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24 October 2017 11:32 (South Africa)

Time for auditors of SOEs to pay back the money?


    Simon Mantell served articles with a big four audit firm and runs a biscuit factory in Cape Town.

If KPMG is starring in its role as the whipping boy of all things wrong with the audit profession, then it is important not to lose sight of the fact that there are other large audit firms whose conduct has and continues to do the reputation of the profession no favours.

As KPMG feels the blowtorch of opprobrium, one would have thought that rival firms would be licking their lips at the prospects of new audit windfalls from former KPMG clients, but instead their response has been muted, making one ponder as to the reasons for their reticence.

A possible answer might be that many of the rival firms who have also audited or provided advisory services for state-owned entities (SOEs) are concerned that they, like KPMG, might be similarly complicit in state capture and that by downplaying the situation, they can potentially fly below the radar and avoid a reputational disaster similar to that which is afflicting KPMG.

Unfortunately for the auditors of SOEs, the annual financial statements over recent years bear witness to their apparent participation in state capture. If annual financial statements are all about numbers and disclosures, then an audit is all about gathering the necessary audit evidence to support the audit opinion of whether the information supplied in the annual financial statements is accurate and free from material misstatement owing to fraud or error.

Auditors are compelled by statute and International Standards on Auditing to conduct their audit work in compliance with regulations and guidelines. An auditor, on accepting an audit appointment, is required to consider the inherent business and audit risk of the client and then plan an audit and schedule of work which will result in the collection of sufficient evidence necessary to support the audit opinion. It follows that in the case of SOEs, the inherent audit and business risk is hopeless internal control leading to corruption and irregular procurement.

The three best known audit opinions are the “clean” audit opinion, the “qualified” audit opinion and the “adverse” audit opinion. In the case of SOEs, a clean audit opinion should provide confidence to all users of annual financial statements including the South African public that the annual financial statements pass muster. A qualified audit opinion, depending on the extent of the qualification, is normally a slightly watered down version of a clean audit opinion where the auditor will confirm that, but for one or two areas, the annual financial statements are free from material misstatement. An adverse opinion is the proverbial killer blow for an entity because this opinion confirms that misstatements are so material and pervasive and that the annual financial statements do not fairly reflect the situation of the entity which is akin to an individual being blacklisted by credit providers.

Space does not allow for the deconstruction of the annual financial statements of all major SOEs audited by external audit firms and for the purposes of this article the performance of the external auditors with respect to two key numbers in the recent annual financial statements of Eskom and SAA has been considered.

Much media space has been devoted to the audit qualification in the most recent set of Eskom annual financial statements. In essence, the auditors gave Eskom a clean bill of health with the exception of a qualification on the disclosed R3-billion worth irregular expenditure which the auditor was unable to verify or validate.

How, with an audit fee of R119-million, is an audit firm unable to verify or validate irregular expenditure when various investigative journalists are able to expose irregular expenditure far exceeding these numbers? If the systems of internal control at Eskom failed so spectacularly to allow unverified irregular expenditure of R3-billion and if the same systems failed to provide the documentation to support this figure, then how can anyone know if the disclosed irregular expenditure is not materially understated, and how did Eskom arrive at this figure in the first place, and what assurance is there that other figures in the annual financial statements are correct?

These are the questions the auditor should have asked and obtained answers to.

Simply put, this audit qualification appears a total cop-out given the reportage of massive fraud and irregular conduct at Eskom with respect to procurement, and everything points to misstatements in the annual financial statements owing to fraud and error which are so pervasive and material that an adverse audit opinion is the only appropriate one – yet the auditor gave what was effectively a clean audit opinion with a tame qualification proviso.

In the most recently available set of annual financial statements for SAA, the auditors go one better than the auditors of Eskom in that they give SAA a clean audit opinion. On the one hand, there is all the reported procurement malfeasance (irregular expenditure) running into billions at SAA, yet the auditors make no findings and raise no concerns that irregular and wasteful expenditure which SAA discloses in its 2016 annual financial statements as R13-million out of a potential R22-billion of procurement could be materially understated.

If the ratio of irregular and wasteful expenditure is a minuscule fraction of 1%, then is it reasonable to conclude that the auditors have no idea what the figure should be – and is it reasonable to conclude that the directors of SAA have misrepresented the figures in the annual financial statements?

It appears that the auditors of SAA have been drunk as well as asleep at the wheel because had the auditors identified the audit and business risk of procurement at SAA and then conducted a thorough and systematic audit of procurement, then their findings would surely have confirmed irregular procurement which was so material and pervasive that the only option would have been an adverse audit opinion.

The two line items identified in the annual financial statements above are but two examples of where it seems to appear that the auditors have let South Africa down. If auditors of SOEs identified a business risk and then planned and performed audit work in terms of International Audit Standards, then it is unlikely that any of the SOEs which are in the media for all the wrong reasons would get anything but an adverse audit opinion.

An adverse opinion cuts off all lines of credit and severely curtails the opportunity for procurement corruption.

KPMG has set the precedent with its commitment to pay back the money for the unacceptable quality of its work contained in the SARS “rogue unit” report and it would appear that the annual financial statements of large SOEs over many years indicate a similar unacceptable level of audit work.

One has no expectations of corrupt officials and crooked business people, but one does have expectations of a profession which extols the virtues of trust and integrity, and auditors of SOEs can choose the low road of remaining silent while hoping that any misconduct on their part is never identified, or they can, of their own volition, choose the high road and confirm their unsatisfactory audit work and pay back the significant audit fees which they have earned.

What choice will these firms make? DM


    Simon Mantell served articles with a big four audit firm and runs a biscuit factory in Cape Town.

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