https://www.accountancysa.org.za Home Wed, 02 Aug 2023 07:34:43 +0000 en-US hourly 1 https://wordpress.org/?v=7.1.2 Analysis: A recurring deficiency – Evaluation of uncorrected misstatements https://www.accountancysa.org.za/analysis-a-recurring-deficiency-evaluation-of-uncorrected-misstatements/ Wed, 02 Aug 2023 07:33:51 +0000 https://www.accountancysa.org.za/?p=26398

This article has been prompted by a report that first appeared in the Independent Regulatory Board for Auditors’ newsletter, IRBA News 58. That report noted that the IRBA had noted an increasing trend of deficiencies in the evaluation of uncorrected misstatements. In addition, the enforcement committee (ENCOM) has concluded on a number of matters in which the evaluation of uncorrected misstatements was a common challenge. In view of the ENCOM’s request that registered auditors be reminded of their responsibilities in terms of International Standards on Auditing, in this article Kumukakwashe Matambo CA(SA) of the IRBA’s Standards Department highlights some salient points regarding this topic and offers links to other resources

Audit quality is a fundamental and critical factor that applies to every aspect of the work of auditors. Audit quality is dependent on the respective roles of those responsible for systems of quality management within audit firms, other stakeholders, such as audit committees, investors, oversight bodies, company directors and financial accountants who are responsible for the integrity of financial information, and all these role players performing their functions with the necessary skill and diligence. Therefore, when a significant deficiency theme arises from firm-wide and assurance engagement file inspections that casts doubt on audit quality, we take it as an opportunity to remind ourselves of the basic tenets relating to the auditor’s evaluation of uncorrected misstatements.

International Standard on Auditing (ISA) 450, Evaluation of Misstatements Identified During the Audit, deals with the auditor’s responsibility to evaluate the effect of identified misstatements on the audit and uncorrected misstatements, if any, on the financial statements.1 A misstatement is defined as ‘a difference between the reported amount, classification, presentation or disclosure of a financial statement item and the amount, classification, presentation or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or fraud.’2 Uncorrected misstatements are misstatements that the auditor has accumulated during the audit and that have not been corrected.3 These are commonly referred to as unadjusted audit differences. The auditor is required to accumulate misstatements identified during the audit, other than those that are clearly trivial.4

When an engagement team does not perform an appropriate evaluation of uncorrected misstatements during the completion stage of the audit, that may result in an inappropriate opinion being expressed on the financial statements. To give some context, the following are important:

The auditor is required to form an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.5
To form that opinion, the auditor shall conclude as to whether the auditor has obtained reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. Among other matters, that conclusion should take into account the auditor’s conclusion, in accordance with ISA 450, whether uncorrected misstatements are material, individually or in aggregate 6.
The auditor is required to evaluate whether the financial statements are prepared, in all material respects, in accordance with the requirements of the applicable financial reporting framework. This evaluation should include consideration of the qualitative aspects of the entity’s accounting practices, including indicators of possible bias in management’s judgements.7
The concept of materiality is applied by the auditor both in planning and performing the audit and in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements, and in forming the opinion in the auditor’s report.8
When evaluating the effect on the financial statements of all uncorrected misstatements, the auditor considers not only the size but also the nature of uncorrected misstatements and the particular circumstances of their occurrence.9
The auditor is required to determine whether uncorrected misstatements are material, individually or in aggregate. In making this determination, the auditor is required to consider:
o The size and nature of the misstatements, both in relation to particular classes of transactions, account balances or disclosures and the financial statements as a whole, and the particular circumstances of their occurrence,10 and
o The effect of uncorrected misstatements related to prior periods on the relevant classes of transactions, account balances or disclosures, and the financial statements as a whole.11
The auditor is required to include in the audit documentation:
o All misstatements accumulated during the audit and whether they have been corrected,12 and
o The auditor’s conclusion as to whether uncorrected misstatements are material, individually or in aggregate, and the basis for that conclusion.13
The auditor is required to prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand significant matters arising during the audit, the conclusions reached thereon and significant professional judgements made in reaching those conclusions, among other matters.14 If, in exceptional circumstances, the auditor judges it necessary to depart from a relevant requirement in an ISA, the auditor is required to document how the alternative audit procedures performed achieve the aim of that requirement, and the reasons for the departure.15

Our inspections have identified several instances across audit firms where the auditor performed an evaluation of uncorrected misstatements and identified them as material, individually and/or in aggregate and then accepted these misstatements as unadjusted audit differences without modifying the auditor’s opinion on the financial statements. This, however, is incorrect and has the potential to result in an incorrect opinion.

Furthermore, the inspection process has also identified a significant lack of documented audit evidence regarding the engagement team’s assessment (quantitative and qualitative) of the unadjusted audit differences and an inappropriate evaluation of the aggregate unadjusted audit misstatements, as required by the ISAs. It has been observed that in some instances there is no documented evidence that uncorrected misstatements were accumulated and assessed for the group, where the audit was an audit of group financial statements.

There were also cases where the engagement team did not identify and resolve inconsistencies between the unadjusted differences in the audit file and those included in the management representation letter.

As a reminder, if the nature of a misstatement is a classification error (that is, the misstatement occurred from an initial incorrect classification), then the misstatement should still be evaluated in terms of the requirements of the standards quoted above. ISA 450, paragraph A20, gives guidance on how these can be evaluated. Where a misstatement does not arise from an inappropriate classification, paragraph A20 of ISA 450 cannot be used as guidance in evaluating the misstatement. The auditor should document the judgements made and the factors considered in making the conclusions, as required by the standards.

Reminder: The fundamental principles of professional competence and due care and professional behaviour
The fundamental principle of professional competence and due care in the IRBA Code of Professional Conduct for Registered Auditors (IRBA Code) requires registered auditors to act diligently and in accordance with applicable technical and professional standards. The fundamental principle of professional behaviour requires them to comply with relevant laws and regulations and avoid any conduct that the registered auditor knows or should know might discredit the profession.

When assessing uncorrected misstatements, quantitative and qualitative factors are both of importance and need to be taken into consideration. The qualitative reasons need to be considered, in line with the principles of the ISAs, and so do the documentation requirements of the ISAs. If uncorrected misstatements exceed materiality (as set by the engagement team) but are not adjusted or dealt with in the auditor’s report, another experienced auditor could come to a different conclusion and not adjusting or dealing with the uncorrected misstatements appropriately would be against the requirements of the IRBA Code.

Notes
1 ISA 450, paragraph 1.
2 ISA 450, paragraph 4(a).
3 ISA 450, paragraph 4(b).
4 ISA 450, paragraphs 3 and 5.
5 ISA 700, Forming an Opinion and Reporting on Financial Statements, paragraph 10.
6 ISA 700, paragraph 11(b).
7 ISA 700, paragraph 12.
8 ISA 320, Materiality in Planning and Performing an Audit, paragraph 5.
9 ISA 320, paragraph 6.
10 ISA 450, paragraph 11(a).
11 ISA 450, paragraph 11(b).
12 ISA 450, paragraph 15(b).
13 ISA 450, paragraph 15.
14 ISA 230, Audit Documentation, paragraph 8.
15 ISA 230, paragraph 12.

