Australia Finance

Victorian Local Government Audits: Findings and Implications

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Summary

The Victorian Auditor-General recently presented his 2019-20 audit report to Parliament. This briefing focusses on the results, with a particular focus on the sector’s financial performance, position, and financial sustainability in light of the COVID-19 pandemic.

Briefing in full

Results of financial audits

The financial audits of the sector were conducted in accordance with the Audit Act 1994 (Vic) and the Australian Auditing Standards. Councils and other local government entities prepare their financial reports in compliance with the Australian Accounting Standards and applicable legislation. In addition, councils prepare a performance statement to report their results against specific indicators set by the Minister for Local Government.

VAGO conducted 189 audits of Victorian local government financial reports for the 2019-20 year including 79 councils, 10 library corporations, and 13 associated entities. It also audited the performance statements for the 79 councils. VAGO provided clear audit opinions for all financial reports and performance statements across the local government sector. This provided reasonable assurance that the reported information was reliable, accurate, and complied with relevant legislation.

Quality of financial reports and performance statements

VAGO identified 262 errors across 79 councils’ 2019-20 financial reports, totalling $327 million in value. In 2018-19, 187 errors were identified, totalling $240.4 million. The increase in the number of errors was due to 41 instances where councils incorrectly applied AASB 15 Revenue from Contracts with Customers and AASB 1058 Income of Not-for-Profit Entities. Councils were required to formally assess each type of revenue and income against the new revenue standards. There were 12 errors due to councils’ incorrectly applying AASB 16 Leases.

Local governments not adequately capturing the impacts of the pandemic in the financial report was also a common disclosure error in 2019-20 financial reports. Disclosures in financial reports relating to COVID-19 varied between councils, depending on the extent of impact to their operations (such as service closures, interest free rate deferrals and rescheduling of capital works projects). VAGO found 25 performance statement errors compared to 78 in the prior year, indicating that performance reporting processes were maturing across the sector.

Internal controls

VAGO considered the internal controls most relevant to a local government’s financial and performance reporting as these are a prerequisite for delivering sound, accurate and timely external reports. VAGO found that overall, councils’ internal controls remained adequate for reliable financial and performance reporting. However, there were instances where important control activities could be improved (such as asset management and valuation processes and poor financial reporting processes).

For 2019-20, 99 new internal control issues (such as procurement and cash management processes, and accuracy of long service leave calculations) were identified that were rated as medium- or high-risk, compared to 127 in 2018–19. Figure 2D shows that while fewer new issues were identified in 2019-20, the total number of issues remained relatively constant over the last four years. Figure 2D also shows there were 79 unresolved prior-period issues in 2019-20 (compared to 68 in 2018-19). The number of unresolved issues has remained relatively constant over the last five years.

Financial performance

In 2019-20, Victorian local governments generated $11.47 billion in revenue and incurred $9.42 billion of expenses, which generated a net surplus of $2.05 billion. Figure 3B shows that the sector’s net result fell by $0.56 billion (21 per cent) and revenue by $0.11 billion (1 per cent) during 2019-20; while expenses increased by $0.45 billion (5 per cent) compared to the previous year. These movements were partly due to the COVID-19 pandemic and new accounting standards.

The sector received Victorian Government funding to mitigate COVID-19’s impact on local government operations, including $50 million in ‘Working for Victoria’ grant funding received by 38 councils during 2019-20. The COVID-19 pandemic is expected to continue to affect the sectors’ own-source revenue (revenue streams a council has control over), grant funding income and expenses. VAGO expects this to have a significant impact on the net results reported by the sector for 2020-21.

Figure 3C shows that all revenue streams except rates revenue declined during 2019-20 compared to the prior year. Proportionally, ‘other revenue’ and ‘user fees/fines’ categories fell the most, by 21 per cent and 10 per cent respectively. This was driven by the decline in local government’s own-source revenues (excluding rates revenue) during the last quarter of 2019-20 due to COVID-19. Councils heavily reliant on parking fees and fines for non-rate revenue experienced the greatest impact during the pandemic shutdowns.

Figure 3F shows that all categories of expenses increased during 2019-20. Depreciation and amortisation expenses increased the most (by 9 per cent) but this was because of the growth in amortisation of right-of-use assets on adoption of AASB 16. The increase in employee benefits for 2019-20 is in stark contrast to the reduction in own-source revenue (excluding rates revenue) with local governments unable to access JobKeeper payments or stand down staff during the pandemic.

Financial position

At 30 June 2020, total assets and net assets increased by 4 per cent, and total liabilities increased by 15 per cent compared to the prior year. Despite borrowings decreasing by $0.66 billion, total liabilities increased by $0.55 billion. Care needs to be taken when interpreting this change as the sector recognised $0.13 billion of new lease liabilities under AASB 16, and there was an increase of $0.23 billion in unearned income with the introduction of AASB 15 and AASB 1058.

