South Africa

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  • Service: Audit
  • Date: 2014/08/22

Value of Audit roundtable: Johannesburg 

This article first appeared in economiamag.com

 

18 August 2014: The need for a full and frank assessment of the future role of the audit profession was highlighted at a recent roundtable discussion in South Africa. The second economia Value of Audit roundtable, sponsored by KPMG and hosted in Johannesburg by KPMG South Africa, examined how demands from investors and the public for more information and transparency is creating opportunities and challenges for the profession. How can auditors offer assurance on this extra information, much of which is forward-looking and outside the traditional remit of auditors?

Prof. Mervyn King, author of South Africa’s key corporate governance code and chairman of the International Integrated Reporting Council (IIRC), pointed out that while traditional financial reporting only tells part of the story there are clearly challenges when it comes to offering assurance on integrated reports. Thanks in large part to Prof. King’s determination integrated reporting is a listing requirement for companies on the JSE.

 

Prof. King pointed out that financial reporting couldn’t explain a large part of any business’ activities, leading many to develop separate sustainability reports. This caused companies to report “in silos”, he said. “There were financial reports and sustainability reports and the one was not speaking to the other and the user was completely uninformed. To be accountable, you have to be understandable. We also prepared reports in language that was incomprehensible to the average user.”

 

Prof. King admitted the issues surrounding audit and assurance on integrated reporting are complex. He suggested that the IAASB is in discussions to start developing what he described as an “international standard offering assurance as to the process of integrated reporting rather than the content”. This is because it will take so long to develop even limited assurance on the content.

 

The requirement for integrated reporting has had a major impact according to Mike Leeming, a non-executive director and audit committee chairman for several of South Africa’s largest companies. “The use of integrated reporting has been an exciting development. I’ve seen how it has changed the way we report and the way we understand our businesses.”

 

 But Leeming welcomed the idea of offering assurance on the process. While he felt auditors could play a role in giving “limited assurance”, in terms of “some of the non-financial numbers”, it remains difficult. “The concept of having assurance given around the systems used [to collect information] would be very valuable,” he said.

 

“Obviously, we need to evolve. And the issue of giving assurance on non-financial information is critical to the marketplace, and what role we play in that.”


Jose Rodriguez, chief operating officer of KPMG’s global audit practice

For Jose Rodriguez, chief operating officer of KPMG’s global audit practice, this issue sits at the heart of the debate about the future of the profession. “Obviously, we need to evolve. And the issue of giving assurance on non-financial information is critical to the marketplace, and what role we play in that.”

 

Rodriguez warned that any expanded role, whether through offering more detailed or expanded audit reports or offering assurance on a wider range of non-financial information, would bring challenges, “We are confined by current standards. And to be very blunt, there are liability and confidentiality issues, too.”

 

Offering an insight into the important banking sector, Rene van Wyk, South Africa’s registrar of banks, a member of the Basel Committee and chairman of the Basel Committee’s Accounting Experts Group (AEG), claimed the need for more frequent information updates meant there was a need for assurance on more than just the annual report and accounts. “We want the market to start regulating the banking system, as opposed to regulators. Therefore, what you disclose is important, as is the assurance that disclosure gives. Comparability and consistency are key, and I think the auditing profession can play a massive role in offering consistency across the world. Banking regulators need information on a continual basis.

 

We get information monthly and we interact on a dynamic basis. We can’t rely on the corporate report to do that. The capital markets interact with banks daily. That means a lot of reports being produced, almost to the extent that the corporate report becomes superfluous.” He added that regulators and the market wanted also forward-looking reports. “We want banks to look forward at what’s coming and not look at what’s behind. Regulators and investors want more dynamic information, more frequently.”

 

Prof King agreed. “The way we have been reporting has not been informative. In this historic context, we were reporting in automotive terms as if we were building a car with a rear view mirror but no windscreen. And it was being perfectly audited, but the external auditor in the nature of things is focused on the financial aspects, which is historical.”

 

For Aarti Tarkoordeen, CFO at the JSE, the issue is one of balance. Stringent reporting and listing requirements help investors, but mustn’t be allowed to get too onerous for management. Regulation mustn’t stifle innovation. “It’s largely a matter of striking a balance around practical implications versus the spirit and intent behind new rules. With integrated reporting, for instance, we have come a long way and I see it as a platform for companies to showcase their business from a progressive, innovative perspective. But it worries me that some of that innovation is at risk of being put into a box.”