Useful resources

IRBA’s 2022 Public Inspections Report on Audit Quality.
SAICA FAQ Question 9 – ISA 450, Evaluation of misstatements identified during the audit.
Application paragraphs A14−25 in ISA 450.

]]> Analysis: Preparers of financial statements as key role players in the financial reporting ecosystem https://www.accountancysa.org.za/analysis-preparers-of-financial-statements-as-key-role-players-in-the-financial-reporting-ecosystem/ Wed, 02 Aug 2023 07:27:14 +0000 https://www.accountancysa.org.za/?p=26395

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.

CONCLUSION
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.

Author
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.

]]> Analysis: When should a company be placed under business rescue? https://www.accountancysa.org.za/analysis-when-should-a-company-be-placed-under-business-rescue/ Wed, 05 Jul 2023 06:23:09 +0000 https://www.accountancysa.org.za/?p=26258

There seems to be an ill-conceived belief that placing a company in business rescue should be delayed for as long as possible. Some quarters may believe that you should never use business rescue as it will result in the business losing customers and supplier support. The 2023 Deloitte South Africa Restructuring Survey1 indicated that early identification of financial distress and pre-assessment before business rescue is crucial to improving local restructuring. The impact of delaying a turnaround or restructuring has been a part of a recently published PhD and has far-reaching consequences.

WHAT IS ‘FINANCIALLY DISTRESSED’?
Accountants are very familiar with the tests for solvency and going concern. Still, many accountants are not aware of the test of ‘financially distressed’ as defined in section 128(1)(f) of the Companies Act of 2008 (as amended).

(f) ‘financially distressed’, in reference to a particular company at any particular time, means that −
(i) it appears to be reasonably unlikely that the company will be able to pay all of its debts as they fall due and payable within the immediately ensuing six months; or
(ii) it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months …

In other words, the company may be solvent, but will it be liquid for the next six months? As most companies in South Africa are thinly capitalised, they may be financially distressed in terms of the provisions of the Companies Act, as the directors live in hope from month to month that things will go better next month. Trading under financially distressed conditions may result in the directors trading recklessly, as contemplated in section 22 of the Act. The directors may be personally liable for the losses suffered by third parties as set out in section 218(2) of the Act. Delaying the implementation of a turnaround or restructuring, with or without the protection of chapter 6 of the Act, may have serious legal implications for the directors.

MEASURING FINANCIAL DISTRESS
How does one go about measuring ‘financially distressed’? While there are many indicators that the company is financially distressed or heading in that direction, the quickest and most objective way to measure whether the business is financially distressed is to critically review the cash flow forecast for the next 12 months.This review should not be viewed through rose-coloured glasses but rather based on what is conservatively seen as most likely to occur in the immediate future.

However, most cash flow forecasts are spreadsheet-based. Many studies have shown a high risk of errors in these spreadsheet-based forecasts, such as not normalising the data used, personal bias, and errors in the formulas and calculations, which may result in the directors underestimating the actual severity of the situation.

In a recently published PhD study at the University of Pretoria, the author developed a mathematical model called the Variable Finance Capacity (VFC)2 model, enabling a clearer picture of funding requirements when dealing with a turnaround.

Figure 1 shows a solid black line displaying the financial and time consequences based on the assumptions of a proposed turnaround plan. This curve shows that approximately R2,5 million will be required in period 3 and that the turnaround duration will last for 6,5 periods. The purple dash line (boundary 1) measures the impact of a delay of one period in the implementation. It shows that the requirements have changed by approximately R4,3 million required in period 4, and the turnaround duration will last 8,5 periods. It becomes clear that a delay by a single period exacerbates the financial requirements and lengthens the duration. If the delay has been extended to six periods, the requirement to implement the turnaround has grown to R11,7 million and will take 16,5 periods to complete. This funding requirement must not be confused with working capital requirements or other capital costs − the funding required to fund the losses until the turnaround has been implemented.

Figure 1 VFC model showing the impact on the financial and time consequences of delays in the implementation of the turnaround or restructuring plan (Gribnitz, 2022)

Each period (usually measured in months) of delay in placing the company in business rescue pushes the break-even point out. Still, and more importantly, the company will require increasingly more funding to implement the rescue.

OPTIONS FOR FINANCIALLY DISTRESSED BUSINESSES
In most cases where the company’s directors are closely involved in the day-to-day running of the business, they will be acutely aware that the business is struggling to meet its payment obligations. They may be making ad hoc and emergency plans to continue trading.

They are undertaking these actions fully aware that they are incurring debt with suppliers and funders while there is a substantial risk that the debt cannot be repaid. As discussed, there are potential persona legal consequences for the directors, who may be held personally liable for conducting the company’s affairs in this manner, so the question arises what the directors should do.

The directors should obtain professional advice from their accountants and/or lawyers and have several options available to them while also being bound by a number of obligations:

They should immediately perform a test to calculate whether the company is able to pay its debts in the next six months and take the necessary corrective actions to ensure that the company is able to do so, or
Upon recognising that the company is financially distressed, the directors may pass a resolution to commence with business rescue in terms of section 129(1), or
If they fail to take either of the above two actions, then in terms of section 129(7), the board must inform all affected parties and the Companies and Intellectual Property Commission (CIPC) why they have not resolved to commence with business rescue − that is, they must inform the parties of their continued reckless trading

There is also the possibility that an affected person may apply to the court in terms of section 131(1) to commence business rescue proceedings and place the company under supervision. Such action is a clear indication that the directors did not take the necessary steps as prescribed in the Act, which may result in the directors being held liable.

If the directors pass the resolution to place the company in business rescue, they will have control over the appointment of a competent business rescue practitioner rather than the court appointing the business rescue practitioner through the section 131(2) process.

WHY DO SO MANY COMPANIES DELAY THE DECISION?
While the provisions of the Act are clear, it fails to recognise the difficult decision that the directors and owners of a company face, namely when to stop the ‘hope tomorrow will be a better day game’. Commencing business rescue is a daunting option as it requires handing over total control to a third party, being the business rescue practitioner. The best chance that the directors have to save the business is to appoint a competent business rescue practitioner. Delaying the decision to take the right actions has, among other things, the following consequences:

The probability of funding the turnaround becomes increasingly smaller with every day that passes, and
The ability to appoint a competent practitioner reduces as the third parties may bring an application for business rescue or even a liquidation application

Delaying the commencement of business rescue is a mistake, as the longer one waits to take the decision, the more difficult it becomes to rescue the business. Delays may result in the business rescue practitioner concluding that the business cannot be rescued and must be liquidated instead.

According to the 2021/2022 CIPC annual report,3 4 305 companies entered business rescue between 2011 and June 2022, with 19% reaching substantial implementation of the business rescue plans. However, 533 ended up in liquidation.

THE SOONER, THE BETTER
If placed in business rescue early enough, the company can be rescued and returned to the shareholders and directors within a relatively short period (three to six months).

