, I stress that I do not want to pre-empt that audit, and that it will be for the independent external auditors to arrive at their views.

Bill Kidd has some questions.

Ms Brown has already given us the background on the circumstances of the valuation of assets. During an evidence session with Scottish Canals in May last year, the then chief executive and the director of finance and business confirmed that the organisation aimed to undertake a new valuation process by the end of last year. They described that as being an ambitious target and had concerns that they would be unable to meet the deadline. Did Scottish Canals meet the deadline to undertake a new valuation on the canal infrastructure estate in its entirety during 2022?

Good morning, Mr Kidd. I can start, then Joanne Brown can say a bit more about that.

The answer is twofold. As we say at paragraph 13 of the report, Scottish Canals “progressed work” to complete the valuation, but has not aligned the progress on it with clear underlying records and data to support the valuation that was presented for audit.

The matter is complex. I do not wish to understate that complexity to the committee. We are talking about very old and, in some cases, potentially heritage assets that have not been valued in that way before. Engineering records were used and the judgments of management experts were used alongside them. However, it proved to be difficult for auditors to validate that information. Therefore, we do not have sufficient evidence to support the valuation on the basis on which Scottish Canals made it. There were other factors, too, which Joanne Brown can set out for the committee.

Scottish Canals developed a project plan that sought to help it to address the disclaimer and to undertake the valuation for 2021-22. The board approved that project plan. There were some slippages, but in that time period, following the prior year disclaimer, the organisation undertook an exercise to procure consultancy support and worked with the consultants from June to November 2022.

By November 2022, the valuers that Scottish Canals appointed had given additional insight into the valuation and a valuation report, which was then the subject of an audit and to Scottish Canals reflecting that in the unaudited accounts. In that period, Scottish Canals worked hard to componentise the assets. Part of the exercise was to understand what assets Scottish Canals holds—on what basis, the type of asset, whether they could be put into components and how they could be grouped. That was a significant piece of work, so Scottish Canals has certainly progressed that element. It was an ambitious project plan but, obviously, I was not able to sign the accounts until a couple of weeks ago.

To what extent, if any, have the issues around valuation of assets impacted on the ability of Scottish Canals to prepare a medium-term financial strategy? Will it be able to do that?

Scottish Canals has an initial financial strategy. The work on valuations in 2021-22 took up a significant proportion of the finance team’s time, which meant that some activities were, in effect, put on the back burner while the team focused on the valuations and annual accounts. Scottish Canals has done an initial outlook for the next three years, and it has made a commitment to produce a more detailed financial strategy that will take into account the decision on the VAT element and the recent pay award. Scottish Canals is committed to that—it is part of an action in our external audit report, which has a deadline of October this year for completion.

That covers what I was going to ask next. Thank you very much.

I will now bring in Willie Coffey, who has a suite of questions to ask.

Good morning, Auditor General and colleagues. I will continue with examination of the historical data side of the problem.

You have identified that valuations for some of the assets were based on cost data that was provided by the management and drew on, for example, estimates of historical project costs. Is the fundamental issue that we just do not have records of what the assets were worth in the past? Is that what we are dealing with, principally?

The situation is, undoubtedly, very complex. It has been challenging to value assets in a different way from how that was done previously and, in doing so, to find reliable records. You mentioned engineering records. Joanne Brown can say a bit more about the methodology and approach that Scottish Canals took with the consultants that it used to support the valuation. That is very relevant. Undoubtedly, however, we are talking about an exercise that was really challenging but which was consistent with the methodology and valuation approach that Scottish Canals was required to follow, in conjunction with the accounts direction from the Scottish Government on the methodology to be employed and reported in the annual report and accounts. That complexity, together with dealing with very old assets and historical records, make valuation very difficult to achieve. Joanne Brown can say a bit more.

Yes—please do.

Scottish Canals determined that, on the whole, the assets are networked specialised operational assets, which requires them to be valued on a depreciated replacement-cost basis. In some instances, it worked closely with the consultants, where third-party cost data was easily available to indicate that something was a suitable measure—for example, lock gates. There were a number of assets for which we were able to substantiate the consultants’ judgment and the data that the consultants used in order to benchmark the costs and the replacement costs of the assets.

