“The 2005/06 Audit of Scottish Enterprise”
Item 3 is a briefing from the Auditor General for Scotland on a section 22 report on Scottish Enterprise.
Mr Robert Black (Auditor General for Scotland):
I have prepared this section 22 report to draw to Parliament's attention the financial position of Scottish Enterprise as it is described in the audited accounts for 2005-06. The auditor has not qualified the opinion in the accounts. Scottish Enterprise ended the year to 31 March 2006 with an overspend of £33 million, against an overall resource budget of £454 million. That overspend consists of an excess of £6 million for cash costs against a budget of £444.4 million, and £27 million for non-cash costs, against a budget of £9.6 million.
A number of factors contributed to the in-year overspend. The first was a failure to address an historic shortfall in the non-cash budget. Scottish Enterprise received a budget of £9.6 million in 2005-06 for non-cash costs to cover depreciation, asset impairments, capital charges and provisions. It overspent that budget by £27 million.
A second factor was the complexity of the application of resource accounting and budgeting to the organisation's key activities of economic growth and investment. Linked to that problem is the fact that there was not an adequate training programme for managers to help them understand the possible effects on the budget of major investment decisions under resource accounting and budgeting.
A third factor was the introduction during 2005-06 by Scottish Enterprise of a new planning and resource allocation model to replace the previous budgetary control framework. The main feature of the new model was that local enterprise companies and business units were no longer given annual budgets, but were encouraged to deliver more projects within a framework of quarterly forecasting. The new resource allocation model was, however, introduced without sufficient controls being in place to support it and there was a lack of clear responsibility and accountability for its operation.
Finally, Scottish Enterprise did not act quickly enough during the financial year in response to the early financial forecasts, which projected an overspend.
As I am sure members know, the minister has already taken action in relation to those problems. As part of that action, he commissioned an independent report. Members will also be aware that the Enterprise and Culture Committee undertook an inquiry into the matter and reported in June on the management of budgets at Scottish Enterprise. As a result of the evidence that the Enterprise and Culture Committee took, the Deputy First Minister made a statement to Parliament on 30 March 2006 in which he confirmed that Scottish Enterprise could draw £30 million of its 2006-07 budget to cover the 2005-06 overspend. Scottish ministers have now set a resource budget for Scottish Enterprise of £467 million for 2006-07. The budget consists of £412 million for cash costs, £35 million for non-cash costs, and £20 million from reserves that have been carried forward from previous years. The £35 million budget for non-cash costs is a significant increase on previous years.
Scottish Enterprise has prepared an action plan that summarises the recommendations from each of the recent investigations and describes the action that it is taking in response to those recommendations. The latest Scottish Enterprise operating plan takes account of the reduced resources that will be available in 2006-07, which is a result of Scottish Enterprise having used some of its resources to fund the 2005-06 overspend. The operating plan budgets for expenditure of £550 million in 2006-07. Legal commitments of approximately £4.6 million are not included. The operating plan also estimates total income as £550 million, including business income and European income. Scottish Enterprise is monitoring its financial position closely and intends to manage it during the year by rephasing projects. It will not enter any new commitments in 2006-07. However, there remains a risk that it will not achieve its resource accounting and budgeting target for 2006-07.
Audit Scotland is in the final stages of preparing its annual report on the audit for 2005-06. When the report is complete, it will be available on Audit Scotland's website. I have asked the auditor to monitor Scottish Enterprise's progress against its action plan.
As ever, I am happy to answer any questions, with help from my colleagues, that the committee may have.
Thank you. You said that you have asked your auditor to monitor progress. Can you add anything on how Scottish Enterprise is tackling the situation?
I do not think that I can add anything at this point, convener.
It is too early. Thank you.
I seek your assistance in understanding the perceived advantage that is to be gained from moving from yearly to quarterly budgeting. Why did Scottish Enterprise make that move? Has it explained that?
In March, I came to the committee with a report on performance management at Scottish Enterprise. In that report, I commented on the background to the new system. Perhaps I may remind you what we said in March. Until the financial year 2005-06, budgets were allocated to each broad theme at the start of the financial year. They were then broken down further to the individual local enterprise companies. There was concern that that might create an incentive for the enterprise companies to spend up to their budget allocation: in other words, they had a sum of money that they had to spend, so there was a risk that the local enterprise companies might select some projects with that objective in mind rather than on the basis of economic justification for the projects.