Most business rescues require some form of restructuring of the balance sheet of the business, which may include a capital injection or raising of post-commencement funding. Here the VCF model can play an essential role in indicating the quantum of finance required and the timing to affect the turnaround. It can be of great assistance in convincing investors or funders that it is worth their while to invest in the business or to fund the business rescue.

CONCLUSION
The South African economy had only started to recover from the negative effects of COVID-19 and the resultant disruptions to the global supply chains when the war in Ukraine started. Furthermore, with the present spectre of global inflation, it is essential that companies facing financial distress take the necessary actions sooner rather than later. Don’t wait to get help.

Source
KJ Gribnitz (2022). Proposing the variable finance capacity model for fundamental moments in turnaround. PhD thesis, University of Pretoria.

Notes
1 Deloitte Restructuring Survey 2023.
2 VFC is a registered trademark.
3 2021/2022 CIPC annual report, table B: 4: Status of business rescue proceedings, p 35.

AUTHOR
Barry Urban CA(SA), Business Rescue Practitioner, Sagacity Corporate Services

]]> Analysis: Medical aids and capitation agreements https://www.accountancysa.org.za/analysis-medical-aids-and-capitation-agreements/ Tue, 04 Jul 2023 14:53:31 +0000 https://www.accountancysa.org.za/?p=26240

Medical aid schemes help people to pay for healthcare needs and medical expenses in exchange for monthly contributions. Sometimes medical schemes in South Africa enter into capitation agreements with another party whereby the medical scheme pays, to such party, a pre-negotiated fixed fee in return for the provision of specified benefits to the members.

The schemes might use a capitation agreement, for example, in the area of managed health care. According to the Medical Schemes Act (MSA), managed health care means clinical and financial risk assessment and management of health care, with a view to facilitating appropriateness and cost effectiveness of relevant health services within the constraints of what is affordable, through the use of rules-based and clinical programmes’.

A scheme may engage with a managed care provider to provide such services for a fixed fee based on the number of members. Other examples of capitation agreements relate to emergency services.

At first glance, some may say that these capitation agreements are reinsurance contracts held by the medical scheme. But are they?

IFRS 17 defines a reinsurance contract as insurance contracts issued by one entity (the reinsurer) to compensate another entity for claims arising from one or more insurance contracts issued by that other entity (underlying contracts).

The definition of a reinsurance contract is principles-based and not dependent on whether the issuer thereof is legally registered as a reinsurer or not.

Let’s backtrack: why is a medical scheme contract with its member considered to be an insurance contract? IFRS 17 defines a contract as an insurance contract if it transfers significant insurance risk. Insurance risk is significant if, and only if, an insured event could cause the issuer to pay additional amounts that are significant in any single scenario, excluding scenarios that have no commercial substance (that is, no discernible effect on the economics of the transaction).

A medical scheme accepts significant insurance risk from the member by agreeing to compensate the member should a specified uncertain event occur that adversely affects the member, for example by bearing certain of the medical or healthcare costs in the event that a member becomes ill. The costs that the medical scheme could be required to bear exceed the contributions payable by the member.

Back to capitation agreements. Two key questions need to be answered: (1) Do all capitation service providers bear significant insurance risk? and (2) Do all capitation agreements compensate the medical scheme for claims arising from its members? The simple answers are ‘possibly’ and ‘no’. The devil is in the detail.

Given that, by their nature, capitation agreements are fixed-fee service contracts, it is possible that the capitation service provider may be exposed to significant insurance risk because the number and extent of the services they are required to perform are unknown and their costs of fulfilment could exceed the fee payable by the medical scheme. However, this is not sufficient for the capitation agreements to be reinsurance contracts held by the medical scheme. The medical scheme must be compensated for claims arising from its members. The compensation does not have to simply be in the form of writing out a cheque to the medical scheme (similar to traditional reinsurance); it could take the form of actually providing healthcare and medical services that the medical aid has promised its members, for example ambulance transport.

However, if the capitation service provider simply arranges for a third party to provide the specified healthcare or medical services to the members of the medical scheme and does not bear the cost of those services, or it provides administrative-type services for the medical scheme, such as financial risk assessment of its healthcare programme, then it is not compensating the medical scheme for claims from its members. Such capitation agreements would not be reinsurance contracts under IFRS 17. They are contracts for services received by the medical scheme.

Based on what has been observed in the medical scheme industry in relation to the implementation of IFRS 17, it is imperative that medical schemes correctly classify their capitation agreements.

Let’s look at two examples to help us better understand whether the medical scheme has reinsurance contracts that it holds. It is important to note that in both examples, the capitation agreement does not absolve the scheme’s promise to its members to provide said services.

Example 1
Medical scheme A enters into a capitation agreement with MRI for it to manage the provision of emergency services to A’s members in return for a fixed fee per month based on the number of members covered by this benefit option. MRI does not provide the emergency services or bear the cost thereof. It simply arranges for third-party service providers to provide the emergency services as and when required, and A remains liable to pay the third-party service providers.
In this case, is this arrangement a reinsurance contract held by A?

No. This is because MRI is only engaged to manage the provision of emergency services and not to provide the actual services or to bear the cost thereof. Therefore, MRI does not compensate A in any way for the insurance risks borne by A in respect of the claims arising under A’s contracts with its members.

Example 2
Let’s contrast this with example 2.

Medical scheme B promises its members that they will receive the following benefits if required as part of their medical aid plan:

Remote medical advice and information
Emergency medical response to the scene of a medical emergency
Medical transportation to hospital
In-hospital transfer

In turn, B enters into a capitation agreement with FARE 911 to manage and provide these services to its members for a fixed fee per month based on the number of members covered by this benefit option.

In this case, is the arrangement with FARE 911 a reinsurance contract held by B?

The answer is yes. FARE 911 is required to provide the actual emergency services to the members of B and it takes on the risk that its costs of doing so, exceed the fee paid to it by B. Thus, FARE 911 is exposed to significant insurance risk. Furthermore, since ultimately B remains responsible to its members for the provision of the emergency services, by being able to require FARE 911 to provide the services to its members, B is being compensated by FARE 911 for such claims by members.

Remember to always delve into the detail of such contracts to determine if IFRS 17 is applicable or not.

AUTHOR
Suvanna Pitamber, Senior IFRS Technical Manager, BDO South Africa

]]> Analysis: Comprehensive regulation of the financial reporting ecosystem https://www.accountancysa.org.za/analysis-comprehensive-regulation-of-the-financial-reporting-ecosystem/ Thu, 01 Jun 2023 07:49:27 +0000 https://www.accountancysa.org.za/?p=26099

Corporate failures trigger pressing questions about what went wrong and who is to blame. Laws and enforcement mechanisms are questioned, and attempts are made to solve for problems without exploring the core issues.

Compliance requires improved scrutiny of the entire ecosystem, particularly in the case of public interest entities and entities with increased technological complexity and cross-border activities.