 

Unfortunately, theory and practice don’t always match. Colin Brayshaw, a former managing partner at Deloitte and an experienced senior non-executive director in the 20 years since he retired from practice, says some integrated reporting leaves a lot to be desired. “One of the problems with some of the reports is that they are too long and you can’t distil the facts that are really important. There’s also an inclination at the moment to tell the good story and not all the story. It has to be warts and all.”

 

Another issue raised by the desire for more assurance on a greater range of information was the role of internal audit and the relationship with external audit. One of the most striking differences between this and the previous Value of Audit discussion in London and this one was the significance given to internal audit. This is partly because of South Africa’s “combined assurance model”. As Leeming explains: “Internal audit has become massively more significant than it was five years ago. As a non-executive director I take huge comfort from external auditors. But I take even more comfort from internal auditors, because they have 365-day-a-year involvement. But the real comfort I get is from management and the assurances they give me. That’s something one has to develop. You need an understanding of the people running the company, and the extent you can rely on their assurances.”

 

Prof. King added that the combined assurance model, developed in South Africa, emphasises all elements, including both internal and external audit and management. “You’ve got to have quality internal and external audit. But for the model to work, the glue is the internal audit. Internal audit ties it all together.”

 

“As regulators, our main concern is the protection of the investor. We think about what would make investors happy, what would help them and what would benefit them?”


Bernard Agulhas, CEO of IRBA

For Bernard Agulhas, CEO of IRBA, the audit quality framework issued by the IAASB explains these relationships as well as the importance of the stakeholders in audit quality. “Audit quality is no longer just the responsibility of auditors. In the past there used to be a divide between management, internal audit, external audit and audit committees. But there’s more recognition that all these parties contribute towards audit quality and have to work together.”

 

Agulhas added that it’s important to remember investors. “As regulators, our main concern is the protection of the investor. We think about what would make investors happy, what would help them and what would benefit them? Whatever reporting we’re talking about, whether it’s integrated reporting or narrower financial reporting, we have to think about the information we’re reporting and the format of the report. What matters is that investors have confidence they are getting the information they require to make the right decisions. Investors can take comfort not only from the external auditor’s assurance but also from other stakeholders. Combined assurance is an important concept.”

 

So what do the recent changes in the audit landscape mean for audit quality. It’s a question closely connected to the issues of independence and audit quality. Dr Terrence Nombembe, chief executive of the South African Institute of Chartered Accountants (SAICA) and former auditor general for South Africa, claimed the issue wasn’t one for practitioners as such, but rather one for those determining the scope and remit of their role. “The bottom line lies not with the practitioners, but with those who set the parameters within which they confine themselves. External auditors always have sensitivity about not crossing the independence line. It’s important guidance is given. External auditors are significant as players in corporate reporting, providing accountability, transparency and integrity. The only question is the scope within which they do that. The biggest criticism is that the scope tends to be confined to one set of information and not the rest. Those who provide guidance to external auditors need to make the first move.”

 

Nombembe added that auditors ought to be given the latitude to look at the bigger picture but that the framework they operate within needed to allow them to do that. “External auditors need the latitude to say ask what is the higher purpose for which we are involved with a client? Standard setters and regulators have got to allow auditors to think outside that confined box. One reason external auditors have never ventured into auditing information in the integrated report is that there is nothing giving guidance to go for it. There is no proactive, early signal to say ‘this is the space you are supposed to venture into’. Auditors have their hands tied.”

 

One concern for Brayshaw, was that expanding the role of external audit might squeeze internal audit. “I have a problem with an expanded remit. If a big company only had external auditors and no internal audit, I don’t think you’d have anything like the reliance on the fundamentals. External auditors aren’t there all day. They come in and their focus is often to make sure the financial statements comply with necessary standards. External auditors can’t tell you whether the petty cash is being properly controlled. But you can get that from internal audit.”

 

Nombembe conceded the point. “Management are there to do certain things, internal auditors are there to do others,” but he restated his point. “I believe external auditors are straitjacketed and we need to liberate their flexibility and horizons.”

