Auditors have warned that Birmingham City Council could face financial collapse unless it deals with mounting debt while cutting costs.

In its annual audit letter, Grant Thornton said the authority is on course to see debt rise to £3.65 billion by 2016 on the back of PFI debt, its equal pay bill rising above £1 billion and £492 million more cuts on the horizon.

District auditor Mark Stocks warns the council will have to make “significant and far reaching choices about service provision” in order to remain a going concern.

Auditors also say that the rising debt threatens the council’s ability to undertake further regeneration as it needs to “carefully consider” any future borrowing decisions. The council’s capital programme reduces from £541 million next year to £181 million by the 2016 financial year.

The auditor was confident the council has “adequate arrangements” in place for securing financial resilience, but highlighted borrowings, equal pay and cuts as areas of concern.

The letter states: “The council will need to manage its finances carefully over the next few years and make some significant and far reaching choices about service provision and the use of its asset portfolio if it is to remain financially stable and remain a ‘going concern’.”

The auditors praise the council as having a “good track record” in achieving its revenue budget against a backdrop of £275 million of savings in the last two financial years.

The council is currently working on Green Papers to deal with future budget cuts, which will question whether some services can be de-commissioned altogether.

However, with additional savings of £492 million need to be made by 2016/17 Grant Thornton says it “has a number of financial challenges that it will need to overcome in the next few years”.

Among them are the equal pay liabilities – which the Post revealed last week was already setting the authority back more than £1 billion. The letter states: “Continued action is needed to limit the level of claims and to ensure they can be financed.”

The auditors also said the council faces “significant” interest bills on borrowings on £3.2 billion, which are set to rise.

Mr Stocks also raises the issue of the council’s pension deficit which stood at more than £2 billion as of March 31. He said it was likely that the council’s annual contribution would have to increase “placing further pressure on its finances”.

Despite expressing some concerns, the auditors concluded that the council has proper arrangements in place for securing financial resilience along with robust systems to manage risk.

It also mentioned a series of highlights during the year, including the Library of Birmingham, reducing levels of obesity in adults over the age of 16, improving educational performance in English and maths at Key Stage 2, improving GCSE results and building more affordable homes.

However, it states that the council isn’t spending enough on children’s social services.

It states: “We note that the council’s planned spend per head on children’s social care for 2012/13 was considerably below the comparator group average. Given the issues highlighted with regard to the protection of vulnerable children the council should consider whether its inadequate arrangements are the result of insufficient resources or are the result of other management, staffing or governance failures.”

A Birmingham City Council spokesperson said its accounts have been given a clean bill of health. He added: “The auditor acknowledged that the council has significantly improved the quality and timeliness of its accounts production, which coming in the second year of a three-year improvement plan is very encouraging. We note the issues and points raised in the audit. We have put together an action plan to respond to the recommendations within the report.

“The auditor recognises the strength of the council’s financial management and our track record in delivering savings as necessary to respond to the financial pressures on it. Our budget and future financial planning addresses the implications of equal pay settlements and our borrowing levels.”