One of the largest challenges during the audit was the canals themselves. In the 2021-22 accounts, they had a value of around £137 million. That was based on assumptions about the lengths of the canals and the costs per metre to replace lengths of canal. That was very judgment based and estimate based. We had some information from engineers who were, unfortunately, no longer with Scottish Canals. The judgments and estimates that they set out had not been fully articulated or documented.

The canals go back 200-plus years, so there is not the usual cost data available: valuing them is not as easy as valuing a road. There is a lot of data about what the cost of a replacement road would be, but similar data is not available for canals, so it was very hard to support the judgments and estimates in the accounts.

Given all that, how will we ever resolve things to the satisfaction of external audit if there is a real difficulty in establishing the original valuations of assets or even in benchmarking those values against similar assets elsewhere? Is that the journey that we are travelling on? Are we trying to benchmark the whole asset portfolio against similar assets elsewhere and being comfortable that that is a fair and reasonable assumption? Is that where we are? That sounds like an impossible task to me, but is that where we are going?

I think that that is largely where we are. Mark Taylor might want to say a bit more about the alternative options. It is not for us as auditors or for Joanne Brown as the external auditor or even the incoming external auditor to say how a public body should value its assets. That is for that public body together with the sponsor body, the Scottish Government—with a degree of flexibility, but not that much. It depends on the judgment on what the assets are for. In the case of Scottish Canals, as Joanne has set out, the assets are operational assets. That drives a particular valuation methodology. However, there are other categorisations of assets. Across the public sector, there is a range of categorisations. Scottish Canals is not the only body that has very old assets. In some places, they are valued differently.

That takes us back to one of the key judgments that we made in the report. Scottish Canals, together with its sponsor department, have to say what its plan—its route through this—is so that the accountable officer and the auditors can be satisfied that there is enough evidence to support valuations, given their centrality to the annual report and accounts.

I absolutely recognise the challenge that Mr Coffey set out. The starting point for what we said in the Auditor General’s section 22 report is essentially having a broader look at what the plan should be. It might be that the work and the approach that has been set out and which Scottish Canals, with the support of Transport Scotland, has determined is the right thing to do should carry on. There are challenges there, but there is also an opportunity to have a broader look and ask, “Are we going about this in the right way? Can we reframe how we are looking to do this?” It is not for us, as the auditors, to say what the solution is in there, but there is a broader opportunity to say, “We are where we are. We’ve got the history that we know about. We’ve seen this coming since 2012. We’ve had a go at it. Is more of the same the right solution, or is there a different solution?”

Thank you for that.

Auditor General, you also raised in the report issues relating to ownership, rights and obligations, which probably further complicate the whole mix. How much have those issues in the background impacted on the ability to produce and prepare accurate statements on the valuation of assets?

That is a good example of additional complexity in this year’s audit. Joanne Brown can say more about what she and her team encountered. Fundamentally, auditors have to satisfy themselves when they look at any sets of accounts of public bodies or elsewhere. If a body is disclosing assets, the auditor has to say, “Prove to us that you actually own them.” They might have the title deeds or associated evidence of ownership. Grant Thornton did not see all that from the sample testing that it did. However, Joanne is best placed to set that out.

From our perspective as an auditor, we are looking for evidence that Scottish Canals has rights and obligations and therefore ownership of the assets to enable it to account for them on its balance sheet. One of the challenges is the nature of the asset base. Within that, there are a number of towpaths, some of which are Scottish Canals towpaths and some of which are bordering local authority towpaths. It had to go back to look at land registry data from Registers of Scotland. Scottish Canals did not have that data; it had to look for it to be able to evidence the existence and ownership of the assets.

09:45  

In our sample testing, there was at least one item where, although Scottish Canals had included it in its fixed asset register, it was not owned by Scottish Canals, and it had to adjust that. That was in a relatively small sample of the total population. Given the nature of Scottish Canals and how much work it does in partnership with other bodies, which includes receiving additional third-party funding, we recommended in the external audit report that, when undertaking partnerships and funding agreements with the likes of Sustrans, Scottish Canals should determine who owns what asset and what the asset is. That would help Scottish Canals to properly account for the asset, if it is its asset. Scottish Canals just did not have the controls in place in the past to be able to properly evidence for audit purposes.