 

Leeming added that in many of his organisations the relationship between auditor and client is already more complex than ever. “In large listed companies the external auditor is very involved in the whole process. They don’t just come in to do a year-end review, audit the numbers and go. In the planning process we talk detail around the integrated report, what’s required and to the extent that they are able to offer it, we make use of those specifics. For bigger companies you build up a relationship with the lead partner and they build up knowledge of the business and are forthcoming in what they think they should be doing.”

 

Rodriguez agreed that client-auditor relationships involve frank exchanges in closed meetings. The difficulties arise, he said, when you want to share these discussions with the wider world. “There will be issues of confidentiality. I am not sure my clients would like the information on some of the things we discuss with the audit committee to be available to competitors.”

 

Raising the subject of competition and auditor independence led to a discussion of the new planned rules for mandatory rotation of audit firms. In South Africa proposals for rotation every five years were countered by a compromise of getting shareholders to appoint members of the audit committee. This led Edson Magondo, head of audit for KPMG South Africa, to suggest that there was an opportunity for Europe to learn from South Africa.

 

For her part, Tarkoordeen felt it would add expense to management, with tendering and the appointment of new auditors draining management resource and making the audit process more time-consuming. “I understand the intention but I don’t think it will be effective and all it will translate into is increased cost.”

 

Muneer Hassan, technical director at SAICA, had concerns about the practicality of getting mandatory firm rotation into place. “We have lots of other layers of complication, including partner rotation and a five-year cooling-off period. If you look at the practicality of adding a third layer to ensure independence, it would mean firms having to plan five years ahead to disassociate themselves from a business they are planning to bid or tender for an audit with in three or five years time.”

 

Prof. King was vociferously outspoken against it. “I was involved in the discussions in the EU and I’m absolutely opposed. As a director of a company one knows it takes years for an auditor to understand a business. If every five years you are going to rotate and go through a tender, first the tender is going to take up time. Second, once you switch, management time will be spent educating auditors. Then after three years just as the new firm has learned, you get to the de-motivational phase because they know they are being kicked out in two years. It is laughable and I can’t see any benefit.”

 

Nombembe felt it was worth asking why the proposals had been suggested. “The environment was irritated by something auditors did and we need to be truthful. That goes back to the conversation about the value and quality of audit, the fundamental anchor of which is independence. We were complacent. Familiarity tends to compromise independence. We should be asking how we continue to enhance our value, independence and objectivity. We need to enhance trust in society, so that what happened before never happens again.”

 

King and Rodriguez agreed that the motivation behind the EU initiative was breaking up the Big Four’s perceived market domination. As Prof. King said: “In discussions with Commissioner Barnier I got the impression he had the Big Four in his sights. I left disheartened that his motivation was to get the Big Four to lose work and give it to other firms. And he has caused a bit of havoc.”

 

Rodriguez agreed: “My understanding is that that was indeed the genesis of this. He wanted to expand the audit market beyond the Big Four to include a Big Six or Big Eight. What is interesting is that mandatory rotation is going to limit the pool of choice and reduce competition. The Big Four will have to pick which clients they want to be associated with for non-audit work and decide whether they would rather play in that space, which is often more profitable, rather than maintain independence in the hope of getting the audit if it should come up in the future. Firms are going to have to make a choice. Do they want to be an auditor or an advisor? When it comes to rotation, choice is going to end up being extremely limited.”

 

Rodriguez also warned that a drop in audit fees could lead to lower quality. “We talk about a drop in audit fees and have seen this in the UK and elsewhere. But how can fees drop with a new set of auditors that are going to have to do more work? Are people getting the same work? The Big Four are businesses and at the end of the day while we may have decided to absorb those costs in some cases, we can’t continue to do so.”

 

Regardless of the issue of rotation, the panel all agreed with Magondo when he concluded that as an audit partner, a key determinant of quality was leadership. “The tone at the top really determines the quality of an audit and that is key. We continue to emphasise the need to prove that we are independent and are delivering a top quality audit and we are investing in the latest tools of the trade. Data is big and it can overwhelm you. So you need to be able to pick the right data and provide the correct insight when you engage with clients.”

 

And that ultimately, regardless of which aspects of reporting are under consideration, is what will provide the quality of assurance to investors and other stakeholders.

 

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Contact
Edson Magondo
Executive Partner: Audit
Tel: +27 (0)82 556 5995 
edson.magondo@kpmg.co.za

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