What is needed is a holistic approach to all the participants in the financial reporting process to prevent corporate failure from happening in the first instance. Currently, there is fragmented legislation regulating some of the participants or some of their activities in the financial reporting process. Ideally, the regulatory framework should extend to all the key role players in the ecosystem in relation to the activity of financial reporting:

Accountants as the preparers of the financial statements. This includes the CFO and CEO.
Approvers of the financial statements. In the case of a company the approval rests on the shoulders of the board as a collective in terms of the Companies Act 2008. A director signs off on the financial statements on behalf of the board.
Those charged with governance, such as the members of the governing body or board and the audit committee, play a pivotal role in the financial reporting process, and also to challenge and ask difficult questions.
Internal assurance providers such as the internal auditors express an internal opinion over the internal controls of the entity or its compliance with laws and regulations.
External assurance providers, including external auditors and independent reviewers, are responsible for providing assurance on the financial statements once they have been approved by the board.

The aim of this holistic regulatory approach is to create a consistent, fair, and certain regulatory regime governing the entire financial reporting ecosystem and holding to account all role players within this ecosystem. The current regulatory framework applicable to auditors and directors should remain and be supplemented with a range of overarching measures to fill the gaps in the regulation of accounting officers and preparers of financial information (CEOs and CFOs, accountants), and those charged with governance (boards and audit committees). This may ask for a completely new regulatory regime authorised by overarching legislation. The current regulatory regime unfortunately applies a very light touch to the financial reporting ecosystem as a whole, with an almost exclusive reactive focus on the assurance provider. In the process, it neglects to effectively and proactively oversee the other crucial players in the financial reporting ecosystem.

Preparers of financial statements
Currently accountants are mostly members of voluntary professional associations and member bodies. Professional bodies are not statutory bodies or regulators and do not necessarily have the regulatory authority to enforce conduct and adherence to standards. Membership is underpinned by compliance to professional codes and the membership rules instead of regulation. A consistent regulatory minimum standard for fit and proper and competency requirements for preparers of financial statements may assist to proactively and consistently close the accountability and liability gaps in the financial statements’ preparation process.

Those charged with governance
Board members are jointly and severally liable for all board decisions, including the approval of the financial statements. However, accountability and enforcement are hampered due to fragmentation in the law and a multiple of regulators across the spectrum.

The differing and fragmented requirements for audit committees across sectors and types of entities include for example the Companies Act, JSE Listing Requirements, Banks Act, Public Finance Management Act, King IV, and industry-specific laws such as the Banks Act. These differences relate to membership, qualifications, skill and experience, independence, duties, and disclosures for those charged with governance. The primary responsibility for the management and direction of a company vests in its board of directors and senior management. In discharging their duties, they are subject to strict fiduciary duties and duty-of-care skill and diligence. Directors of state-owned companies are also bound by the Public Finance Management Act. A directorship is not a profession with entrance qualification requirements, and it is absolutely necessary that directors must initially on appointment, and on an ongoing basis, thereafter, be required to undergo education and training on the law in respect of their duties and responsibilities.

With specific reference to the duties of the audit committee, clarity and consistency is needed on the role of the audit committee as it relates to:

Overseeing the appointment and continuous independence of the external auditor
Monitoring audit quality
Overseeing the effective design and implementation of the internal financial controls
Assurance providers

Unlike internal auditors that affiliate with member bodies and associations, the external auditor is subject to direct regulatory oversight. In terms of the Auditing Profession Act, the Independent Regulatory Board for Auditors (IRBA) is tasked with the registration of auditors and ensuring the adherence to auditing standards and audit quality. This is achieved through periodic inspections and disciplinary action where required. Sanctions may include a pecuniary fine or de-registration.

The scope of the audit as currently framed in terms of the auditing standards remains a concern. There appears to be an expectation gap regarding the financial statement audit − that is, what is required of an audit in terms of the International Standards on Auditing and what the users of financial statements expect an audit to do. Questions in the public interest are being asked about the auditor’s role in, among others, fraud detection and prevention, assurance of internal controls (including internal financial controls), business viability and going-concern status of the business, as well as the company’s performance. The users of financial statements require the auditor’s opinion to provide an informed view on not only the financial statements of the business, but also other matters required to form a holistic view of the soundness of a business.

The IRBA’s authority and functions extend only to the external auditor in the ecosystem. The World Bank published its Report on the Observance of Standards and Codes: Accounting and Auditing (ROSC) in June 2013. One of the key recommendations contained in this report is that appropriate legislation should be enacted to provide for the regulation of both accountancy organisations and an audit regulatory body. While the auditing profession is highly regulated, there is no national supervision over the accountancy bodies or its members.

Conclusion
Perhaps what is needed is to develop a shared orientation to the financial reporting process and create an environment for improved regulatory harmony. This may mean a single overarching regulator or more deliberate co-ordination between various regulators. The aim is ultimately to close 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 (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 core of corporate failures holistically. The Financial Reporting Council (FRC) in the UK, for example, takes a holistic approach to regulating the UK financial reporting ecosystem by acknowledging the inextricable links across the different players therein. The FRC’s remit spans across investors, companies, auditors, institutes who train individuals to become qualified 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. It will certainly hone management’s focus on internal controls over financial reporting by elevating the emphasis on fraud in the control environment and propel the audit profession into a state of audit quality, consistent with the views of a former board member of the US Public Company Accounting Oversight Board.

AUTHOR
Carla Budricks, Deloitte Africa Regulatory and Public Policy Lead. Carla has worked in the professional services industry for 17 years, with a specific focus on laws that impact professional services firms, auditors and accountants.

]]> Analysis: International Tax Reform Pillar Two Model Rules https://www.accountancysa.org.za/analysis-international-tax-reform-pillar-two-model-rules/ Thu, 01 Jun 2023 07:27:07 +0000 https://www.accountancysa.org.za/?p=26091

In March 2022, the Organisation for Economic Co-operation and Development (OECD) released guidance on its 15% global minimum tax proposed as the second ‘pillar’ of a project to address the tax challenges arising from the globalisation of the economy specifically as it relates to the impact on the way of working, referred to as the Pillar Two Rules. This guidance elaborates on the application and operation of the Global Anti-Base Erosion (GloBE) rules agreed upon and released in December 2021 which lay out a co-ordinated system to ensure that multinational enterprises with revenues above €750 million pay tax of at least 15% on the income arising in each of the jurisdictions in which they operate.

The International Accounting Standards Board decided to respond to stakeholders’ concerns about the accounting implications arising from the adoption of these rules by jurisdictions.

The application of the Pillar Two recommendations may result in an impact on current and deferred tax or potentially may not represent an income tax as defined in IAS 12 Income Taxes. This is because adoption by specific jurisdictions may have its own set of tax legislation which may require to be assessed and may result in a significant number of unknown variables within the calculation of the global income to be taxed as well as the jurisdiction that is allowed to collect that tax.

Due to this significant uncertainty, the board has decided to propose an exemption to IAS 12, as it relates to deferred tax specifically until the uncertainties in the global tax system have been resolved and the board can thoroughly assess the situation and provide a reliable solution.