Is Scottish Canals making sufficient progress in the area to reconcile that? Is it making good progress or any progress towards that? Disentangling all that is really complex. Is that being done?

From what we saw, a huge effort was made during the audit process to get evidence of the existence of assets. Scottish Canals understands the importance of having evidence of rights, obligations and the existence of assets, and it has endeavoured to get that evidence for all assets that ultimately go into the final fixed asset register. In some respects, that part, although it is complicated, is easier than some of the judgments and estimates on, for example, the cost data around canals’ length.

My final query is on the comment that you made earlier about errors in the accounting statements. I will read this bit so that I get the wording correct. The report states:

“the reconciliation of the reconstructed closing balances to the figures in the draft accounts identified several errors.”

Will you just flesh out for us a wee bit what those errors are and what has been done to correct them?

In our external audit report, we highlight about 10 pages of adjustments to the unaudited accounts. Some of those adjustments relate to identified errors. For example, there was a valuation report that did not reconcile to the TB. There were reconciling differences, so Scottish Canals needed to adjust for that.

What is the TB?

Sorry—it is the trial balance. In effect, the trial balance drives the accounts, and that is the financial ledger. Scottish Canals made some changes there.

We identified a number of errors, which comes back to the nature of the disclaimer opinion. We knew that there were errors and that, extrapolating from those—given that we sample tested—they were highly material. Some of the errors were in the categorisation of assets under construction and additions that Scottish Canals had put through in 2021-22 that should have been in the prior year’s accounts. When you have something as an addition, if it is already in operation, it should be valued, and those obviously had not been valued. Scottish Canals had made a decision to retain an asset at historical cost, and we were not clear about the judgments on that. We felt that that should have been included in the valuation.

There was a challenge about the residual value of canals and what time period should be involved. Some of those are highly material. Scottish Canals judged that a canal would have a residual value for 12 years, but it did not necessarily have evidence to support that judgment. If that changed even to 10 years instead of 12, there could be a £30 million difference in the accounts.

There was a series of errors. There are known errors that Scottish Canals will need to correct, and there are other errors that it needs to investigate to ensure that it puts forward a complete and accurate accounting record.

That sounds to me like plain and simple accounting errors and lack of awareness of accounting practice. Could you give us any assurance that that is being addressed, and that that kind of error rate will not be seen in the next set of accounts?

Some of that comes back to the earlier points about the skills and capacity of the finance team, plus the turnover in the team.

I am aware that Scottish Canals has effectively done a restructure of its finance team and has introduced two new posts to increase the capacity and skills in the team. That recommendation is in our external audit report, which Scottish Canals management have signed up to take action on. By strengthening that team, the quality of the accounts and the evidence for audit should improve.

If you are involved, will you be keeping a close eye on that next time?

That will be Joanne Brown’s final audit report on Scottish Canals, but a new team of auditors will do just that.

I will add to a couple of Joanne’s points. She said that there were 10 pages of errors reported in the external auditor’s annual report that accompanies the accounts; that is most unusual. We rarely see an auditor’s report with that number of reported errors or requested changes. Bear in mind that that is based on sample testing. Auditors test samples of transactions or assets and then apply judgment or models to see what that means for the population. That brings us back to the range of factors that Grant Thornton built into its judgment that a disclaimer was the most appropriate opinion on the accounts.

One of the points in the report is that Scottish Canals needs to consider the value for money of its approach to valuations, including whether it is getting value for money from the consultants that it engages. Have you seen any evidence that it is doing that?

We refer to the fact that Scottish Canals has spent £500,000 on consultants to support the asset valuation activity in year, and it planned to spend a further £100,000 in the 2022-23 financial year that has now concluded.

We also note in the report that, in commissioning the work from the consultants, Scottish Canals does not retain ownership of the valuation model. Scottish Canals should consider whether that was a good decision to make, given the importance of the model and how it connects to a fixed asset register. Having an operational fixed asset register was not part of the overall commission. We have not arrived at a view on that, but we think that it is a relevant factor for Scottish Canals to consider.

