If a provision of legislation is interpreted and applied correctly but the results have unintended consequences that obscure the overall intent of the legislative provision … is the legislation achieving the desired result?
A topic that is regularly debated among professionals in both the public and private sector space is whether regulations, when interpreted and applied, yield the desired result, or whether in certain instances they impede the overall intent of the legislation. This brings us to today’s topic: material misstatements identified during the audit – what is the cost of compliance?
If we consider the responsibility placed upon management − accounting officers and the like − concerning the preparation of financial statements, the legislation requires that annual financial statements be ‘prepared’ to ‘fairly represent’ the financial affairs of the relevant institution. Looking specifically at sections 40 and 55 of the Public Finance Management Act, as well as section 122 of the Municipal Finance Management Act, it is clear that the preparation function has been designated to management. However, how ‘prepare’ is currently interpreted requires a level of discourse.
If we consider the word ‘prepare’, does management prepare financial statements for an audit? Or does it prepare financial statements for publishing to the end-user, the general public? The interpretation as it stands appears to align with the former, which admittedly is a part of an institution’s preparation process, but is this interpretation correct given the position of the Auditor-General (AG) in the preparation process?
To reiterate, the question is whether the current interpretation of the relevant legislative provisions is correct and, if so, whether there is potentially a need for amendment.
At this stage, I need to stipulate that this article is in no way questioning the audit methodology employed by the AG. The question posed is mutually exclusive as it concerns whether the legislation is being correctly interpreted for the AG’s purposes … and if so, whether there may be a need for National Treasury to consider the relevance of the legislative provision given the unintended consequences that appear to be occurring in relation to material misstatements identified during the audit.
The situation at hand concerns a fear that has been instilled within every government institution within the country. In the public sector (and I write this statement with trepidation), the reputation of an institution hinges on an audit opinion rather than the quality of service delivery, and the inherent fear of non-compliance has now become a far greater concern than implementing the planned service delivery. It has now reached the point where, during the audit, government institutions routinely appoint consultants for financial reporting purposes. With an already constrained fiscus, government institutions opt to pay exorbitant consultancy fees to avoid the reputational risk associated with a poor audit outcome, specifically the non-compliance finding.
Consider the implication of this … Institutions are now wary of the audit, which inadvertently detracts from the true essence of it. This, coupled with reactive solutions and the incorrect positioning of consultants, places government institutions in a precarious position. No matter the audit, there would be significant push-back and differences of opinion throughout the audit process, not because of technical aspects but rather to avoid a non-compliance finding − officials may put forward positions that are perhaps not entirely correct just to avoid non-compliance. I then ask: can fair presentation be negated due to fear of a non-compliance finding?
If we look at the number of prior period errors posted by institutions that have not received a material misstatement finding, one may very well ask − given the fear that is so clearly evident − whether where an institution in a current year is adjusting prior period errors to figures that were previously ‘fairly represented’, did management become aware of the need to adjust in the current year, or did they hold back in the prior year for fear of a non-compliance finding? In the event of the latter, is the current legislative interpretation aiding the intended fair representation?
Casting back to the legislation, would a non-compliance finding not be warranted where an institution is unable to adjust during an audit when a qualification in audit opinion is attained?
Before we analyse this question, let us consider our private sector counterparts who are allowed to adjust. Ultimately, they are not subject to the legislative parameters that are in place in the public sector. This fact is widely accepted given the need to hold government to higher accountability standards.
If we look at the intent of the audit in conjunction with the average maturity of government institutions, the conclusion is that should government institutions be afforded this opportunity to adjust, it would place an undue burden on the office of the Auditor-General. The audit would become a mechanism to correct and prepare the financial statements.
So back to our question − it can be inferred that the current interpretation of the legislation implies that an institution cannot adjust. However, if it is clarified that the financial statements are ‘prepared’ for users and not for the audit, would the AG not have the right to issue a non-compliance in the case of a qualified audit opinion? Ultimately, at this stage, where non-compliance is evaluated in the preparation process is questionable.
Turning to the matter of relevance …
First, even if the interpretation of the legislation is correct, with the unintended consequences being deemed not to obscure the legislative intention, should National Treasury not reconsider the relevance of the current legislation and its application? If we look at the funds expended on reactive solutions, with consultants continuously positioned at a point where sustainable reform is rendered futile, is legislation achieving its purpose? If we consider the intention of the non-compliance finding, is it not to drive credibility and reliability in reporting? Yet, if we cast back to the question raised in relation to the number of prior period errors posted in a current year − has fair presentation been achieved?
Second, can we consider such legislation to be relevant to a developmental state? Why has such legislation remained static? And can we consider it to remain aligned to the national imperative?
To provide a simple example, let us consider the professionalisation of the public service as mandated by the National Development Plan 2030. Currently, government’s workforce is struggling. Apart from potentially not resulting in fair presentation, the fear of the non-compliance finding would inevitably impede officials’ ability to learn. How then do we drive professionalisation when rather than engaging in dialogue with the AG on how to resolve matters, a fight is continuously fuelled, exacerbated by an increasingly burdened fiscus? Our current reality sees audit costs increasingly on the rise due to technical consultations and the use of consultants, while a sustainable solution is seldom achieved due to the reactive nature of their appointment. Is this the intention of the legislation and is this relevant?
To conclude, I wish to reiterate that the position advanced in this article is not to question the audit methodology and related practices employed by the Office of the Auditor-General. The intention is to create discourse around whether the legislation is correctly interpreted and, if so, whether we consider it relevant to a developmental state that is desperately seeking the professionalisation of the public service. So, I ask you, what is the cost of compliance?
Garth Pretorius CA(SA), RA, Founder and Principal Owner of GPA Consulting