The amendments to IAS 12 have been detailed in an exposure draft: IASB/ED/2023/1 International Tax Reform − Pillar Two Model Rules (proposed amendments to IAS 12). The summary of these amendments are:

The board proposed to provide an exception to the requirements in IAS 12 that an entity does not recognise and does not disclose information about deferred tax assets and liabilities related to the OECD Pillar Two income taxes. An entity would disclose that it has applied the exception.

The board proposed that, in periods in which Pillar Two legislation is enacted or substantively enacted, but not yet in effect, an entity would disclose:

Information about such legislation enacted or substantively enacted where the entity operates
The jurisdictions in which the entity’s average effective tax rate is below 15%, and
Whether there are jurisdictions where the entity expects either to pay Pillar Two income taxes although the 15% threshold does not apply or not to pay Pillar Two income taxes although the 15% threshold does apply

The IASB proposes that an entity applies the exception immediately upon issuance of the amendments and retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors and the disclosure requirements for annual reporting periods beginning on or after 1 January 2023.

The exposure draft and related comment letters on International Tax Reform − Pillar 2 Model Rules can be downloaded here. Exposure draft feedback was expected in April 2023.

AUTHOR
Yingisani Maluleke, Manager, Audit Quality & Risk IFRS, from KPMG

]]> Analysis: Letters of comfort and support https://www.accountancysa.org.za/analysis-letters-of-comfort-and-support/ Thu, 01 Jun 2023 07:15:05 +0000 https://www.accountancysa.org.za/?p=26071

A common response to factual insolvency is for a parent company or fellow-subsidiary to provide a so-called ‘letter of comfort’, also known as a ‘letter of support’.

The value and benefit of such letters to an auditor (and indeed to the company itself and to its creditors) depend on the specific wording thereof, and in particular whether the letter amounts to a financial guarantee and enforceable legal undertaking, or merely records a ‘best efforts’ or a general corporate governance commitment. The auditor must be cautious regarding the degree of importance attributed to such letters.

A letter of comfort cannot be regarded as a substitute for a subordination agreement. These types of letters vary, but commonly include statements from a parent company or related party that it is aware of the subsidiary’s financial position; the group policy is that group companies should meet their obligations; it will ensure that the company is properly managed; and it supports its subsidiary to meet their obligations. A letter of comfort or support indicating a general intention to provide support may not create a legally enforceable obligation.

A letter of comfort or support is only one factor to be considered by an auditor. A letter of comfort or support cannot be conclusive in relation to the consideration of commercial solvency or going concern, which requires various other exercises and considerations. An auditor examines and considers each letter of comfort or support on its own merits and in the particular circumstances – considering in particular the practical effect of the letter of comfort or support on the company and its creditors, and the enforceability thereof.

This note attempts to deal with the following question as regards letters of comfort and support: Are they legally binding?

OUR VIEW
In interpreting comfort and support letters the key question will normally be whether the relevant statement in the letter amounts to a contractual promise, typically to ensure that a subsidiary will be able to meet its liabilities to the lenders or a merely a representation as to existing fact. Where the statement can be construed as a contractual promise as to the future (ie an implied promise by the parent that the subsidiary will at all times be able to meet its liabilities), the subsidiary would normally have a remedy in breach of contract against the parent in the event the subsidiary becomes insolvent. However, if the statement is only one of existing fact, the subsidiary will only have a claim against the parent if the statement was in fact untrue at the time it was made. This will generally be very difficult to prove.

In commercial transactions and absent clear words to the contrary, comfort and support letters will create binding enforceable obligations. However, the problem with comfort and support letters is to know what they actually mean. Whether a letter of comfort and support is capable of giving rise to a legally binding undertaking will depend on the intention of the parties and the circumstances.

The meaning of an agreement is to be discovered from the words used, read in the context of the circumstances in which the agreement was made. While there is a presumption with commercial arrangements that parties intend to create legal relations, and that the courts should strive to give effect to the express arrangements and expectations of those engaged in business, nonetheless there can be no binding and enforceable obligation unless the terms of the bargain, or at least their essential and critical terms have been agreed upon.

Classifying and categorising the legal rights that flow from one of these comfort and support letters is very tricky. There must be some purpose to a comfort and support letter, some value that is provided by the writer of the letter. That being said, ostensibly the letter is not a full guarantee, otherwise the author of the comfort letter would have simply agreed to give a guarantee in the first place.

The difference between comfort and support letters and a guarantee lies in the terms of their enforceability. While guarantees create an independent financial obligation on the guarantor in case of any default by the parent company, this need not necessarily be the case with a comfort and support letter. International practice distinguishes between so-called ‘hard’ and ‘soft’ comfort letters on the basis of the definiteness of the undertaking.

However, soft comfort letters, whereby the issuer refrains from giving express assurances regarding its intentions, are uncommon. In general, the external auditor expects a subsidiary’s parent company to make a commitment to use its best efforts to ensure that the subsidiary performs the obligations arising from the underlying comfort and support letter.

Typical provisions found in comfort and support letters vary in their wording, but most will contain one or more of the following provisions: the parent company indicates that it is aware of its subsidiary’s loan; the parent company states that it will not reduce its shareholding or participation in the subsidiary during the currency of the loan; the parent company states that it will provide its subsidiary with the financial means to meet its obligations; the parent company states that it will do everything in its power to ensure that the subsidiary is properly managed in accordance with prudent fiscal policies so as to ensure repayment of any loan, and the parent company states that it will exercise its influence on the subsidiary to meet its obligations. The parent company states that it is its policy to ensure that the subsidiary is in a position to meet its obligations.

There are various reasons why a parent company may prefer to issue a comfort and support letter instead of a guarantee. The following are probably the principal reasons: the parent company may wish to avoid a legal obligation and merely make a policy statement or moral commitment; the parent company may not want to show its commitment as a contingent liability in its balance sheet; the parent company may wish to avoid unfavourable tax consequences; and the parent company may be concerned about its general credit standing and credit rating and consider it to be below its standard to issue a guarantee for its subsidiaries.

Comfort and support letters should be drafted very meticulously so as to reflect clearly the true intentions of the parties. A few practical hints which may be useful for the meticulous drafting of comfort letters are discussed below.

A comfort and support letter should clearly stipulate the nature of the support which a parent company intends to give to its subsidiary. A statement of the effect that a parent company will ‘fully support its subsidiary’ is vague because no indication is given as to the nature of the support. It could be of either a financial or nonfinancial nature. A comfort and support letter should clearly stipulate the extent of the support which a parent company intends to give to its subsidiary. Reliance can be placed only on obligations which clearly fall within the ambit of the comfort and support letter.

A comfort and support letter should clearly stipulate the period for which the letter is operative. A stipulation concerning the period of operation is extremely important in the case where a subsidiary goes into liquidation prior to the repayment of its debts. In this case, the comfort and support letter must be construed to determine whether it provides any cover in the case of liquidation. This contingency should always be borne in mind and the intention of the parties as to whether a comfort letter should cover liquidation or not should be clearly stated. Declarations to the effect that it is a parent company’s policy to provide full financial support to its subsidiary to ensure that the latter fulfils its obligations should be avoided.