I emphasise the point that Mark Taylor made earlier about whether it is the best approach to plough on and get to a conclusion on the methodology, or whether there are other routes to arriving at a true and fair set of accounts. It is relevant that there are still considerable sums of public money being invested in consultants to support an approach that has not yet borne fruit.

I will move on to a different question, which is about the leadership of the organisation. We are aware that the former chief executive of Scottish Canals left and that, as recently as May this year, a new chief executive started. Was there a gap before that position was filled and, if there was a gap, has that contributed to some of the difficulties?

I will ask Joanne Brown to set out the timescale, and then I will come back in.

The previous chief executive left the organisation in December. That was a planned exit, in effect, given that she had been chief executive of Scottish Canals for five years. It took steps to appoint an interim chief executive, who was the chief operating officer of Scottish Canals. He had been with the organisation for many years, and he was very familiar with Scottish Canals. He filled that role on an interim basis until the new chief executive started last month.

I do not think that that contributed to the difficulties. The interim chief executive was within the organisation in the prior year, when the disclaimer was there, and he was a member of the board that supported the project plan. There was knowledge and experience in Scottish Canals and the challenge of the valuation and what the organisation was attempting to do was well known across the leadership team, so the change in chief exec did not, in my view, impact on the situation.

Joanne Brown has made a fair assessment. However, there is a significant onus on the new chief executive to take his own view about the approach that he has inherited and about whether that approach will produce the result of a valuation methodology that leads to a compliant annual report and set of accounts.

The question also links to the wider, strategic purpose of canals. Are canals an operational asset? Is there an alternative approach? Part of that wider strategy of the organisation incorporates the maintenance of the canal network alongside, as Joanne mentioned earlier, some of the other activities that Scottish Canals has engaged in over the past 10 years.

My final question is about the relationship with the Scottish Government sponsor division. We were told in evidence last year that Transport Scotland attends board meetings of Scottish Canals and that it—this is the expression that was used—“sits hand in glove” with Scottish Canals. Is that a characterisation that you recognise?

Certainly, we recognise that Transport Scotland attends board meetings. I will leave the phraseology for others to describe. It brings us back to one of the judgments that we have made in the report, which is that the sponsor team at Transport Scotland will have an important role in working with Scottish Canals to determine the way forward and to arrive at a valuation approach and strategy that can be fit for purpose to deliver a clean set of audit opinion in future.

Mark Taylor mentioned earlier that there had been a risk warning about this being a possibility as far back as 2012; we are almost a decade on and auditors are still issuing disclaimers. Some fundamental problems still exist, such as turbulence in the finance team and the leadership of the organisation, and so on. Why is Transport Scotland not injecting some stability into that equation?

I will take that in reverse order. Stability is an important question for Transport Scotland in relation to its views on the way forward.

On the chronology, Scottish Canals became a public corporation in 2012-13, and I know that the committee has engaged with the Office for National Statistics on elements of its history. The Scottish Government, in discussion with the ONS and Scottish Canals, recognised that “public corporation” was not the best descriptor of the core purpose and activities of Scottish Canals. As we know from last year’s evidence and as is reflected in today’s report, that recognition has led to Scottish Canals becoming a non-departmental public body and having to adopt different accounting practices. There is a great deal of history behind the point that we have reached. However, we need to take the opportunity that exists now, with the new leadership of Scottish Canals and the sponsor team, to say what the best way forward is that will deliver value for money and a clear, compliant set of annual reporting accounts.

Thank you. We have run out of time, so I will draw this part of this morning’s session to a close.

I thank the Auditor General for his evidence this morning, as well as Mark Taylor and Joanne Brown, who has been moved on, which is a routine thing—it is not because you have done anything wrong, Joanne, is it?

I thank you all for your evidence, which has been very illuminating. We will need to consider our next steps as a committee in response to the evidence that we have heard this morning. I now propose to suspend the session in order to allow for a changeover of witnesses.

09:59 Meeting suspended.  

10:02 On resuming—