In previous articles, we have explored the questions triggered by corporate failures about what went wrong and who is to blame. Some suggest that a holistic approach to all the participants in the financial reporting process is needed to prevent corporate failure from happening in the first instance. Fragmented pieces of legislation regulate only some of the participants or their activities in the financial reporting process. The ideal is a comprehensive framework based on regulated (mandatory) and consensual (voluntary) participation that extends to all the key role players in the ecosystem in relation to the activity of financial reporting.
Preparers of financial statements
In this article, we explore the role of the preparers of financial statements in the financial reporting ecosystem. Preparers of financial statements are generally accountants led by the chief financial officer. However, the ultimate responsibility for the preparation of the financial statements rests with the paramount body of the organisation, which in the case of companies that are established in terms of the Companies Act 71 of 2008 is the board of directors. This, however, does not absolve the professional accountant from their responsibilities as a key part of the value chain.
Currently accountants are mostly members of voluntary professional associations and member bodies. These professional bodies are more often than not bodies that have enforcement or regulatory capabilities and do not always have the authority – moral or otherwise – to enforce conduct and adherence to standards. Some may have the ability to require that their members adhere to a code of conduct and to sanction their members in the event of misconduct. The SAICA Code of Professional Conduct is, for example, applicable to all SAICA members and associates. Membership is underpinned by compliance with professional codes and membership rules instead of regulation. This goes some way towards setting a regulatory minimum standard for fit and proper and competency requirements for preparers of financial statements and assists to proactively and consistently close the accountability and liability gaps in the financial statements’ preparation process.
It is a moot point to state that investors, creditors, employing organisations, the business community, governments and the general public might rely on the work of the professional accountant. The professional accountant is responsible for the preparation and reporting of financial and other information on which their employer and third parties might rely. However, what is important to highlight is that in order for the professional accountant to discharge their duties with diligence, they are required to ensure that they are capable of providing effective financial management and competent advice in respect of the business of the organisation that they are involved in. This demonstration of competence requires that the professional accountant should adhere to the five fundamental principles of ethics that guide their work, being integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour. We will address two of these principles in this discourse.
The principle of professional competence and due care requires that the professional accountant attain and maintain professional knowledge and skill at the level required to ensure that a client or employing organisation receives competent professional services, based on current technical and professional standards and relevant legislation and that the professional accountant act diligently and in accordance with applicable technical and professional standards.
Professional competence requires the exercise of sound judgement in applying knowledge and skill by professional accountants as they undertake their work. This will require that the professional accountant maintain a level of competence that will facilitate this, which competence comes about from being aware of and understanding the relevant technical, professional and business developments that affect their role. Diligence, as it is referred to under this principle, is the responsibility to act in accordance with the applicable technical and professional standards. This places the burden of keeping up to date with changes in such standards on the professional accountant and also makes it clear that they must be au fait and sufficiently informed about those standards that are applicable to them in their role and any changes thereto. This principle must be read and understood together with the second principle that we will address, being the principle of professional behaviour.
This second principle requires the professional accountant to comply with relevant laws and regulations; to behave in a manner that is consistent with the profession’s responsibility to act in the public interest in all professional activities and business relationships; and to avoid any conduct that the professional accountant knows or should know might discredit the profession.
The obligations to comply with relevant laws and regulations and to act in the public interest place the onus on the professional accountant to ensure that they interrogate and determine which laws are applicable to them when it comes to the tasks that they are responsible for. We mentioned earlier that the board of directors has the final responsibility for the preparation of a set of financial statements for companies that are incorporated in terms of the Companies Act. However, this does not absolve the professional accountant from their own responsibility of ensuring that the information that is prepared for and provided to the board to enable them to discharge their obligations is dealt with in accordance with the due diligence that is expected of the professional accountant. Further to this professional conduct requirement, the Companies Act itself places a requirement on the conduct of directors and prescribed officers in that it requires them to act in good faith and for a proper purpose; in the best interests of the company; and with the degree of care, skill and diligence that may reasonably be expected of a person acting in the role of director or carrying out similar functions to a director. The Companies Act recognises that directors of the company may not be experts in every aspect of the functions and management of the organisation and to address this, it provides that the directors are entitled to rely on those employees of the company whom they reasonably believe to be reliable and competent in the functions performed or in the legal counsel, accountants or other professional persons retained by the company (paragraph 76(5) of the Companies Act). However, this does not absolve the directors from taking steps to assess the professional competence of the persons on whom they place reliance.