Where the parties intend their comfort and support letter to be binding, it is always useful to indicate a period of time within which the parent company must be informed that the recipient of a letter will exercise its rights. If no express provision to this effect is inserted, a date will have to be implied.

CONCLUSION
In spite of the uncertainties surrounding the legal nature of comfort and support letters, they are used increasingly in South Africa, and only time will show the significance which South African courts will attach to these letters, the legal scope of which ranges from clearly non-committal language (often referred to as ‘cold comfort letters’) over a legally grey area to letters which come close to, or are identical with, guarantee by the parent company for the respective subsidiary’s financial standing and ability to meet at all times its financial obligations. In our opinion there are strong grounds to believe that soft comfort and support letters indicate merely a moral undertaking by the issuer, which does not create enforceable obligations.

AUTHORS
Dr Steven Firer, Forensic Practitioner and CEO of FirerForensics, and Aubrey Magerman, Attorney and Director at Abrahams Kiewitz Inc Attorneys

]]> Analysis: CIPC’s Corporate Compliance and Disclosure Regulation unit update https://www.accountancysa.org.za/analysis-cipcs-corporate-compliance-and-disclosure-regulation-unit-update/ Thu, 01 Jun 2023 06:21:10 +0000 https://www.accountancysa.org.za/?p=26057

The Companies and Intellectual Property Commission’s (CIPC) Corporate Compliance and Disclosure Regulation unit, as part of its functions per section 187(3) of the Companies Act 71 of 2008, covered various areas of enforcement during the past few months. These included qualitative reviews of annual financial statements submitted in iXBRL and proactive monitoring and enforcement of financial reporting contraventions.

ANNUAL FINANCIAL STATEMENTS REVIEW COMMITTEE (AFSRC) FINDINGS
Each quarter, the AFSRC presents its findings and consolidates them for further enforcement action and compliance monitoring. In the past three quarters of the year, the reviews revealed the following areas of non-compliance:

View graph – Areas of non-compliance

PROACTIVE ENFORCEMENT

Public companies − 18 compliances notices were issued during the outgoing financial year to public companies that had contravened the Act by not meeting their financial reporting obligations in terms of section 33. One of the companies included a JSE-listed company, albeit suspended from trading.
Onsite inspections − In pursuit of fostering better compliance by improving the culture of accountability by those charged with governance, the CIPC assigned inspectors to conduct onsite boardroom visits during February. The visits were aimed at verifying adherence to record keeping and the maintenance of accounting records in line with sections 24 and 25 of the Act as well as Regulation 23 of the Companies Regulation 2011. More onsite inspections will be conducted in the upcoming financial year.

Abridged recurring areas of non-compliance – summary

IN THE HORIZON

Taxonomy gap analysis and stakeholder consultations −Engagements with industry, software vendors, professional bodies and the public will ensue from May up to the end of August to identify any gaps between the current taxonomy and the most recent and yet-to-be-implemented IFRS standards.
Old taxonomy deprecation − With effect from 01 July 2023, the 2016 and 2019 taxonomy entry points will be deprecated. More information can be found here: Gazetted Notice No 3085.
Updated taxonomy roll-out − Per past iterations, 01 October each year marks the roll-out of an updated taxonomy to remain abreast with financial reporting standards published by the International Accounting Standards Board. This ensures that companies are always able to report in alignment with the latest financial reporting standards.

OTHER REGULATORY DEVELOPMENTS

XBRL International − Commissioner Advocate Rory Voller continues to serve as a member of the XBRL International board of directors. Attention is being given towards inter-regulator data sharing to enhance proactive regulation and unlock the value behind XBRL digital financial data.
IFRS Taxonomy Consultative Group (ITCG) − South Africa continues to be represented in the ITCG by a CIPC staff member, Mr Cuma Zwane. The IFRS Foundation will renew all ITCG members’ tenures up until the end of August 2023 to allow the formation and finalisation of the Sustainability Accounting Standards Board (SASB) Taxonomy Consultative Group with the intention of bringing the two groups together.
IRBA Public Interest Entity (PIE) Task Group − The CIPC was invited to be part of IRBA’s PIE Task Group and subsequently nominated two staff members to represent it. The staff are from the Corporate Governance Surveillance and Enforcement and Corporate Compliance and Disclosure Regulation units. The CIPC provided the required input to cover the Companies Act scope of issues pertaining to the objectives being pursued from an inter-regulator perspective.

STAKEHOLDER ENGAGEMENTS
Demand for further deliberations around the iXBRL financial reporting dynamics continues to grow, with companies and professional bodies requesting increased hand-holding and platforms to voice their challenges, seek clarity on matters of interpretation and improve their compliance. The CIPC is considering various options to engage industry more meaningfully and granularly to achieve its objectives while reducing the administrative pains of compliance.

The CIPC wishes to thank the Customer Liaison Committee (CLC) secretariat, professional bodies and their members and all participants for their valuable input and robust discussions over the past year. More effort will be exerted towards improving service delivery and the ease of doing business.

Authors
Hennie Viljoen, Senior Manager, Process Engineering, Business Intelligence and Systems Group, CIPC, and Cuma Zwane, Senior Investigator, Corporate Disclosure and Compliance Regulation, CIPC

]]> ANALYSIS: Ten Key Challenges for Assurance Engagements https://www.accountancysa.org.za/analysis-ten-key-challenges-for-assurance-engagements/ Mon, 21 May 2018 09:14:40 +0000 https://www.accountancysa.org.za/?p=10540 Ten Key Challenges for Assurance Engagements

IAASB: Feedback on discussion paper

AUTHOR │ Hayley Barker Hoogwerf, Project Director: Assurance at SAICA

After a board meeting held in December 2017, the International Auditing and Assurance Standards Board (IAASB) issued a feedback statement to inform stakeholders of the key messages received in response to their outreach activities relating to emerging forms of external reporting (EER). This article provides an overview of the feedback statement

With the view that the reporting of historical financial information alone does not provide investors, shareholders and other stakeholders with a broad picture or holistic information about the reporting entity that these users may be looking for, EER continues to evolve. Along with the increased demand for more holistic reporting came the call for action to support credibility and trust in EER reports.

The IAASB responded to these calls for action and in August 2016, they issued the discussion paper: Supporting Credibility and Trust in Emerging Forms of External Reporting: Ten Key Challenges for Assurance Engagements. The purpose of the discussion paper was to inform stakeholders of the principal findings from the initial research and outreach activities undertaken on the global developments around EER frameworks and professional services being rendered in relation to EER. The IAASB also intended using the responses received from the discussion paper in determining how to meaningfully progress this project.

In January 2018, the IAASB issued a feedback statement: Supporting Credibility and Trust in Emerging Forms of External Reporting: Ten Key Challenges for Assurance Engagements to inform stakeholders of the key messages received in response to the discussion paper and the path ahead for this project. The IAASB indicated that the sharing of this information is an important part of the process in provoking further thought and discussion around EER.