In 2005-06, Scottish Enterprise introduced quite a major change in how it funds projects. Budgets were not allocated in advance either by theme or by area; instead, project staff were to apply for funds as project proposals were approved during the year, and applications would be reviewed—and either approved or rejected—each quarter. There is now no set budget for specific areas of activity and, as we point out, financial control will rely on robust forecasting and strategic alignment based on the quarterly management reviews.
The new system should help to ensure that projects are driven by their economic justification rather than by a need to spend up to budgetary limits, and should allow projects to be more closely aligned with Scottish Enterprise's objectives. However, as we have said, this is the first financial year of that approach, and management reports to the Scottish Enterprise board were indicating that demand was exceeding available resources. At that time, it was too early for us, as the auditors, to comment on the effectiveness of management action to contain expenditure. The audited accounts are now available and I have been able to make the section 22 report.
I could not help but be faintly amused by your opening remark that you wished to draw Parliament's attention to Scottish Enterprise's financial position. Many of us, particularly those who are members of the Enterprise and Culture Committee, feel that we have been paying perhaps an unhealthy degree of attention to the organisation's financial position for a great many months now.
Although I acknowledge Audit Scotland's specific role and obligations, I am keen to get a sense of what, if anything, the committee can say or do to add to the parliamentary scrutiny that has already been carried out. Do you feel that the section 22 report highlights any issues that are new or different to those that have been previously considered, particularly by the Enterprise and Culture Committee? Are there any outstanding issues that should be of particular interest or concern to the Audit Committee?
You referred to the report that you presented to the committee in March. I recall that, at that time, you said in response to one of my questions—forgive me for paraphrasing you instead of quoting verbatim—that you felt that, with regard to its financial management systems, Scottish Enterprise's overall direction of travel was the right one. Do you still hold that view?
I should point out that, as far as the first part of that question is concerned, under agenda item 6 we will discuss how to proceed with the section 22 report. However, such was the length of the question that it contains a lot of meat for the Auditor General's consideration.
I am obliged to report to Parliament on the audited accounts if there is a significant overspend or any other breach of statutory or financial requirements. To that extent, the section 22 report fulfils that obligation.
As for new information, the figures in the report are slightly different from those that were reported to the Enterprise and Culture Committee, because we are now using audited accounts. However, the fundamental position and general issues remain the same. The Enterprise and Culture Committee produced a thorough and extensive report on the matter and its general conclusions are appropriate.
This section 22 report to Parliament contains a lot of detailed work by the audit team. As part of the final audit process, a full audit report, which will also be a public document, will be given to the Scottish Enterprise board. I suggest that that report's recommendations will probably contain more detail than it would be absolutely necessary for the committee to get involved with.
On whether Scottish Enterprise's direction of travel is appropriate, I point out that the overspend on cash costs was only £6 million on a £444 million budget. The main problem was the failure to provide adequately for non-cash costs. It is quite interesting that the KPMG report for the minister said that non-cash overspend was £27 million in 2003-04 and £26 million in 2004-05, and I can confirm that it was £27 million this year. The fundamentals have not changed terribly much, and the overspend on the cash costs has been fairly marginal, given the size of the budget.
Given that I support the new project management system in principle—for the reasons that I gave to Mr Harper earlier—I think the direction of travel is appropriate. There was a significant failure of financial monitoring and control during 2005-06, which has been thoroughly analysed. Scottish Enterprise should stay on course to deliver its programmes effectively.
On the direction of travel, if there are systemic problems—there were clearly budgeting problems in the past—is Scottish Enterprise now better equipped to spot and trap such budgeting problems? For example, are there additional in-built early-warning systems to catch such problems, now that matters are being dealt with quarterly?
If I may, in answering that question I shall continue to use the language that I used a moment ago. The direction of travel is appropriate, and action has been taken, but I cannot give you an absolute assurance about the adequacy of that action. As I mentioned, the audit process is concluding at the moment and a final audit report is currently being considered between the Audit Scotland team and Scottish Enterprise management. Also, as I said in my opening remarks, Scottish Enterprise has produced a list of actions that it has taken and that it intends to take to ensure that the situation is better controlled in the future.
We shall check against delivery.
There are no further questions from members, so I thank the Auditor General for that briefing. We shall return to the subject under agenda item 6, when the committee can decide whether it wants to take further action.