Focus: Change who pays the fiddler and calls the tune

The Independent Regulatory Board for Auditors (IRBA) plays the ‘professional’ role in regulating auditor independence through their professional standards and codes of ethics. This is what I term ‘professional’ regulatory oversight. This public policy forms the auditors’ ‘self-regulation’ of their behaviour. For example, before accepting an appointment as an auditor, it is incumbent on the auditor to ensure that they are independent in mind and appearance.

The provisions in the Companies Act that govern auditor independence place the duty on the directors (not any directors but the independent directors) to ensure that the auditor is independent before the auditor’s appointment. For example, section 90 of the Companies Act places the responsibility upon the directors not to appoint an auditor who is not independent of the company. Section 94 of the Companies Act places this responsibility on the independent directors of the audit committee.

The auditor independence provisions in the Companies Act provide insight and deliver the ‘clues’ as to who should be paying the fiddler. The first clue is found in section 94(7)(b) of the Companies Act where the provisions state that an audit committee must ‘determine the fees to be paid to the auditor and the auditor’s terms of engagement’. This task is split into two: the audit fee and the auditor’s terms of engagement − two tasks that seem contrary to current practice and auditing standards.

In my experience, the audit fee has always been the result of discussions between the ‘financial director’ and the auditor. This is how the idea is formed that the payer is the company itself. In my experience, I have only seen either the ‘managing or financial’ director sign the auditor’s engagement letter. This adds to the belief that the payer is the company itself. However, this is contrary to section 94(7)(b) of the Companies Act. Why would the Companies Act contain such a provision? Well, it’s to tell us who really and in terms of the law should be responsible for the auditor’s independence; to ensure that auditors are protected from themselves.

IRBA unfortunately can only determine whether an auditor was independent post the auditor signing the audit report and by that time, the damage is done. Professional oversight is after the fact, while Companies Act oversight is before the fact.
With regard to the audit committee determining the auditors’ terms of engagement, one cannot interpret this as the audit committee telling the auditor what to do, as it is self-explanatory as to why this cannot happen. So, what is the Companies Act trying to tell the audit committee?

I submit determination of the audit fee cannot be divorced from the auditors’ terms of engagement. Why? Well, the audit committee must ensure that the audit fee charged by the auditor is not set at a level that could lead to audit quality being compromised. In determining the audit fee, the auditor must explain to the audit committee their audit strategy, what are the audit risks and how the auditor is going to mitigate those risks. The audit fee is a crucial determinant of audit quality, and so is the auditors’ terms of engagement.

In determining the sufficiency of the audit fee, the audit committee must ask questions of the auditor such as what level of resources will the auditor devote to the audit, does the auditor demonstrate a sufficient understanding of the business, operations, and risk areas relevant to the financial report, and do they plan to respond appropriately to assessed risks. This includes relevant industry expertise and valuation expertise appropriate for the types of assets, liabilities and exposures of the company. Will the senior audit team members, and particularly the engagement partner, be sufficiently involved in the audit? Are the firm’s arrangements for supervising and reviewing the audit, and internal firm quality reviews and controls, adequate? Will the auditor review and rely on systems and controls in performing the audit, particularly where there are large numbers of systematically processed transactions? How is the auditor addressing any general overall findings reported publicly by the IRBA − from audit firm inspections or from the firm’s own internal quality reviews?

The question arises as to whether the audit committee has the right to ask these questions, as the auditor cannot be told what to do. The audit committee has no right to tell the auditor what to do but the audit committee has a right to recommend the immediate removal of the auditor by the directors if they do not receive satisfactory and plausible answers to the questions. Such a sentiment is supported by the King IV Code of Corporate Governance which suggests that the audit committee should monitor audit quality. Reduced audit fees will clearly impact audit quality.

The audit committee is an independent statutory committee made up of whatsoever in the day-to-day running of the company. Hence the audit fee is the sole responsibility of the independent directors on the audit committee and no one else, not even management.

The audit committee in playing its role in determining the audit fee and monitoring audit quality must do so on its own and without interference from management. By law, the audit fee in South Africa is a matter between the audit committee and the auditor.
So, he who pays the fiddler calls the tune: the new payer is the audit committee − a specially designed independent body that is not involved in the day-to-day management of the company. It is they who should pay the audit fee; this is the diktats of public policy. The law is straightforward in respect of public interest entities; it is the audit committee that appoints and pays the auditor and monitors the auditor’s approach to the audit; all in the name of ‘audit quality’. These rules are not being complied with and the auditor’s quality is suffering as a result. The IRBA have no control over audit quality before the audit starts, but the audit committee does.

Author
Dr Steven Firer is the CEO of Steven Firer & Associates, a leading independent niche forensic accounting and litigation support specialist firm