A general overview of responses received
Key messages received from respondents where there was a majority consensus included the following:

Although current demand for assurance on EER is limited, this is likely to increase as EER evolves.
The use of ISA 720 (Revised) in enhancing trust and creditability of EER when included in an entity’s annual report is not sufficient and creates an expectation gap.
Overall agreement with and additional insight into the IAASB’s understanding of (also refer to Overview of responses to specific questions below):
The four factors that enhance credibility and trust
The professional services and other external inputs provided or called for, to support the credibility of EER reports, and
The ten key challenges
The IAASB’s proposal to develop guidance in applying the existing international assurance standards rather than developing new standards, with the following key messages:
Guidance on the ten key challenges would be helpful.
The focus should be on guidance for the application of ISAE 3000 (Revised) rather than international standards for other types of engagements, although there was some support for the latter.
Caution that any guidance developed should not suppress innovation in EER and related assurance engagements.
The highest priority key challenges were the suitability of criteria; materiality; and form of the assurance report.
ISAE 3410 is not widely used and there was little support for further subject-matter specific assurance standards at this point, with some respondents indicating support for this in future.
The IAASB should continue to provide thought leadership on assurance issues and continue to coordinate its efforts with a wide range of other relevant stakeholders.

Overview of responses to specific questions
The discussion paper included nine specific questions on areas for the IAASB to consider in determining the way forward. In many instances, responses to these specific questions were covered in the general overview of responses received. A summary of the responses to the remaining questions is as follows:

Question 1: Factors that enhance credibility and trust
There was general consensus with the four key factors that enhance credibility and trust as identified in the discussion paper with additional insight provided on each of these factors, including the following:

Factor 1 – A sound reporting framework: Key attributes of a sound reporting framework include transparency, the ability to drive consistency across time and between entities, and the need for the framework to be generally accepted.
Factor 2 – Strong governance: The competence and accountability of preparers of EER reports are important to create credibility and trust, and entities should have appropriate and reliable information and IT systems.
Factor 3 – Consistent wider information: Ensuring the completeness of EER reports would also contribute towards achieving consistency between various sources of information available, enhancing the credibility of the reporting.
Factor 4 – External professional services and other reports: While regulatory involvement may increase trust in reports issued by professional services providers, practitioners’ competence, objectivity and independence are central to trust.

A possible additional factor relating to external user experience and education was identified in that there may be a need to educate users of EER reports, particularly to improve understanding of the different levels of assurance that can be obtained by external professional services and therefore reduce the expectation gap.

Question 2: Professional services that enhance credibility and trust
The discussion paper identified the following professional services covered by the IAASB’s International Standards that are most relevant to EER:

Reasonable assurance engagement
Limited assurance engagement
Agreed-upon procedures engagement, and
Compilation engagement

Other types of professional services identified by respondents were as follows:

Benchmarking, for example where a professional benchmarks one EER report against another report that is considered to be best practice for a particular business sector.
Expert opinions, which involve the evaluation of a matter, based on the expertise and experience of a professional accountant in circumstances in which the prerequisites of an assurance engagement either cannot be met or are not cost effective.
Hybrid engagements, which can comprise an agreed-upon procedures type engagement being supplemented with additional assurance procedures, and
Presentation type engagements, where the presentation engagement is mainly used to help small and medium-sized enterprises (SMEs) prepare their financial statements while providing a certain form of assurance on the latter. This engagement is specific to France.

Question 7: Ten key challenges in relation to EER assurance engagements
The ten key challenges identified in the discussion paper were as follows:

Determining the scope of an EER assurance engagement can be complex
Evaluating the suitability of criteria in a consistent manner
Addressing materiality for diverse information with little guidance in EER frameworks
Building assertions for subject-matter information of a diverse nature
Lack of maturity in governance and internal control over EER reporting processes
Obtaining assurance with respect to narrative information
Obtaining assurance with respect to future-oriented information
Exercising professional scepticism and professional judgement
Obtaining the competence necessary to perform the engagement, and
Communicating effectively in the assurance report

There was overall consensus with the IAASB’s analysis of the ten key challenges and that guidance on these challenges would be helpful.

The way forward
In line with the proposals advanced by the respondents to the discussion paper, the IAASB plans to progress this project in the following areas:

Develop non-authoritative guidance in applying the IAASB assurance standards to EER, specifically ISAE 3000 (Revised).
Continue to provide thought leadership on assurance issues in relation to EER.
Co-ordinate the work of the project with related initiatives of other relevant international organisations.

In January 2018, the IAASB issued a project proposal: Guidance on Key Challenges in Assurance Engagements over EER, , which outlines their way forward in this area. In terms of the project proposal, the IAASB intends to develop non-authoritative guidance that addresses the ten key challenges. This project will be tackled in two phases with the first phase intended to result in the issue of an exposure draft of non-authoritative guidance addressing the key challenges allocated to this phase. In March 2018, a project advisory panel consisting of 23 individuals was established to assist the IAASB in the development of this non-authoritative guidance.

Based on the timeline contained in the project proposal, the exposure draft relating to phase 1 of this project is expected to be issued in December 2018.

NOTES

http://www.ifac.org/publications-resources/discussion-paper-supporting-credibility-and-trust-emerging-forms-external

http://www.ifac.org/publications-resources/supporting-credibility-and-trust-emerging-forms-external-reporting-ten-key?Reference_ID=53134453

ISA 720 (Revised), The Auditor’s Responsibility Relating to Other Information.

ISAE 3000 (Revised), Assurance Engagements Other than Audits or Reviews of Historical Financial Information.

ISAE 3410, Assurance Engagements on Greenhouse Gas Statements.

Feedback statement, page 6.

For a description, refer to page 2 of the response from the Association of Chartered Certified Accountants (ACCA), https://www.ifac.org/publications-resources/discussion-paper-supporting-credibility-and-trust-emerging-forms-external

For a description, refer to page 4 of the response from the Institut der Wirtschaftspruefer (IDW), https://www.ifac.org/publications-resources/discussion-paper-supporting-credibility-and-trust-emerging-forms-external

For a description, refer to page 3 of the response from the Institute of Chartered Accountants of Scotland (ICAS), https://www.ifac.org/publications-resources/discussion-paper-supporting-credibility-and-trust-emerging-forms-external

For a description, refer to page 4 of the response from Compagnie Nationale des Commissaires aux Comptes and the Conseil Supérieur de I’Ordre des Experts-Comptables (CNCC-CSOEC), https://www.ifac.org/publications-resources/discussion-paper-supporting-credibility-and-trust-emerging-forms-external

http://www.ifac.org/publications-resources/iaasb-project-proposal-emerging-forms-external-reporting

]]> ANALYSIS: 6 Mythbusters on NOCLAR https://www.accountancysa.org.za/analysis-6-mythbusters-on-noclar/ Thu, 01 Feb 2018 00:00:41 +0000 https://www.accountancysa.org.za/?p=9337 The amendments to the IRBA Code of Professional Conduct for Registered Auditors (IRBA Code) relating to Non-compliance with Laws and Regulations (NOCLAR) may still be relatively new, but have you already been a victim of a myth or two?