Financial sustainability

VAGO undertakes an annual assessment of financial sustainability based on seven indicators covering profitability, financing, asset renewal and maintenance. The key indicators have been considered below.

Adjusted underlying result

The adjusted underlying surplus indicator measures a local government’s ability to generate a surplus from its ordinary course of business, excluding non-recurrent capital grants, non-monetary asset contributions, and other contributions to fund capital expenditure from its net result. It is calculated as: Adjusted underlying surplus or deficit/adjusted underlying revenue. A breakeven or surplus result indicates the council is able to generate sufficient revenue to cover its ordinary expenses including depreciation (proxy for asset renewal).

Figure 3K shows that all cohorts (except the metropolitan cohort) recorded adjusted underlying deficits for 2019-20. With the COVID-19 pandemic continuing to affect the sector’s revenue and expenses into 2020-21, local governments will need to monitor their adjusted underlying results to ensure they can generate sufficient funds to deliver service levels and meet asset renewal needs. A longer-term negative trend in this indicator will have an adverse impact on the services that these councils are able to offer to their communities.

Liquidity

Liquidity measures a local government’s ability to pay current liabilities in the next 12 months. It is calculated as: current assets/current liabilities. A ratio of one or more means that an entity has more cash and liquid assets than short-term liabilities. This means that a council can easily meet its bills as and when they fall due over the short term.

Figure 3L shows that the liquidity ratio of all cohorts decreased at 30 June 2020. However, all cohorts had a ratio of two or more, indicating that the amount of cash and liquid assets held is at least twice that of short-term liabilities. The sector continues to be very liquid, with $5.86 billion in cash held at 30 June 2020 (compared to $5.70 billion at 30 June 2019).

Indebtedness

Figure 3P shows that the sector’s debt declined over the last five years from $1.20 billion at 30 June 2016 to $0.99 billion at 30 June 2020 (an 18 per cent decrease). In contrast, the sector’s cash and term deposit balance rose from $3.43 billion to $5.86 billion over the same period (a 41 per cent increase).

Asset renewal

The asset renewal gap indicator measures if a local government has used its capital spending to purchase new assets or renew and upgrade existing assets. It is calculated as: renewal and upgrade expenditure/depreciation. Ratios higher than 1.0 indicate that spending on existing assets is faster than the depreciation rate and asset renewal needs are being met.

Figure 3S shows that, with the exception of metropolitan councils, all cohorts experienced a reduction in the renewal gap ratio as they adjusted their capital works programs to respond to the COVID-19 pandemic. It is likely that most local governments will have large carry forward capital works programs from 2019-20 to be delivered in 2020-21, which may also explain the high level of cash and term deposits on hand at 30 June 2020.

The sector as a whole has a low-risk profile for financing indicators, with significant cash holdings, low debt levels, and the ability to repay debts when they fall due. The role of debt in achieving financial sustainability is discussed in more detail in an earlier LGiU Australia briefing.

The VAGO website provides an interactive dashboard that allows local governments to view and benchmark their performance against other councils. This is a useful tool for councils to compare and contrast their performance with others in their cohort who may be performing relatively better over a range of financial indicators.

Comment

VAGO found the sector responded well to the disruption caused by the COVID-19 pandemic, with 78 local governments certifying their reports within the extended statutory deadlines, and all local government entities receiving clear audit opinions.

In regard to the sector’s financial performance in 2019-20, VAGO found that the sector’s financial position remained resilient despite the uncertain operating and economic environment caused by the COVID-19 pandemic – however, the full-year effect on their operations and finances will only become apparent in 2020-21 and beyond. With 15 councils keeping their rate increases at 0 per cent or less for the 2020-21 year in response to community pressure, and with many councils expecting to report operating deficits in the 2020-21 year (some for the first time), there will no doubt be a heightened interest by VAGO in the 2020-21 financial results.

As local governments turn their minds to preparing their 2021-22 budgets their will again be pressure from the community (and newly-elected councillors) to keep rate increases less than the cap of 1.5 per cent (or even 0 per cent). For Victoria, which experienced a second wave and lockdown in the second half of the 2020 year, many councils are only reaching pre-pandemic operational levels now in the first half of the 2021 year. So, finding the balance between supporting pandemic-impacted communities while ensuring ongoing financial viability will be challenging. Many councils may simply choose to take a short-term hit to their bottom lines and plan for a gradual return to viability as the post-pandemic view of the world becomes more certain.

To improve access and utilisation of their reporting, Audit Offices nationwide are incorporating dashboards that allow for comparisons across LGAs. In addition to the VAGO dashboard, the Queensland Audit Office has an interactive dashboard that allows for detailed comparison of different councils across a range of indicators.

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