Specifically for the preparation of financial statements, the Companies Act provides that these must be prepared in terms of the financial reporting standards with the form and content that the legislation requires. Such reporting must promote sound and consistent accounting practices and while this may differ between profit and non-profit companies, regard must be had for the legislative requirements all the same. It states specifically that for public companies, the financial reporting standards contemplated are International Financial Reporting Standards of the International Accounting Standards Board or its successor body and that the guidance for the other categories of profit and non-profit organisations will be determined in the regulations (paragraph 29(5) of the Companies Act). The regulations introduce a basis for differentiating between the requirements for various categories of entities, which is primarily premised on their public interest scores for entities that are not state-owned or listed on a stock exchange, with IFRS and IFRS for SMEs being the mainstay frameworks that must be applied (regulation 27 of the Companies Act).
In addition to the foregoing, for companies that are listed on the JSE, the responsibility to assess the competence of the executive financial director is enshrined in the Listings Requirements. These require that the audit committee of an issuer entity consider, on an annual basis, and satisfy itself of the appropriateness of the expertise and experience of the financial director and that also ensures that the issuer entity has established appropriate financial reporting procedures and that those procedures are operating as intended (section 3.84(g) of the JSE Listings Requirements).
For companies that are not established in terms of the Companies Act, one would need to consider the legislative framework through which they were established in determining the requisite governance (and accounting responsibility) response. Regardless of the founding legislation, the golden thread that runs through all the legislative requirements and that is apparent in all of the foregoing is the primacy of the competence of the preparer of the financial statements. While the obligations that are imposed on them may differ by type of entity, the bottom line remains that it is the role of the professional accountant to prepare the financial statements and implement the systems that ensure the application of sound financial principles.
The makings for an effective ecosystem for the regulation of the financial reporting environment are largely in place. What appears to be lacking is its enforcement across all players in the market, including the corralling into the net of those parties that are currently unregulated. A significant number of people who work as accountants remain unregulated despite the best efforts of professional accountancy organisations to bring them into their fold. We have seen this in the preponderance of new designations that have emerged in recent years with professional accountancy organisations attempting to create homes for those of their students and prospective members who are yet to attain the qualifications which they initially set out to obtain or have given up on doing so but have retained their interest for working in the accountancy field. These initiatives need to be supported and possibly bolstered by legislation as well as we have seen in some jurisdictions such as Botswana where it is illegal to work as an accountant without registering with an appropriate professional accountancy organisation.
Another pillar to strengthen the environment may be to develop a shared orientation to the financial reporting process and create an environment for improved regulatory harmony amongst the various players – individuals, employers, professional accountancy organisations and regulators. This may mean a single overarching regulator that will be responsible for closing accountability and liability gaps in the financial reporting process between the fragmented legislation and various regulators and member bodies. This could be achieved by identifying high-impact practices that have delivered desirable results in some jurisdictions (for example Sarbanes-Oxley legislation in the US) and by the use of stakeholder forums to move toward consensus regarding a preferred model, discouraging ‘add-on’ interim regulatory measures that do not address the fundamental cause of corporate failures. The Financial Reporting Council (FRC) in the United Kingdom, for example, takes an approach to regulating their financial reporting ecosystem that acknowledges the inextricable links across the different players therein. The FRC’s remit spans across investors, companies, auditors, and organisations that are responsible for the training of accountants and actuaries.
It also sets the UK’s Corporate Governance and Stewardship Codes. In line with recommendations from recent reviews, the FRC will soon be replaced by the Audit, Reporting and Governance Authority which will have broader powers.
But will comprehensive regulation of the financial reporting ecosystem eliminate corporate failures? It may for one yield positive results in better assisting law enforcement agencies to prosecute the perpetrators of white-collar crime. For it to be effective, it will need the buy-in and cooperation of everyone involved – regulators, professional accountancy organisations, employer entities, the professional accountants themselves, and the accountancy services-seeking general public.
Raymond Chamboko CA(Z), CA(SA) is a director with W.consulting, an independent corporate reporting advisory, training and software development business and a member of SAICA’s Legal Compliance Committee, and also represents the Pan African Federation of Accountants in various fora.