It happens to all of us. A standard or legislative amendment is released and before you’ve had the opportunity to digest the complete text, you are pulled into a conversation in which you are asked for your opinions and an analysis of the consequences of the amendment. You present and defend your views with a few key messages from one conversation to the next, and soon you have ‘learnt’ several ‘facts’.

While corridor conversations are one of the effective ways to learn and share with colleagues and keep up to date with the ever-changing environment, occasionally these ‘learnt facts’ turn out to be myths. The recent amendments to the IRBA Code, based on the International Ethics Standards Board for Accountants (IESBA) Code of Ethics, have been no exception. This article intends to dispel a few of those myths.

Myth 1: NOCLAR is not new for South Africa

According to recent media reports, South African entities, both private and public, have been associated with non-compliance with laws and regulations. Additionally, the reporting of certain non-compliance is well embedded in South African legislation, for example the requirement in section 45 of the Auditing Profession Act 26 of 2005 (APA) regarding reportable irregularities (RI). However, the NOCLAR amendments set out some new responsibilities for registered auditors (RAs) when encountering non-compliance or suspected non-compliance.

The NOCLAR provisions set out a framework for RAs on what actions to take when they become aware of a suspected non-compliance. These include any act of omission or commission, intentional or unintentional, committed by a client, including by management, those charged with governance, or by others working for or under the direction of the client, which is contrary to prevailing laws and regulations.

While this article’s primary focus is on the RAs, professional accountants (who include chartered accountants) will have similar considerations, in response to NOCLAR, when rendering professional services or within their employing organisations. This is new for the accounting profession in South Africa.

The NOCLAR provisions share some similarities with RI responsibilities and other legislative requirements where the RA is required to report directly to a regulator. The NOCLAR provisions do envisage the possible existence of local laws that govern how the RA addresses non-compliance.

An RA is required to comply with jurisdictional laws and regulations. Additionally, an RA needs to be aware of any differences between the NOCLAR provisions and local legislative requirements, and then comply with the more stringent requirement and guidance, unless prohibited by law or regulation.

Simply dismissing the NOCLAR provisions as nothing new may lead to inadequate planning, training and documentation on the part of the RA. There could then be a risk that a NOCLAR is not responded to adequately, which would be a contravention of the IRBA Code.

Myth 2: The NOCLAR provisions considerations are only required for audit engagements

An RA’s responsibility to NOCLAR extends to all professional services, which include engagements other than the audit of financial statements.

The framework is considered under the following categories:

Audit of Financial Statements, and

Professional Services Other than Audits of Financial Statements

Each category has different approaches and considerations.

While RAs may find their experiences with the RI requirements helpful, they should be cognisant of the specific requirements and considerations under the NOCLAR provisions, as these differ from the RI requirements.

Myth 3: Reporting is always required under the NOCLAR provisions

The RI reporting requirement has allowed RAs to become familiar with a reporting framework. However, reporting is only one consideration of the NOCLAR provisions, and not the necessary default position. The NOCLAR provisions have a response framework that may include a reporting consideration.

The robust NOCLAR response framework includes the following:

Become aware of NOCLAR
Obtain an understanding of the matter
Address the matter
Communication with different individuals, for instance within the firm
Consideration whether further action is required in the public interest after management’s response to the NOCLAR. This includes:
Disclosing the matter to an appropriate authority even when there is no legal or regulatory requirement to do so, and/or
Withdrawing from the engagement and the professional relationship, where permitted by law or regulation
Documentation, including all considerations

There are circumstances when the RA will make disclosure to the appropriate authority immediately. But this is only in exceptional circumstances, when the RA becomes aware of actual or intended conduct, that the RA has reason to believe would constitute an imminent breach of a law or regulation that would cause substantial harm to investors, creditors, employees or the general public.

Myth 4: Reporting a reportable irregularity negates the NOCLAR provisions

The RA must firstly comply with local law or regulation, which in this instance is the APA. However, Section 225 of the IRBA Code contains other provisions that would still apply, if not already required or prohibited by law or regulation.

Examples of the NOCLAR response framework that may still need to be complied with are:

Provisions addressing the escalation of the matter within the entity
In the case of an audit of group financial statements, communication with the relevant RA involved in the group audit
Advising management or those charged with governance to take appropriate action, if they haven’t already done so, to rectify, remediate or mitigate the consequences of the non-compliance; to deter the commission of the non-compliance, where it has not yet occurred; or to disclose the matter to an appropriate authority, where required by law or regulation or where considered necessary in the public interest, and

Determination of the need for further action (including withdrawal from the client relationship) in appropriate circumstances

Complying with section 45 of the APA, and its specific timelines, may result in the RA partially discharging some obligations that are required by the NOCLAR provisions. This will not need to be repeated, but the RA will be required to document their consideration of both the RI and the NOCLAR provisions.

Though an RA may have reported an RI to the IRBA, the RA must still respond to NOCLAR or suspected NOCLAR, including the consideration of reporting the NOCLAR or suspected NOCLAR to an appropriate authority. Also, it is possible that an RA may report an RI to the IRBA and determine that additional disclosure of the matter to an appropriate authority is an appropriate course of action.

Myth 5: NOCLAR will lead to a loss of client trust

The NOCLAR provisions should not change the RA’s relationship with clients or the outlook on the engagement. The RA does not approach an engagement looking for potential NOCLAR, but rather considers his obligations when he/she encounters a NOCLAR or suspected NOCLAR.

An RA is always expected to use professional judgement while performing all professional services and professional scepticism in assurance engagements. Thus, the RA’s outlook should not change, and the relationship of trust should not be drastically altered.

Additionally, while the NOCLAR provisions may allow for the RA to report directly to an appropriate authority, this is usually within a framework that includes sufficient consultation with the client. This, however, does not necessarily put the client and the RA at odds with each other.

Communication with a client on the NOCLAR provisions is vital. Investing in sharing information and conversations on the NOCLAR provisions will help facilitate the process of responding to a NOCLAR or suspected NOCLAR, if required to in the future.

Myth 6: The NOCLAR provisions are burdensome and involves more work, time and costs for the RA

The default answer is the NOCLAR provisions are not necessarily burdensome as not every engagement will include a consideration of the NOCLAR response framework.

Yes, additional documentation, training, and more time may be required, but this is not unlike any other new requirements in standards or legislation.

In producing the NOCLAR amendments, the IESBA and IRBA were responding to a need for guidance on what actions an RA should take in the public interest when they become aware of a NOCLAR or suspected NOCLAR. The success of this initiative will be dependent on the positive contribution of all parties and the proper application of the framework. All parties will agree that there is no myth in that.

RAs and others are encouraged to refer to additional guidance that has been released on this subject, and this includes the IRBA Frequently Asked Questions on NOCLAR available on the IRBA website link below.

https://www.irba.co.za/guidance-for-ras/technical-guidance-for-ras/ethics:-the-rules-and-the-code/noclar

AUTHOR l Saadiya Adam CA(SA) is Professional Manager: Ethics, Independent Regulatory Board for Auditors (IRBA)

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